Germany is playing a dangerous game on trade

It could get left out in the cold.
It could get left out in the cold.
Image: Reuters/Kacper Pempel
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Germany’s got a nasty habit—one that it’s foisting on the rest of the world. The country just announced record-breaking surpluses in trade and its current account. So huge is the latter that, in 2016, it exceeded that of China—a mind-blowing feat considering Germany’s economy is about a third the size of China’s.

So what’s the problem?

Germany chronically overproduces and under-consumes. The surpluses that this creates—along with those of China and, increasingly, Japan—force pockets of debt and unemployment elsewhere in the global economy, such as the US, the UK, and the euro zone periphery.

This isn’t a value judgment; it’s a simple matter of national accounts. The more Germany’s current account balance (the difference of its savings over domestic investment) balloons, the more unstable the global economy becomes. And as the 2016 data suggest, the ballooning has reached unsustainable proportions—a whopping 8% of Germany’s GDP.

A country’s trade balance reflects the difference between what it supplies to the world (exports) and what it demands from other countries (imports). In a balanced system, countries typically export the goods they specialize in, using their earnings to buy things they can’t get at home. The money they save—i.e. don’t use to consumeis also invested domestically. Sometimes rising productivity or trade with economically devastated countries causes countries to export more than they import. Balance is eventually restored as currencies, wages, and prices adjust.

But a country can run surpluses another way—through policies that tax their own consumers in order to subsidize domestic production, shifting wealth from households to businesses, the wealthy, and government. This usually comes about when nations cheapen their currency or otherwise protect domestic industry. But sometimes, as in Germany’s case, they directly reduce their households’ purchasing power by suppressing wage growth.

Running surpluses this way forces someone else to run deficits—because one country’s excess exports are another country’s excess imports. And as foreign products outcompete the importing country’s goods, its workers lose jobs. When a country does this repeatedly, it not only deprives its trading partners of potential demand; it saps demand from the global economy as a whole. As a result, growth slows.

Germany has benefited from the artificially cheap euro, which gives a competitive boost to its exports. Even within the euro zone, though, the government’s tight leash on wage growth, its fanatical fiscal thrift—the “schwarze Null,” or “black zero,” of a balanced budget is a private obsession of its finance chief, Wolfgang Schäuble—and its deep aversion to inflation have suppressed both domestic consumption and the price of goods, helping it undercut its euro zone neighbors’ exports.

“[I]ts neighbors need German demand for their goods and services far more than they need Germany to set an example of fiscal prudence,” Brad Setser, a senior fellow at the Council on Foreign Relations, wrote in a blog post. “It is clear—given the risk of a debt-deflation trap in Germany’s euro zone partners—that successful adjustment in the euro zone can only come if German prices and wages rise faster than prices and wages in the rest of the euro zone.”

Beyond the euro zone, Germany’s refusal to pop the lid on domestic demand is also rankling the US and UK—two of its biggest export markets—contributing to the economic consequences that led in part to Brexit and to the rise of Donald Trump. And there may be more backlash to come. In January, Trump threatened German carmakers with a 35% tariff, while his top trade adviser called the euro “grossly undervalued,” suggesting Germany has an unfair advantage of its trading partners (paywall).

Germany has two big choices here, say Cedric Gemehl and Nick Andrews, analysts at Gavekal, a research firm. It can remain on, or close to, its current course—a choice that would deepen the imbalances that currently warp the euro zone and the rest of the world. Or it can can voluntarily rebalance by “doubling down on euro zone integration” and investing in the bloc’s poorer peripheral countries, to make the whole region more competitive globally.

As Setser notes, stimulating its own economy through public investment would also reflate the German economy, giving other euro zone manufacturers a chance to compete.

Despite the ominous trade data, there has been a recent flicker of auspicious signs of strengthening German consumption. Inflation is picking up, driven by domestic demand. Its labor market is tightening too, which should boost wages and, therefore, consumer purchasing power. And Germany finally looks to be relaxing its fiscal rules somewhat.

Whatever the case, Gemehl and Andrews have a hunch that with Trump threatening the whole eurozone, ”Germany’s ability to effectively maintain a free ride within the dysfunctional, but relatively stable EU is coming to an end.”