Despite weakening economic growth and industrial production in recent months, Germany continues to look much better than the rest of Europe on the surface. It boasts a very low unemployment rate (although uber low-wage work has grown tremondously) and relatively small public deficits. However, none of that is stopping Merkel and her administration from betting their re-election on the fact that they can implement significant austerity in the next 2 years, while also containing the Euro crisis, and "lead by example". Sven Böll, Peter Müller and Christian Reiermann report for Der Spiegel:

Leading by Example: Merkel Bets Austerity Will Result in Re-Election

 

Just how healthy German finances are was revealed at the beginning of last week, in the form of an early-warning report by the European Commission. Germany was the only large country to be given an almost perfect grade.

 

And yet, if Merkel and Schäuble have their way, the country many in Europe already see as a model of sound budget management will become even more exemplary. "We cannot expect Greece and the other crisis-stricken countries to accept more and more austerity measures, while nothing changes in Germany," says a close associate of the chancellor.

 

As such, Merkel and Schäuble want to significantly ratchet up consolidation efforts. The 2013 budget, currently being prepared at the Finance Ministry, will include many billions in savings. In addition, the last stage of the so-called debt brake -- Germany's constitutionally anchored law regulating state borrowing -- will be brought forward by two years instead of going into effect as planned in 2016. Measures under discussion include cuts in social benefits and a reduction in government services. Merkel and Schäuble believe that Germany can only remain credible in the euro crisis by demonstrating that it is not simply reaping the benefits of past efforts. Germany wants to lead by example.

In other words, the German populace is about to find out just how destructive austerity can be to an economy when the world is in the midst of an ongoing Depression, in a system that values credit creation above all else. Of course, the most immediate threat to the Germany economy is financial contagion when (again, not if) Greece exits the Eurozone, which will certainly be within 0-2 years. Merkel is also betting that this will now be contained, primarily due to the ECB's LTRO programs (the second one to occur in a week). If you ask me, that's a lot of losing bets she's placing on the table. Back to the austerity:

It's an ambitious goal. To achieve it, the coalition will have to adhere to strict austerity rules in the current year's budget, but especially when assembling the budget for 2013. According to CDU deputy floor leader Michael Meister, new borrowing will remain at €26.1 billion this year, even though the first installments of at least €8.6 billion for the new euro bailout fund, the European Stability Mechanism (ESM), will come due in the summer. Meister intends to achieve this goal primarily through "smart budget management." In other words, each of the 5,500 items in the budget will be closely examined and will be granted only as much as absolutely necessary.

 

In addition, tax revenues last autumn were significantly higher than forecast. And Germany has also saved billions on sovereign bond interest rates, with returns at record lows due to the ongoing euro crisis.

 

The challenges will be greater next year. In 2013, the finance minister hopes to reduce new borrowing to €15 billion. But because the planned financial transaction tax cannot be implemented throughout Europe, and a number of additional expenses will be incurred, Schäuble will have to find some €10 billion in order to hit his target.

 

That is the primary motivation for assembling a new austerity package. Finance Ministry officials already have a clear idea of what it should look like. In particular, they have set their sights on the social benefits coffers, which, thanks to a strong economy, are currently well funded. Federal healthcare subsidies are to be reduced by up to €2 billion and the government's contribution to the pension insurance system is to be trimmed by a similar amount. Both cuts are to be lasting.

 

Schäuble also intends to cut the budget of the Federal Employment Agency by several hundred million euros and to cap outlays for the parental leave allowance program, expenditures for which have risen substantially in recent years.

As explained in Employment = Poverty and Inequality, the German populace is not in a great position to absorb these cuts to social spending that amount to almost a 40% reduction in new borrowing by next year, and 100% in the next two. Many of them are performing part-time, low-wage work that has greatly exacerbated wealth inequality within the population. As the German export industry is squeezed from the revenue side of the equation due to extremely low demand in Europe and the world, it will be forced to lay off workers and cut wages further, placing even more people into relative poverty.

POPULATION BELOW POVERTY LINE (%)

Assuming that everything is contained within the Euro crisis, and Greece either stays in without further German money or exits peacefully (fat chance!), these "exemplary" and ambitious austerity plans will simply place more downward pressure on German aggregate domestic demand, economic growth and tax revenues, making its deficit situation worse over time. That is especially true if Merkel sticks with the Euro experiment and is forced to pony up ever-growing sums of bailout money and Germany's sovereign borrowing costs correspondingly rise. So Merkel may be leading Germany and Europe by example, but she's leading them straight into the depths of economic depression and sociopolitical chaos.