German crisis heralds wider decline

Analysts bluntly described the latest growth figures from Germany as shocking. In a nasty surprise for economists, gross domestic product in the world's third most important economy shrank 0.2% in the first three months of this year.

Following from a slight decline in the fourth quarter, this means Germany is in recession, technically defined as two consecutive quarters of negative growth. This is not only bad news for Germany, but for the world economy as a whole.

A big question mark already hangs over the strength of the US recovery, which yesterday's weak retail sales figures did nothing to dispel. As the world's biggest engine for growth fails to gather momentum, it becomes all the more imperative for Europe to pick up the slack. But the 12-member eurozone is falling down badly on the job.

It is not just Germany. Figures today from Italy and the Netherlands also showed those economies shrinking in the first quarter. Charles Bean, a Bank of England official, today said he was puzzled at the eurozone's sluggishness. He was being polite.

The European Central Bank must shoulder a lot of the blame for the eurozone's feeble economic performance. The ECB has fallen behind the curve by not cutting interest rates more aggressively. Earlier this month, the Bank left interest rates at 2.5%, missing yet another chance to jolt faltering eurozone economies into life.

No wonder Gordon Brown, the chancellor, is in no hurry to hand over control of the UK's monetary policy to Wim Duisenberg, the ECB president. As long as the eurozone suffers the double whammy of tight monetary policy at the hands of the ECB and the EU's notorious stability and growth pact, Tony Blair will find it difficult to persuade the British public to ditch the pound in favour of the euro.

Meanwhile, the rise of the euro does no favours for the eurozone countries. The stronger the euro, the more difficult for the eurozone to flog exports - a source of growth. The weak euro was once a source of embarrassment for European officials, but they now belatedly realise its benefits.

The euro has been gaining at the expense of the dollar as US officials have made it pretty clear that they favour a weaker greenback to boost exports and inject some growth into their own anaemic economy. Some commentators have suggested that the Bush administration, fed up at Europe's inability to provide any impetus to world growth, is resorting to a weak dollar policy to boost the US economy.

The trouble with that kind of approach is that countries can end up competing to have the lowest currencies, a situation economists call competitive currency devaluation.

But it is hardly a recipe for international financial instability. In early 1997, people worried about such a scenario in the Asian financial crisis. Now economists fret about a similar scenario among the major economies. As an economist at Deutsche Bank put it: "It all adds up to stress and instability."