** Troubling Signs out of Germany and Saudi Arabia

By Kamran Bokhari 

Aug. 2, 2016 

A daily explanation of what matters and what doesn't in the world of geopolitics. 

Deutsche Bank and the Saudi central bank released unnerving statements yesterday. 

The global exporters’ crisis is intensifying. Germany’s largest bank has expressed deep concerns about “secular stagnation” in the United States. Separately, Saudi Arabia’s central bank has injected $4 billion into the kingdom’s banking sector in an effort to deal with liquidity issues. Both developments have implications for their respective regions, which are already in turmoil, as well as for the world.

In early 2016, we highlighted the 10 nations that had been hit hard by decreasing global demand for exports and identified those next in line. Following China and Russia, Saudi Arabia was third on the list of countries that were already reeling from the slowdown. Germany topped the list of the five we identified as most vulnerable. The statements out of Berlin and Riyadh yesterday suggest the situation is going from bad to worse.

Germany’s largest bank, Deutsche Bank, is already in deep financial distress. The United States, which is due for a cyclical recession, could be affected by the banking crisis spreading through the European Continent. These two dynamics have come together in the form of a research note issued by Deutsche Bank, which warned the U.S. Federal Reserve that an interest rate hike in September would be a “big policy error.” It is not normal for a bank like Deutsche Bank to insert itself so blatantly into a conversation about U.S. economic policy. So why is the biggest German financial institution worried about a potential recession in the United States when it has plenty of other things to worry about?

The answer is because the United States is the largest destination for German exports, which account for almost half of the country’s GDP. Trouble in the U.S. economy would have a devastating impact on Germany’s economy. Even as the German economy has suffered with declining demand from China and Europe it has been able to weather the storm because of continued demand from the U.S. and the U.K. Beneath the calm tone of the advisory note is a certain level of fear and panic. It's a confirmation of our view that Germany would suffer from any potential hiccups in the U.S. economy.

The sense of German panic is understandable. A decline in exports could create extremely uncomfortable social conditions and political instability in the country. But this isn’t just a German issue; it has enormous wider implications for Europe. Berlin has already been stretched thin trying to deal with a disintegrating EU, especially in the aftermath of Brexit. A financially battered Germany will greatly add to the commotion in Europe.

Another struggling exporter now grappling for ways to reduce economic risks is Saudi Arabia. We have been saying for a while that the plunge in crude prices could weaken the Saudi kingdom, which is one of the four main players in the Middle East and the only remaining Arab power. This is why, at a time when the Saudis have been forced to rely on their reserves, their move to support domestic banks raises eyebrows.

On Aug. 1, Bloomberg, citing five unnamed sources familiar with the issue, reported that the Saudi Arabian Monetary Agency (SAMA), the country’s central bank, has offered to provide an unspecified number of banks in the kingdom with $4 billion in loans for one year. The move is being explained as a means of boosting short-term liquidity and supporting the banks’ ability to lend. The kingdom’s banks have been facing a financial crunch because of government deposit withdrawals and sale of local currency debt to fund the budget deficit. Earlier, in an effort to try to ease liquidity pressures, SAMA permitted banks to lend up to 90 percent of their deposits (an increase from the previous ceiling of 85 percent).

The Saudi financial situation is highly opaque – in large part due to the fact that the kingdom goes to great lengths to keep it that way. This is why the Bloomberg report is odd. If the Saudis wanted to conceal that they were loaning money to their banks, this information would not have seen the light of day. But it has and therefore it appears to be a deliberate leak.

It is also odd because in this context $4 billion is a small amount, which adds to the opacity of the Saudi financial situation. We know that the Saudi economy has been under strain. We also know that often the first indicator of a serious economic crisis comes from the banking sector, and that oil (after a brief rally above $50 per barrel) dipped below $40 at one point yesterday. But if there were a liquidity problem brewing, $4 billion would be insignificant.

Saudi Arabia is one of the world's richest export-dependent countries. Proceeds from oil exports account for 90 percent of the government’s revenues and low prices have forced the kingdom to run deficits. Their economy is under stress, and the Bloomberg report could either be a harbinger of trouble or indicate a balancing act.

Germany is the largest economy in Europe and the U.S. is its market of last resort. Saudi Arabia is the second largest economy in the Middle East and must continue bleeding money to maintain domestic stability and keep the chaos around it at bay. Therefore, we are studying both of these reports carefully. 

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