The eurozone is banking on a weak euro and strong global growth to boost exports and inflation and offset the weakness of domestic demand. How likely is this? China might yet avoid a recession, but there is no doubt that it is set for a period of much slower growth. At the same time, pretty much every emerging market is weakening, partly because of their dependence on China, and partly because of sluggish productivity growth. The US Federal Reserve's decision not to increase official interest rates is welcome: a rise would have prompted further capital outflows from emerging markets. But there is no doubt that the global economy is labouring, and that this poses a threat to the eurozone's anaemic recovery.
The eurozone ran a trade surplus of €125 billion over the first six months of 2015. Over the same period of 2011, it had a deficit of €17 billion. Over the last four years, exports have risen 18 per cent; imports just 2 per cent. The data for net exports (exports minus imports), which measures the impact of foreign trade on economic growth, is striking. Between the first half of 2011 and the first half of 2015, the eurozone economy expanded by 1 per cent. Without rising net exports, it would have shrunk by 1.3 per cent. In short, without global demand, there would have been no eurozone recovery at all.
The eurozone's rising surplus is down to trade with developed countries, especially English-speaking ones, and commodity producers, not China or other emerging markets. Just 7 per cent of the increase in eurozone exports over the last four years was to China, whereas nearly half of the increase was with the US, the UK and Canada. Moreover, these countries accounted for over 40 per cent of the rise in the eurozone's net exports (as imports from these countries barely rose). Most of the rest of the increase in eurozone net exports was with commodity producers, as falling oil and other raw material prices reduced the value of eurozone imports from these countries. By contrast, net exports to China were negative over this period, as the value of eurozone exports to China rose by less than the value of imports from China.
The eurozone will certainly be hit by the slowdown in China and elsewhere. Emerging markets buy over a quarter of eurozone exports, and these are set to come under pressure, while the competitiveness of emerging market manufactured goods will increase as the value of their currencies falls. Eurozone net exports to these economies, especially China's, could weaken substantially. Can the Anglo-Saxons continue to act as the eurozone's 'consumer of last resort' and offset the impact on the currency union of the slowdown in emerging markets?
Both the US and UK economies are growing relatively robustly and investors are currently sanguine about their rising trade deficits. This may well persist for a while, especially as capital flows out of emerging markets into developed ones. But it leaves the eurozone vulnerable to a slowdown in the US and UK, which are themselves not immune to weakening global growth, especially the UK which is more dependent on foreign trade than the US. They will not be able to sustain a big drag on their economies from negative net exports indefinitely. So far, the US-dollar and Sterling have been rising in value against the euro just as US and UK trade deficits with the eurozone have been widening. But this positive sentiment could easily reverse if investors turn bearish about the growth prospects of the US and UK.
Meanwhile, there is little to suggest that domestic demand in the eurozone will be strong enough to deliver robust GDP growth. Domestic demand has picked up over the last year as lower inflation and energy prices have temporarily boosted household incomes. But this is largely a one-off boost to growth. There is no sign of a pick-up in investment in the eurozone as a whole. Fiscal policy has become mildly expansionary, and should remain so, but there is no prospect of a major programme of fiscal stimulus.
The eurozone's need to focus on boosting domestic demand is as pressing as ever. The currency union cannot rely on a weak euro and strong global economy to offset economic fragility at home. Aside from leaving it highly vulnerable to external events, the eurozone has become a major drag on the global economy itself. Unfortunately, the European Commission is powerless to do anything about the biggest obstacle to stronger growth in eurozone domestic demand: excessive savings in Germany and the Netherlands. Germany's current account surplus is on course to exceed 8 per cent of GDP this year and the Netherlands' 11 per cent. In all likelihood, the eurozone will only adopt the aggressive monetary and fiscal measures needed to raise domestic demand when it can no longer rely on external demand. That time might not be too far off.
Simon Tilford is deputy director of the Centre for European Reform.