Putting the Brakes on Overreaction to VW's Euro Influence

The emission scandal at the world's second largest automaker, Volkswagen, offers reportedly "rocked" the German politics and business elites.  Some possess argued that it will rival the actual refugee challenge for Germany.  Other people have argued that it is a supply of euro weakness.

To be sure, Volkswagen is the not first car maker caught manipulating its emissions tests. Ford did a similar thing with its vans in The late nineties.  Hyundai and Kia compensated $100 mln in fines last year for fixing their tests.

This is not to justify in any way what Volkswagen has done, but simply to note that there is no precedent for this turning into some sort of systemic crisis.  One should not exaggerate its impact on the euro's exchange rate.  First, consider the euro-dollar's correlation using the DAX.  Conducting the correlation around the percentage change finds the actual correlation is -0.39 over the past 60 days and -0.45 over the past 30 days.  However, the inverse relationship is greater between the euro and also the S&P 500 than it is using the DAX at -0.52 and -0.Sixty for the past 60 and 30 days respectively.

Second, here is a Great Graphic (made up on Blomberg) that shows the performance of Volkswagen ADR (whitened line) and the euro-dollar exchange price (yellow line).  The dinar rallied strongly in April through mid-May, while Volkswagen shares continued to trend lower.  Similarly, in the first part of 06, the euro appreciated without an interruption of Volkswagen's downtrend.  This particular happened again in late July.  When news of the scandal first broke, the euro had been coming off from its post-FOMC rebound.  

Just because the Volkswagen scandal may not have larger capital market implications doesn’t take away from the gravitas of the situation.  Volkswagen employs 270k workers straight and even more indirectly through its suppliers.  The German car sector employs 775k people.  Autos and parts are the biggest German exports accounting for about 20% of roughly 200 bln euros.

The good from US authorities may be a maximum of $18 bln.  There are also other lawful costs, including likely penalties from other authorities.  In addition, there are costs associated with the recall.  There may also brand costs and increased costs of production to fix the problem, let alone expenses associated with tougher regulation, which will be a probable consequence.  In terms of valuation, the market cap is lower by a little more than 20 bln euros.  The German auto industry also encounters headwinds from the Russian sanctions and also the slowdown in China.

More broadly, the scandal comes at a time when many Germans find themselves in a crossroads.  Through the financial crisis and the sovereign debt crisis, Germany emerged as the regional hegemon, though many Germans would not accept that label.  Yet it is clear that France has been unable to match German economic prowess or competitor it for leadership within Europe, even if still may command key appointments in the multilateral institutions.  

Germany was widely criticized for wanting strict enforcement of the controlling treaties associated with EMU, especially on fiscal exchanges.  After losing a election at the ECB, the Bundesbank participated in a finish run to the European Court of Justice.  The ECJ overruled the Bundesbank's objections.  Germany has additionally received criticism from the European union, the IMF, and the US because of its large current account surplus and the lack of stimulus to help offset the austerity in the periphery.  Most recently, criticism has been over displaying flexibility over the rules for its unilateral overture to take 800,000 refugees. 

The Vokswagen scandal is much more embarrassing for the German model and conceit of rules-based society than material for the German brand.  Germany's two fears, being isolated or blamed for that destruction of Europe, is not at play here.  However, the German export associated with schadenfreude is fully in play.

Volkswagen and the Euro: Preliminary Ideas is republished with permission from Marc to Market