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Volkswagen Mess to Trigger Global Recession?

One German newspaper called it the “most expensive act of stupidity in the history of the car industry.”

It’s hard to disagree.

U.S. regulators looking to reconcile the results of Volkswagen’s (VLKAY) diesel emissions test results with actual real-world data have forced the German automaker to confess that it fudged the numbers.

This was no mistake or one-off, either. The company had written special software to deliberately produce fake results and fool the emissions-testing regulators.

Michael Horn, President and CEO of Volkswagen Group of America, admits, “Our company was dishonest… we have totally screwed up.”

And before resigning in disgrace, ex-Volkswagen CEO Martin Winterkorn was “endlessly sorry that we have disappointed trust.”

It’s a truly shocking admission from the world’s top-selling carmaker. And investors have responded by crushing the company’s shares. From a closing price of $38.03 on September 17, VLKAY currently sits at $25.68 – a 32.4% plunge.

But it could be bad news for the rest of the world, too. This event significantly increases the chance of a global recession. Let me explain…

Why Volkswagen Just Raised the Bar for Corporate Scandal

While other corporate cover-ups have proved far more dangerous, this one is different.

For a start, the software fraud is worldwide and could directly affect the emissions tests of 11 million vehicles. Millions more cars have the software installed, but haven’t been affected.

The company has set aside over $7 billion to fix the problem – but that’s just a guess and is before whatever it pays in fines. The final number will likely be far higher. And that doesn’t include criminal prosecutions and civil lawsuits.

So why should Volkswagen’s culpability be higher than other manufacturers’ cover-ups?

After all, General Motors (GM) buried its problem with ignition switches and settled for under $1 billion in fines and no criminal prosecutions. And those switches caused 124 deaths!

Surely that’s more important than a few thousand extra tons of nitrogen oxide, which isn’t even a greenhouse gas?

Well, the difference is the intent. While GM’s cover-up was unconscionable, it didn’t intentionally design the ignition switches to cause fires.

By contrast, Volkswagen must have known in advance that its engines wouldn’t meet pollution standards. And you can’t “accidentally” write software that fakes the numbers!

While it remains to be seen just how far up the executive chain this fraudulent scheme went, you can be sure that it wasn’t just a couple of rogue engineers – it would’ve taken many highly placed executives and managers to get this into production.

But Volkswagen’s scandal isn’t just restricted to the company. It affects Europe and the rest of the world, too.

Another Day… Another European Crisis

The last thing Europe needs is another mess on its hands. Not with the persistent fiasco in Greece and refugee crisis engulfing the region.

While the European economy has expanded recently, it’s not growing at the same rate as the United States. And in addition to the Greek and migrant challenges, the Spanish, Italian, and Portuguese economies are still struggling, with a big slowdown in China, too.

As Europe’s economic backbone, Germany was expected to weather the Chinese downturn (even though Volkswagen makes around one-third of its profits in China).

Indeed, traders just “celebrated” the recent relatively weak eurozone manufacturing and service sector numbers because it feared the Chinese slowdown would make those results even worse.

Germany is also crucial in helping with the European debt and refugee crises. How? Because its strong government fiscal policy and rising tax revenue have produced a balanced budget. A rise in corporate taxes and capital gains taxes have powered those higher tax receipts.

But the Volkswagen fiasco is likely to change that.

Volkswagen Turns Off the Revenue Tap

Now, Volkswagen won’t disappear, even if it ends up going into receivership over the scandal.  But the company will certainly shrink.

In addition to the direct damage done, the damage to its reputation is far worse. It’s betrayed trust among both consumers and investors.

It’ll be a long time before the company repeats the record 10 million auto shipments from 2014.

And even if nothing else happens, I guarantee it’ll be a long time before Germany’s government gets much capital gains tax revenue from Volkswagen shares!

Not to mention the fact that Volkswagen workers who each received $6,250 in profit-sharing checks six months ago will probably get little or nothing for this year.

But much more than that could happen.

Dominoes About to Fall in Europe… And Beyond?

The German auto industry accounts for around 15% of its manufacturing activity, 3% of its GDP, and 2.5% of its employment. For an economy that grew by less than 1% last year, it’s pretty easy to see that it won’t take much disruption of the auto industry to throw Germany back into a technical recession.

And a government facing a domestic recession and falling tax revenue wouldn’t be in the same position to help its neighbors as one enjoying growth and rising tax receipts.

Given Germany’s financial muscle, the potential domino effect is obvious. In particular, already-poor countries like Spain and Italy will find it hard to finance deficits without the prospect of a German-led bailout or other agreement.

And with the prospect of Europe in recession and China slowing, the U.S. economy suddenly becomes vulnerable, too.

The good news? The situation isn’t liable to get as bad as it did in 2008. Volkswagen isn’t Lehman Brothers. But the company’s terrible behavior does have the potential to make an already-shaky worldwide economic situation much worse.

To living and investing in the future,

Greg Miller

Greg Miller

, Senior Analyst

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