In the media a lot is spoken of a country’s trade deficit and the concern that it is borrowing from abroad to finance current purchases of goods and services. China’s surpluses have been a big talking point but it is Germany with a current account surplus since 2002 (introduction of the Euro) with a 2105 surplus of 8% of GDP which has taken the limelight – see graph from The Economist.
A lot of students taking the subject for the first time believe that a trade surplus is good and a trade deficit is bad. However, as in a lot of areas of economics, you can’t categorically say they are good or bad. For instance, a deficit might be caused by importing vast amounts of capital goods which will create value in the economy through jobs and goods which can be sold domestically or overseas. The capital goods can also increase the level of productivity and improve competitiveness of such goods. In some respects deficit countries can be better off than surplus countries, as they are consuming more goods that they are producing.
Is a trade surplus good or bad?
For a lot of countries the purpose of exports is to generate revenue so that they can buy imports of goods which they may not produce – or could produce but relatively less efficient. In China a surplus does keep the export sector industries employed but suggests there is a strong presence for saving or weak domestic demand. More balanced trade would increase the level of imported goods into a country and increase real incomes as the value of its currency rises. This will allow for more inflows of foreign capital from abroad stimulating growth in the domestic economy. It would help a sluggish world economy if surplus countries, like China and Germany, were to spend more on imports.
Reasons for Germany’s trade surplus.
There are three main reasons for Germany’s ongoing trade surplus:
- Since the advent of the Euro in 2002 its value has been very weak. This is because the Euro is valued in relation to the entire 19 country eurozone and given the economic condition of the other member states, Germany’s strength in trade is not significant enough to boost the currency. If Germany still had the Deutschemark today it would be no doubt stronger and therefore reduce export competitiveness. It has been calculated that the Euro gives Germany about a 20% price advantage compared to what it would have had if it was still using the Deutschmark and has the largest foreign exchange advantage of any country in the world, with the possible exception of China.
- Another reason is that the German government has been running a very tight fiscal policy and also keeping the wages levels down. In the wake of the worries over the eurozone, Germany slashed its public expenditure with reducing public infrastructure spending and been more focussed on running surpluses. This is all very well but they are taking money out of the system which leads to less demand in the global and European economy.
- The lower cost of imports of oil and gas increased the trade balance in 2015 by around 1.2%. Without the decline in oil and gas prices, the trade surplus would have fallen compared with the previous year.
Germany’s trade surplus is a worry for countries in the EU as well as overseas in that it is importing demand from other countries and reducing output and employment. This is especially prevalent when you consider that monetary policy in a lot countries has become ineffective. When this happens expansionary fiscal policy – dropping taxes and increasing government spending – is way of trying to boost demand but even though the fiscal position of the German economy is very healthy they are doing the opposite and being prudent. Germany is one of the few major economies in a position to easily and cheaply increase demand.
The impact of Brexit on the New Zealand economy should be limited when you consider the following statistics:
- 3.5% of total exports from NZ go to the UK – mainly sheep and wine.
- 2.7% of total imports from the UK to NZ – mainly transport goods
- 6.7% of all short-term visitor arrivals come from the UK
When the UK joined the EEC (as it was then know as) in 1973 there was a major shift away from trade with the Commonwealth. However New Zealand has been able to move away from the traditional dependency of the Commonwealth to become increasingly integrated to the Asia Pacific region.
Reserve Bank of New Zealand
The RBNZ is a good position even with a record low OCR of 2.25% which paradoxically is among the highest in the developed world. By not being aggressive with OCR cuts the RBNZ has the ammunition to stimulate aggregate demand further which is in contrast to the European Central Bank and the Bank of Japan who are in negative territory. With the turmoil in Europe over Brexit the US Fed will most likely hold off on a rate hike to ease the pressure on markets – it may even cut the US Fed rate.
Gold and Sterling – US$ rate
The graph below shows the reaction to the Brexit – GBP drops significantly against the US$ and gold, as a safe investment, appreciates in value. The uncertainty that surrounds Brexit saw more investors buy gold, which rose to about $1,315 an ounce on June 24th, up by 4.7% on the previous day. This was the largest increase since the global financial crisis in 2008. The rise was in stark contrast to the plunging pound, which tumbled to its lowest level in 30 years.
Below is video from the FT looking at Five Consequences of the UK’s exit form the EU.
On Thursday the UK vote whether to stay or leave the European Union. Below are some consequences and also a good video clip from the FT.
Remember the line in Monty Python movie ‘Life of Brian’, ‘What have the Romans ever done for us?’ This can be applied to the question of a British exit from the EU – ‘What has the EU ever done for us?’ Below is an informative video clip from the FT with a bit of humour. The questions in the Pub Quiz are:
- Which country I am describing in the year it joined the EU? Is the poorest European nation – incomes slipping behind its European competitors by £185 per year. Regular power cuts.
- In 2015 who was richer? The average person in German, France and Italy or England, Scotland and Wales?
- What caused Britain’s improved performance?
- How has Britain’s membership of the EU improved economic performance?
- Has the EU made Britain richer?
Basically the answers suggest that EU membership has been very beneficial to the British economy.
European Central Bank -0.3%
Swiss National Bank -0.75%;
Danish Central bank -0.75%
Swedish Central Bank -1.1%
Why are they in negative territory?
For all these countries it is the the exchange rate against the Euro that is important. Negative interest rates weaken a country’s currency and make imports more expensive and exports cheaper. Furthermore central banks could be trying to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery.
In theory, interest rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice, there’s a risk that the policy might do more harm than good. If banks make more customers pay to hold their money, cash may go under the mattress instead. Janet Yellen, the U.S. Federal Reserve chair, said at her confirmation hearing in November 2013 that even a deposit rate that’s positive but close to zero could disrupt the money markets that help fund financial institutions. Two years later, she said that a change in economic circumstances could put negative rates “on the table” in the U.S., and Bank of England Governor Mark Carney said he could now cut the benchmark rate below the current 0.5 percent if necessary. Deutsche Bank economists note that negative rates haven’t sparked the bank runs or cash hoarding some had feared, in part because banks haven’t passed them on to their customers. But there’s still a worry that when banks absorb the cost themselves, it squeezes the profit margin between their lending and deposit rates, and might make them even less willing to lend. Ever-lower rates also fuel concern that countries are engaged in a currency war of competitive devaluations. Source: Bloomberg
Another satirical clip from Clarke and Dawe of ABC in Australia, this time on the crisis in Greece and understanding Grexit. Interesting use of the word ‘Grexitentialism’.
When Greece went through euro-zone entry exam in 2000 it is said that it cheated on its deficit figures. Greece was able to enter the currency bloc after claiming its deficit was less than 1% of GDP, well within the bloc’s 3% threshold. EU reports have since revealed Greece’s budget hasn’t been within the 3% limit a single year since its accession. Below is a video from RealNews which explains the background to the present crisis. Worth a look