Could Volkswagen save Europe?
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.