Lenny Brecher was in a foul mood yesterday as he wheeled his bicycle out of the Volkswagen factory in Wolfsburg. Germany, the powerhouse of Europe, is in recession and the bad news had just caught up with the 24-year-old welder.

“Recession, what does that mean?” he asked, trying to push his way through a knot of colleagues leaving the early shift. “It's just another excuse to get rid of us.”

He was grumpy because VW's first reflex in the swirling economic crisis has been to shed 750 workers before Christmas. Thousands more temporary workers like Lenny are expected to be laid off early in the new year. This at a time when VW results are looking rather good: deliveries and production will be better than the boom year of 2007 and the company is on course to generate pretax profits of €6.15 billion (£5 billion).

German workers had just been getting used to the good times, were starting to spend more and borrow more, when the recession hit. It was made official yesterday: the country's economy contracted 0.5 per cent in the third quarter, after a shrinkage of 0.4 per cent in the second.

Industrial output fell 3.6 per cent in September compared with August. And exports, the engine of the German economy, are flagging.

The car industry, which employs one German in seven, provides a good illustration of the country's economic malaise. In August sales were 10.4 per cent down on the corresponding month last year, and they are still in a steep decline - down 8.2 per cent in October. Lenny's boss, Martin Winterkorn, chief executive of VW, says that 2009 will be a hard year.

His counterpart at Audi, Peter Schwarzenbauer, says: “I have never experienced such a wildfire running through the economy.” Daimler is sending 150,000 workers home early for Christmas; BMW is considering deep cutbacks.

It was only a matter of time before the global financial crisis, which tops the agenda at this weekend's G20 summit, hit the real German economy. Wolfsburg, a one-company town, is particularly sensitive. As Lenny and I head down Porsche Street, the town's main pedestrian precinct, he gives a running commentary on the creeping recession.

“See that?” he says, pointing to a club offering “Happy Hour, 50 per cent reduction on cocktails between 17 and 20 hours”. “The place shuts at 8. We have the longest happy hours in the world.”

Bookshops are offering their 2009 calendars at a 20 per cent discount, sensing that ready cash is already running out. A jeweller announces in a big sign: “We buy dental gold and accept teeth with gold”. The only activity is in mobile phone shops - worried teenagers trying to change their contracts - and in two shops offering “Everything for One Euro”.

Orazio Nardi set up his ice cream parlour, the Eiscafe Roma, 20 years ago. Porsche Street - named after Ferdinand Porsche, the founding father of VW - is full of Turkish and Italian snack bars set up by foreign VW workers who saved up enough to go into business before they were laid off. “There have been ups and downs but this is as bad as I've seen,” Mr Nardi says. “I've been open seven hours and you're my second serious customer.” Serious signifies a waffle with chocolate spread.

Yet there is a sense that German boardrooms are talking up the crisis. Carmakers in particular have been lobbying for state assistance, arguing that if they go down, so will the whole economy. And if the Government is ready to prop up the banking system to the tune of €500 billion, it can spare a few billions to keep manufacturing alive.

After a fierce argument in the coalition Government, the Chancellor, Angela Merkel, has agreed to suspend the vehicle tax on new car purchases for the next six months. Critics say that this is grandstanding - next year is election year - rather than sound policy.

The US Administration has offered American car manufacturers access to $25 billion (£16 billion) worth of cheap credit. The European Commissioner for Industry, the German Günter Verheugen, has been considering a €40 billion rescue package for the European car industry.

It is suppliers rather than the main production hubs that are suffering. To make the windscreens and mirrors of the VW Golf, parts are needed from 16 specialist companies; the electronics demand the services of another 15 niche firms. They are being hit by the sudden drop in demand for cars and by the lack of credit lines.

That is what German recession figures conceal: the drop in exports largely reflects the problems of small businesses, the so-called Mittelstand, in keeping hold of their markets.

Friedhelm Sträter, the head of the car parts supplier ESU - it makes car seat levers and the bit of metal that connects the seat with the headrest - complains: “Every morning the car manufacturers send through their plans, and every morning the figures shrink.”

Contracts with suppliers are usually weighted heavily in favour of the manufacturer. “We work in cycles, of course. That's the business, but it has never been like this.” In August he received €3.2 million worth of orders. In October it was down to €350,000.

The suddenness of the downturn has left people in shock. But there is an argument that the recession will be fast and shallow, with a bounce-back in the second half of next year. That is certainly the hope of Mrs Merkel, who needs to enter the September 2009 general election with a solid reputation as an economic crisis manager.

The key question for Germans about this recession, though, may be not so much “How long will it last?” as “How can we best use it?”. The local Wolfsburg historian Ingo Sielaff argues that it was the recession in the mid-1970s - when VW cut more than 10,000 jobs - that spurred the transition from the outdated VW Beetle to the compact Golf.

Mr Sträter is using the downturn in a similar way, diversifying from car components. His company is making parts for espresso machines, aluminium cat-feeding bowls, surgical tools and, just in case the climate-change crisis is not supplanted by the financial crisis, rotor blades for wind-power generators.

BORN FROM CRISIS

- The G20 brings together important industrial and emerging-market countries. Its member countries represent about 90 per cent of the global Gross National Product, 80 per cent of world trade and two thirds of the world's population

- It was created as a response to the financial crises of the 1990s and to a growing recognition that emerging-market countries were being left out of key economic discussions and governance

- The G20 chair rotates among members and is selected from a different regional grouping of countries each year. This year it is chaired by Brazil, next year it is Britain

- G20 includes 19 countries. The EU has a separate representative

Source: g20.org

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