Europe’s leaders can no longer rely on the argument that German resilience will cushion the blow to the continent from the worst global recession in just about anyone’s living memory.

Germany’s economy, Europe’s largest, is now officially confirmed as the basket case of Europe, thanks to a plunge in demand for high-tech goods, stagnant domestic demand, and a strong currency.

Having shrunk by 2.1 percent in the fourth quarter alone compared with 1.5 percent for the 16-member euro area, Germany will hold for a brief period over the weekend the dubious title of the fastest contracting economy in the developed world.

That is, until Japanese GDP data are published on Monday.

Trading floors in Tokyo must be bracing for a very ugly morning indeed. Already expected to shrink by 3.1 percent on the quarter — or a staggering 11.7 percent if stretched over an entire year — the risks are high that the hole in the world’s second largest economy turns out to be even bigger.

Pioneer’s decision on Thursday to cut 10,000 jobs and exit the business of manufacturing flat-screen televisions was an ominous sign of just how quickly world demand is falling away for the high-tech manufactured goods that have made Germany and Japan famous.

And there is little reason to believe that with unemployment soaring across the globe, that demand will rebound any time soon.

German and Japanese policymakers gathering in Rome for the G7 finance ministers’ and central bankers meeting must be very worried that if there is no respite soon for the euro or yen, it will take a very long time to recover from this downturn.

Trade protectionism – or at least the threat of it — has raised it head as the global economy has declined, bringing with it all the historical fears about the Great Depression. Consider the flurry of concern about a “Buy American” clause in one of the U.S. stimulus bills.

It is traditionally assumed that widespread protectionism would most hurt the biggest economies, the United States and Japan. But Barclays Capital analyst David Woo says this is not so and that Russia, Canada, Australia and Sweden are the most vulnerable.

Woo studied various factors that would play on the effect of protectionism on a country, from openness and flexibility to its dependence on trade and it savings.

Japan turned out to be the least vulnerable. “Its relative closeness, relative flexibility of its labour market, and its terms of trade more than outweigh the negative contribution to its growth from a narrowing of its trade surplus in a global protectionist environment,” Woo writes.

As for the United States, “the only reason why it failed to take first place is because of its extremely low saving rate, which will limit the scope for domestic demand to offset falling exports.”

Mexico,  India and China took the third, fourth and fifth places, respectively. So it’s not all about emerging markets.

The world’s second largest economy, Japan, and Europe’s largest, Germany, all of a sudden have a lot in common. 

Their most striking resemblance in recent weeks is the breathtaking speed of economic decline, with output ransacked by a collapse in world demand for high-quality manufactured goods and an overvalued currency.

The fundamental problem is simple and doesn’t take an economist’s model to explain. At this stage of the financial crisis, who wants to replace a fully-functional Audi they bought a few years ago? What’s wrong with the 2007-vintage Sony PlayStation connected to the two-year-old Bravia or Grundig flat-screen TV? And who in their right mind would want to import the stuff in bulk when the euro and the yen are so expensive?

It’s very simple, but somehow analysts remain nearly universally stunned.

News that German industrial production plunged by 4.6 percent in December, nearly double the Reuters consensus and the steepest decline since 1989, triggered much handwringing. “Really horrific”, one analyst gasped. “Pretty horrible”, another muttered. “Devastating”, another shrieked.

Those were more or less the same words used to describe the near-10 percent collapse in Japanese industrial production, driven by the same trouble from those same frugal global consumers. Compounded, of course, by even more thrifty domestic consumers, as in Germany.

Perhaps the ever-hawkish European Central Bank, which did not think it necessary to seriously consider cutting rates this month, is now warming to the idea that Germany’s economy has completely frozen over.  ECB über-hawk Axel Weber appeared to be sporting a more dovish feather earlier on Tuesday — but only after flying halfway around the world to give a speech in Kuala Lumpur.

“We should not at this point avoid to lower rates aggressively, because we understand at the current juncture all indicators look like the economy is in free fall,” Weber said.

Perhaps the ECB may have more than one 50 basis point interest rate cut left to deliver after all?

Merrill Lynch's monthly poll of fund managers around the world has a bit of a surprise in the small print. More investors now reckon the Japanese yen is overvalued than see it as undervalued. This is the first time this has been the case since Merrill began asking the question, said by staff to be about eight years ago.

It clearly reflects a 13 percent dive in dollar/yen this year and a 24 percent plunge in euro/yen. But does the new view of value suggest that the unwinding of the carry trade is over? Another question from the Merrill poll shows hedge fund deleveraging levelling off.