Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / German Export Machine Runs on China Risk
Transcript
- Lucas: German exports hit a record one point nine trillion dollars last year. But here's the number that keeps me up at night — almost eight percent of that still goes to China. Luna: Eight percent doesn't sound huge, but for a country that sells machinery and cars, China was the single biggest customer for years. Lucas: Exactly. And that share is actually down from almost ten percent in 2022. So the question is — is this a strategic rebalancing or just cyclical? China's economy slowed, demand softened, but German companies also started building factories in Eastern Europe and Mexico. Luna: Right — the 'China plus one' playbook. But is it actually working? I saw a report from the Kiel Institute saying the value of German exports to China still grew in absolute terms last year, even if the share dropped. Lucas: That's the nuance. The pie got bigger, and China's slice still grew, just slower than the rest. So the diversification is real, but it's not a decoupling. Take Volkswagen — they sell about 35 percent of their cars in China. They can't just walk away. What they're doing is building more battery plants in Europe and North America to hedge. Luna: And Siemens — I think their China revenue is around 13 percent of total. They're opening a digital factory in Singapore to serve Southeast Asia instead. Lucas: Right. So the machinery sector is the one to watch. Germany's machine tool industry exports about 15 percent to China. That's down from 20 percent a decade ago. But here's the twist — Chinese companies are now buying fewer German machines because they're making their own. So the pressure isn't just geopolitical, it's competitive. Luna: That's the real risk. If Chinese machine tool quality keeps improving, Germany loses a moat it's had for fifty years. Lucas: Precisely. And that's why the euro weakness helps a bit. The euro has slipped to one point sixteen against the dollar. That makes German exports cheaper outside the eurozone, which cushions the blow. But it also makes imports of raw materials more expensive, so it's not a free lunch. Luna: I'm looking at the VGK — that's the Vanguard FTSE Europe ETF — up 3.5 percent in the last five days. So the market seems to be pricing in resilience. But is that just a dollar-weakness story or actual confidence in European earnings? Lucas: Probably a bit of both. The dollar has strengthened overall — the trade-weighted index hit 119.3 — but the euro is still cheap relative to purchasing power parity. So exports get a tailwind. Meanwhile, German industrial orders have been volatile. They rose in March, but the trend is flat. So the market is betting on a recovery that hasn't really shown up in the hard data yet. Luna: That feels precarious. If the Fed has to hike again in July — and some bond-market commentators are calling for it — the dollar could strengthen further, undoing that export benefit. Lucas: Exactly. Kevin Warsh is being sworn in as Fed chair on Friday. He's seen as hawkish. If he signals higher rates, the dollar rallies, the euro drops further, and suddenly European companies face imported inflation while their export advantage gets competed away over time. It's a delicate balance. Luna: So the rebalancing story is real, but fragile. Let's talk about where that 'plus one' is going. Eastern Europe — Poland, Romania, Czechia — they're picking up a lot of the supply chain work that used to be in China. Lucas: Yeah. Volkswagen just announced a new battery plant in Hungary. BMW is building an EV factory in Debrecen. And it's not just cars — mechanical engineering firms are setting up components plants in Romania. Labor costs are higher than China, but proximity to the German customer base and lower logistics risk make up for it. Luna: And political risk? Poland and Hungary have had their spats with the EU over rule of law. Does that factor in? Lucas: It does, but so far it hasn't been a deal-breaker. The EU has released recovery funds to Poland recently, so the tensions are easing. And companies are looking at it pragmatically — they'd rather deal with Brussels bureaucracy than Beijing's strategic directives. Luna: Makes sense. So where does the ECB fit into this? They've been holding rates steady, but if the euro weakens too much, they might have to worry about imported inflation again. Lucas: That's the balancing act. The ECB wants to support growth — the eurozone economy is barely growing, real GDP growth annualised is only 2 percent in the US, and Europe is probably slower. But if the euro falls much below 1.10 against the dollar, energy imports get more expensive, and that feeds through to consumer prices. For now, they're in wait and see mode. Luna: Before we move on — a quick note. If today's episode was useful to you and you want to keep it ad-free, buy me a coffee dot com slash fexingo helps. It's a small thing that makes a big difference for us. Lucas: Yeah, genuinely. We don't run ads — that's a deliberate choice, and listener support is what keeps it going. So thank you to everyone who's chipped in. Luna: Okay — back to the rebalancing. One thing I've been watching is the services sector. German exports are mostly goods, but the future of trade is services — software, engineering consulting, financial services. Does Germany have a services export story? Lucas: It's growing, but from a small base. Germany runs a services trade deficit, meaning it imports more services than it exports. But within that, business services — things like R&D, design, and licensing — are growing. SAP is a good example: they sell enterprise software globally. But they're the exception. Luna: So the real action is still in hardware. Machinery, cars, chemicals. And that hardware is increasingly made with components from Eastern Europe rather than China. But the final assembly still happens in Germany. Lucas: Right. And that's where the value-added stays. The German economy captured about 45 percent of the value in its exports, which is high. Compare that to a country like Vietnam, where it's more like 20 percent. So even if supply chains shift, the core intellectual property and high-value manufacturing remain in Germany. Luna: That's the moat. But it only holds if Germany keeps investing in R&D and automation. And there's been some hand-wringing about the German 'innovation gap' — not enough digitalization, slow adoption of AI. Lucas: It's a real concern. The German government has pledged to spend 2 percent of GDP on R&D, but they're not quite there. And corporate R&D spending has been flat as a share of revenue. Meanwhile, China is pouring money into basic research and AI. So the competitive pressure isn't just about cost — it's about capabilities. Luna: So the narrative that Germany is successfully decoupling from China is too simplistic. They're managing exposure, but not eliminating it. And the real race is in innovation, not just supply chain geography. Lucas: Exactly. And the market is rewarding that nuance. The VGK is up, but it's not a straight line. Investors are differentiating between companies that are genuinely globalizing their R&D and those that are just moving assembly lines. Volkswagen's stock has underperformed Siemens this year — precisely because Siemens has a stronger services and software story. Luna: Good point. So the winning strategy is: de-risk supply chains, but also upgrade the value proposition. Not just 'make it elsewhere,' but 'make it smarter.' Lucas: That's the takeaway for me. Germany isn't going to stop exporting to China. But it is going to export different things — fewer commoditized machines, more high-end automation tools and specialized vehicles. And that shift, if it works, will protect the export machine for another decade. Luna: We'll be watching the trade data closely. Thanks, Lucas.