To understand the current trade conflict between Europe and the USA it is important to reassess the political situation of German foreign trade. What’s happening now is nothing new. I vividly remember Larry Summers, then US treasury secretary, telling me at a G7 meeting some twenty years ago that since the early 1980s the American administration had actually given up hope having serious discussions with a German administration on international issues such as balancing trade surpluses or stimulating the global economy. The situation has not changed since, as countless attempts by the Obama administration within the framework of the G20 after the great financial crisis have shown.
Germany, together with its “leading media” and the majority of compliant “experts”, has a long tradition of defending its position with all sorts of possible and impossible arguments, independent of US president Donald Trump. So trying to portray Mr Trump as a complete idiot and to ridicule the position held by all American presidents for many years is foolish and can have serious consequences.
I don’t know what these people really want to defend. If they wish to justify the economic-policy position advocated by the German government on a global scale – and that is what this is all about – all countries (or all European countries, which amounts to the same thing) would have to improve their competitiveness in order to free themselves from a phase of economic weakness. That is intellectual nonsense, indefensible – unless you are a paid ideologist and have to do so.
Closely related to this is the indisputable fact that there is simply no concept of how to create additional employment in Germany. Not just for twenty years, but for almost forty, there has been no concept for overcoming crises in Germany. With Chancellor Helmut Kohl’s “intellectual and moral shift” in 1982, German economic policy was committed to microeconomics, while all macroeconomic thinking ground to a halt because it was considered left-wing. In today’s environment it is simply impossible to put an economy back on a growth trajectory. One is then dependent – as one was under Kohl – on chance events and historical factors, where one does things contrary to one’s own prejudice, as one might never otherwise have done.
Real mercantilism under the euro
Real mercantilism could only emerge from all this when, with the transition to European monetary union, the possibility of an appreciation of the currency that had previously protected the other countries from the worst consequences of Germany’s export mania, ceased to exist. This was compounded in 1998 by the complete ignorance of the new Social Democrat-Green government, which in its desperation to improve the German economy, relied on massive wage restraint and decisively weakened the trade unions. This policy too was successful only because of exports. A positive domestic economic component never materialised. On the contrary, the domestic economy fell into a long hibernation that lasted almost ten years.
The real victims of German mercantilism are not the US but the nations trapped with Germany in the euro zone. They have suffered greatly under the German beggar-thy-neighbour policy in Europe but also in all third markets of this world, as can easily be proven. If Mr Trump were only a little smarter and a little less vain, he would use the US dollar as a weapon in this struggle between nations, because a significant devaluation of the dollar would solve multilaterally the problem he is tackling with his tariffs bilaterally and in mini-steps. Who could “prove” that a significantly weaker dollar is unjustified?
It’s about Germany, not Europe
Germany is doubly undervalued, and it seems difficult for the American administration to handle. First, Germany is undervalued in real terms in the euro zone because of its wage dumping and second, it is undervalued internationally because the euro has remained very weak over the years. After all, the euro reflects both, a weak overall Europe, which was weakened by Germany, and Germany’s strength. When Trump talks about Europe and unfair trade, he means Germany. But he can only react to Europe because German trade is part of the EU trade zone and Germany does not even have its own trade representative. Even if Trump were to devalue the dollar, this would negatively affect all Europeans, which is of course unfair.
So, because Trump is hitting the saddlebag and not the donkey – to use a German expression – he has to trust that the other Europeans will go after Germany if they themselves suffer from higher tariffs (or a weak dollar) through no fault of their own. So far, however, this has not happened because the other Europeans do not want to openly challenge Germany, preferring to complain about Trump.
What is the benefit of a surplus in foreign trade?
As I have often written, surpluses in foreign trade bring a net gain in jobs and income for the surplus country. This is indisputable. Anyone who sells more goods than he buys himself has, like any company in this situation, made a profit that immediately improves his economic situation. Anyone who sells less than he buys himself must take out a loan in order to cover this deficit.
This state of affairs is not generally threatening for the loss-making partner. There are, of course, economic situations in which the person who takes out a loan and invests is better off in the end. But things are different if, behind the loans he takes out, there is a permanent deterioration in his competitiveness against his main competitors. For a country, too, it is not a current account deficit as such that is a problem, but current account deficits that have arisen from a real appreciation, i.e. from a deterioration in competitiveness.
The emergence of a country’s current account surplus (or its increase) is recorded in the national accounts as an increase in GDP, i.e. total economic income: more goods and services have been provided by this country than it has received from other countries. The country has thus refrained from consuming its own production (which would also have increased GDP), but has created additional domestic jobs through its “export success”. The opposite is happening in the deficit country, where jobs are lost on balance. You can’t deny that if you base your argument on logic. Surpluses and deficits are a global zero-sum game. Incidentally, this does not mean that international trade as such is a zero-sum game, as is repeatedly claimed.
What happens in the case of a current account surplus can also be interpreted in terms of our macro lending/borrowing balances: The surplus country withdraws demand from the deficit country, which acts as an additional saving in that sector (in this case the savings of the foreign sector). In order to prevent an overall economic setback and rising unemployment in the deficit country, this must be offset by other sectors (if necessary by the government of the deficit country) by higher credit-financed public demand.
Overall, it is clear that a surplus in foreign trade resulting from improved competitiveness offers an advantage that the deficit countries have to pay for. Because that is the case, there has always rightly been the idea in the history of free-trade theory that countries must not permanently acquire such absolute advantages, caused by an undervaluation or real devaluation. The most important instrument for offsetting such benefits is the exchange rate of one’s own currency, which loses value in the surplus country, whereby for the importing countries the products of the surplus country become more expensive, decreasing demand. With its senseless foreign trade policy, Germany is calling into question this consensus, which has been valid for centuries.
What do capital flows and high primary incomes mean?
In Germany the most abstruse arguments are invented to ward off foreign criticism, and demonstrate that the others are wrong. This is more than astonishing, since in Germany people are incredibly proud of their efficiency, and see that confirmed by the surpluses. Does this efficiency not exist, if the ifo Institute insists these surpluses need to be put into perspective? Do the Germans perhaps enjoy no advantages in international trade? Why then has Germany tightened its belt for years and not adequately increased its wages? Was this whole policy actually completely pointless because Germany has no advantages at all? Why is it that those euro-zone countries in particular, which raised their wages, have got themselves into a mess?
There are no sensible answers to all these questions when Germany is actually weak. This is exactly what the Institute for the World Economy in Kiel, which seriously claims that Germany promoted growth abroad with its capital exports, which are the counterpart of the current account surplus in the statistics. This is the thesis applied to other countries, according to which higher savings promote growth because they automatically entail higher investments. However, as we have often written, this is simply wrong, because a causality is derived from an identity (S = I) that does not exist. No process has yet been invented that automatically transforms higher savings into higher investments.
Recently, the claim has emerged that Europe has no trade surplus with the US, which is why Trump has no grounds for attacking Europe with tariffs. As mentioned above: Trump is not targeting Europe, but Germany; and there the current account surplus is completely undisputed. However, the ifo Institute (on the basis of American statistics!) argues that Europe’s current account surplus is much smaller (or even a deficit) because of high primary incomes (enjoyed by global US companies, see below), which puts the effect of the Americans’ high deficit in trade in goods into perspective. In services, too, the US has a surplus vis-à-vis Europe, although this is quantitatively less significant than primary incomes. In European statistics (i.e. Eurostat) this effect is not of a comparable magnitude.
Primary incomes are the incomes of American companies that transfer profits back to the US; in addition, there are secondary incomes, which are mainly money transfers by foreign workers to their home country. These two types of credit transfer reduce Europe’s current account surplus, because the statistics correctly assume that such payments are not offset by counter-financing in the form of loans, which is the rule for the surplus in goods.
Whether it can be concluded that there are therefore no negative effects on trade between these regions is more than questionable. The American complaint about unfair trade is probably justified if, for example, the effects of primary and secondary income had existed for a long time (for which there are probably no American statistics), but the US deficit in commodity trade has only increased in the past 15 years. This is because Germany enjoys absolute advantages under the umbrella of the euro in the US and in third markets. And that is regardless of whether the overall balance for a year (the ifo claim is based solely on 2017) shows an American deficit or a surplus vis-à-vis Europe as a whole.
The real exchange rate is crucial
The American action would also be justified even if it were not based at all on current account balances, but solely on real exchange rates, whereby the euro is constantly depreciating. If the Americans had surpluses in the current account and at the same time had to accept a permanent real appreciation of the dollar, which would erode their export position in industry in the long term, they would have to be able to take action against this in a rational world trade regime.
Friederike Spiecker and I also pointed out some time ago that on the German side the statistics are burdened with high uncertainty. The German press naturally does not go into this. In the meantime, the real current account surplus for 2017 reported by the Deutsche Bundesbank has even risen significantly once again, surpassing that of 2016 by almost 100 billion euros and not just 80 billion as we had assumed. Since the statistics on the average values of imports have not yet been corrected, it is fair to say, with reference to these statistics, that Germany’s claim to have stimulated the economy by domestic demand for 2017 is without substance. All positive impulses for real GDP must have come from foreign trade. The American administration should be made aware of these statistics.
What follows?
All attempts to reduce the severe implications of German mercantilism, whether with the help of statistics or abstruse theories, cannot change the fact that Germany has been abusing foreign trade and damaging its trading partners for many years. It was long foreseen that an American president would take action against this and every surprise on the part of German politicians is mere play-acting. The American accusations have been there for decades, but have consistently been ignored. It turns out that German politicians act very “haughtily” towards Washington where the supposed national interests of the German economy are concerned.
The real problem of German mercantilism is its consequences in Europe and especially for monetary union. With the pressure on wages, German politicians have undermined the functional conditions of European monetary union from the outset and have precipitated the crisis that has now lasted for ten years. To have denied this from the outset and, moreover, to have punished their euro-zone partners with completely unsuitable concepts from a position of arrogance, has been the undeniable fault of German politicians since the beginning of the unique experiment called European Economic and Monetary Union. The resulting national and nationalist movements in Germany and in many EU nations can be directly attributed to this German inability to recognize and correct its own mistaken policy.
This article was published in German on Makroskop (makroskop.eu) and in English on Brave New Europe (braveneweurope.com).