Could Volk­swa­gen save Europe?

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Volk­swa­gen’s stock price has re­bounded more than 20% since its early Oc­to­ber low, but there re­mains un­cer­tainty about the firm’s fu­ture. Since news of the diesel pol­lut­ing scan­dal broke, $30 bln has been wiped off VW’s mar­ket value, and you do not need to be con­spir­a­to­rial to see a sce­nario that has the value of the Ger­man car­maker’s eq­uity go­ing to zero.

The broader ques­tions re­main very much in play: how will the Ger­man econ­omy re­act to the VW shock and will Europe’s en­tire diesel au­to­mo­bile mar­ket be hit? It is not hard to con­struct down­side risk sce­nar­ios, but what is less ap­pre­ci­ated is the “up­side risk” in the event that VW’s prob­lems turn into a ma­jor eco­nomic event.

The more the VW cri­sis deep­ens and spreads, it be­comes likely that a ma­jor po­lit­i­cal re­ac­tion will emerge, pos­si­bly in the form of a huge car-scrap­ping scheme fi­nanced by Ber­lin. Cer­tainly, it is be­com­ing clear that the events of 2015 — in par­tic­u­lar the VW scan­dal and the mi­grant cri­sis — will likely mark the zenith of Ger­many’s sav­ings frenzy, and the start of a more growth-friendly and euro-com­pat­i­ble eco­nomic pol­icy. This has to be good news.

Even with the VW share price hav­ing fallen -50% (peak-totrough) since the scan­dal broke, things can ob­vi­ously get much worse. With “cheat­ware” em­bed­ded in 11 mln cars, re­place­ment costs and po­ten­tial fines could reach EUR 100 bln glob­ally — al­most twice VW’s cur­rent mar­ket value and five times its cash flow. As with Gen­eral Mo­tors and Chrysler in 2009, VW may get bailed out by both its re­gional and fed­eral gov­ern­ments. With VW ac­count­ing for about 10% of Ger­man ex­ports and given the brand rep­u­ta­tion of “Das Auto”, the fall­out could easily ex­ceed the ef­fect of China trade slow­ing. We will get a clearer idea of the im­pact on busi­ness sen­ti­ment with up­com­ing sur­veys (ZEW comes out Tues­day, PMI on Oc­to­ber 23, IFO Oc­to­ber 26).

So, how does such a neg­a­tive sce­nario gen­er­ate up­side? The worst case sce­nario for VW im­plies some kind of “re­pay­ment” to VW own­ers at mar­ket-value, which would pro­duce the largest ever car-scrap­ping scheme. What’s more, it would ul­ti­mately be fi­nanced by the Ger­man gov­ern­ment! For Ber­lin, EUR 100 bln would amount to just five months of Ger­many’s cur­rent ac­count sur­plus. Yet as­sum­ing that each car owner was rec­om­pensed at an av­er­age EUR 10,000, the Ger­man fis­cal trans­fer would rep­re­sent about 1.2% of GDP in Bel­gium, 1% in Aus­tria, 0.5-0.6% in Spain, Por­tu­gal and Swe­den and 0.4% in Italy, France and the UK.

And this does not ac­count for the large-scale clas­s­ac­tion suits that Ger­many’s Euro­pean neigh­bours would be well ad­vised to en­cour­age. More­over, Ger­man do­mes­tic de­mand would also get a boost as 2.8 mln VW cars would have to be re­placed in the do­mes­tic mar­ket, rep­re­sent­ing at least EUR 28 bln, or 0.8% of GDP.

Such a huge car-scrap­ping scheme could in fact grow even larger if Europe’s whole diesel mar­ket — rep­re­sent­ing 50% of car regis­tra­tions — is called into ques­tion as a re­sult of a less hazy pic­ture emerg­ing on Europe’s ac­tual pol­lu­tion sit­u­a­tion. It is en­tirely plau­si­ble that EU gov­ern­ments make a ma­jor move to favour other tech­nolo­gies and fi­nance an ac­cel­er­ated switch from diesel, to hy­brid and elec­tric cars.

Con­versely, it is, of course, en­tirely pos­si­ble that the costs in­volved for VW are lower as EU gov­ern­ments choose to pro­tect VW and more broadly the diesel lobby through a patch-up so­lu­tion. In any case, the pres­sure on Ger­many to spend its huge sav­ings will not abate. The In­ter­na­tional Mon­e­tary Fund pre­dicts that Ger­many will record a cur­rent ac­count sur­plus of 8.5% of GDP this year, a sig­nif­i­cant fis­cal sur­plus, and a public debt ra­tio that is 40% less than that of the rest of the eu­ro­zone, the US and UK.

This is an aber­ra­tion that can­not last. In this re­spect, 2015 has al­ready seen two de­vel­op­ments that point to a re­ver­sal — the in­tro­duc­tion of a na­tional min­i­mum wage in Jan­uary, and the re­cent de­ci­sion to fi­nance the en­try of mil­lions of mi­grants, which is lead­ing Ger­many to pro­duce the first sig­nif­i­cant ag­gre­gate fis­cal stim­u­lus of a G7 coun­try since 2010. The Volk­swa­gen cri­sis might well rep­re­sent a third sig­nif­i­cant his­tor­i­cal “ac­ci­dent” of the same vein in less than a year. Europe should re­joice.

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