In 2016 Germany recorded the world’s largest current account surplus of €297bn (approx US$315bn) overtaking that of China again to become the world’s largest. The country with the biggest deficit is the USA and head of the National Trade Council Peter Navarro (see earlier blog post) has accused Germany of currency manipulation by having a weaker Euro as compared to the stronger Deutschmark, its previous currency.
As you already maybe aware a weaker currency makes a country’s exports more competitive and imports more expensive. Therefore German cars, tools etc are very competitive on world markets. Trump has indicated that he may put a 35% tariff on imported BMW’s but for America to say that Germany is manipulating its currency is not a winning argument for the following reasons:
1. The Euro is weak as it is more an indication on the Eurozone economy which includes countries which have poor economic conditions – yes if Germany had the Deutschmark again it would be stronger
2. The US is embarking on a policy of expansionary fiscal policy with tax cuts and increased government spending on infrastructure. This will boost jobs but will also increase domestic interest rates which makes the US dollar stronger and thereby reducing export competitiveness of US goods and services but makes imports a lot cheaper.
3. The European Central Bank has cut interest rates to virtually zero and is implemented a policy of quantitative easing (buying back bonds) in order to stimulate the weaker economies in the eurozone.
4. With virtually zero interest rates, German savers are being punished as are German life insurers.
5. Does Navaroo’s allegation hold any creditability when the US is running massive deficits.
The German Problem
In order for German industry to remain competitive employers and trade unions agreed to restrain wage growth – this led to a weakening of the euro. To overcome this imbalances in economies wages should be increasing in Germany as it is a stronger economy and weakening in the poorer countries like Greece and Spain. This means that the latter has a competitive advantage and should attract investment.
Also a ageing population tend not to be big spenders and with the current demographics in Germany, firms are looking abroad to sell their products instead of at home. Ultimately this leads to excess savings which is capital sent abroad
With a current account surplus of 9% GDP the only way this can be reduced is with extreme measures such as:
– Lowering VAT (value-added tax)
– Increasing wages
– Government to increase its spending and run budget deficits
However the surplus is a sign of German’s export prowess and as one German politician said ‘America needs to make better cars”. Only when the German savings are turned into cash will surpluses turn into deficits.
Source: The Economist – Feb 11th 2017
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.
German Current Account Causes
- Germany’s labour costs have been approximately 20-30% lower that its Eurozone competitors and the German real exchange rate is strongly undervalued relative to the rest of the eurozone. This makes its goods artificially cheap, crowding out those of other eurozone countries from both eurozone and world markets. If Germany still had the D-Mark, it is almost certain that the increased competitiveness of German exports would have caused an appreciation in the German currency. This appreciation would have rebalanced demand – increasing the price of exports and reducing the price of imports. A flexible exchange rate would have moderated the rise in the German current account surplus.
- German manufacturing has been very competitive in recent years with improvements in productivity, and high-tech German exports have weathered the global downturn, better than many other countries. Germany had less exposure to financial services and has a very competitive manufacturing sector.
- Germany’s jobless rate is at a very low 4.7%. This should be stimulating demand but the German regulatory and tax structure is geared in favor of output and exports, and against consumption and investment. Furthermore, the German government are running budget surpluses which takes money out of the circular flow. This is when its infrastructure is looking very tired – canals, the rail network and autobahns need upgrading. Investment has fallen from 23% to 17% of GDP since the early 1990’s. Net public investment has been negative for 12 years.
German Current Account Consequences
- The large current account surplus and undervaluation of currency was good for Germany, but it was holding back exports in other countries. Greater German domestic consumption and targeting higher inflation would provide a boost to global demand and help to stimulate growth in terms of export demand especially in southern Europe. Surpluses steal demand from elsewhere and they export unemployment to other countries. This matters in an era of “secular stagnation” and excess global savings.
- Given the imbalances in the Eurozone, southern European economies face a long period of deflation as they slowly seek to restore competitiveness against their northern competitors. However, given European wide austerity, this period of deflation is proving very costly in terms of lost GDP and high unemployment.
With the AS Level resits approaching I thought it would be useful to go through this informative video by Phil Holden which covers part of Unit 4 and 6. Can Current Account Deficits cure themselves? Why a depreciating currency might be both a consequence of and a cure for a deficit.