Project Syndicate, March 30st, 2017
US President Donald Trump has criticized Germany’s enormous current-account surplus, which he considers the result of German currency manipulation. But the president is wrong. While Germany’s external surplus, at 8% of GDP, is big – too big – it is not the result of currency manipulation by Germany. The real culprits are an inflationary credit bubble in southern Europe, the expansionary policies of the European Central Bank, and the financial products US banks sold to the world. So, instead of blaming Germany, President Trump would do well to focus on institutions in his own country.
Germany’s trade surplus is rooted in the fact that Germany sells its goods too cheaply. Here, the Trump administration is basically right. The euro is too cheap relative to the US dollar, and Germany is selling too cheaply to its trading partners within the eurozone. This undervaluation boosts demand for German goods in other countries, while making Germany reluctant to import as much as it exports.
The euro is currently priced at $1.07, whereas OECD purchasing power parity stands at $1.29. This implies a 17% undervaluation of the euro. Moreover, Germany is 19% too cheap within the eurozone if one uses as a baseline a calculation by Goldman Sachs from 2013 and subtracts the appreciation in real terms since that time. On the whole, this implies that Germany’s currency is undervalued by about a third.
So the fact that German products are undervalued is indisputable. The question is why the exchange rate has strayed so far from fundamentals.
The undervaluation within the eurozone has its roots in the inflationary credit bubble triggered by the announcement and implementation of the euro in southern Europe after the Madrid Summit of 1995, which brought with it drastic interest-rate cuts in these economies. Interest rates in Italy, Spain, and Portugal fell by about five percentage points, and in Greece by roughly 20 percentage points.
The cheap foreign credit brought about by the euro enabled these countries’ governments and construction sectors to raise wages faster than productivity increased, thereby pushing up prices and undermining the competitiveness of their manufacturing sectors. Germany, which was at that time in a deep crisis, kept inflation low, in line with the requirements of the Maastricht Treaty, so it became cheaper and cheaper in relative terms.
The undervaluation of the euro, by contrast, has two root causes. One is the European Central Bank’s ultra-loose monetary policy, particularly its program of quantitative easing (QE), under which €2.3 trillion of freshly printed money is being used to buy eurozone securities.
Part of that money is flowing abroad in search of higher returns, thus leading to euro depreciation. This is indeed a form of indirect currency manipulation. It should be noted, however, that the ECB’s governing council adopted QE and other expansionary measures, despite the fierce opposition of the German Bundesbank. So this is not a policy for which Germany can be held responsible.
The second root cause of the euro’s undervaluation lies within the country over which President Trump presides. Thanks to the dollar’s status as the world’s main reserve currency, the US financial industry has managed in recent decades to offer international investors a potpourri of alluring products. This has driven up the dollar’s value and chronically undermined export competitiveness, much like the financial products offered by the City of London did in the UK by fueling sterling appreciation in the years of undisputed EU membership.
Economists speak of “Dutch disease” in situations like this, because the emergence of the Netherlands’ gas industry in the 1960s placed upward pressure on the guilder, decimating the manufacturing sector. Whether a country sells gas or financial products to the rest of the world doesn’t matter all that much; the point is that the successful sector crowds out others by causing real exchange-rate appreciation. In lamenting the strong dollar’s effect on manufacturing employment in the US, President Trump should look to Wall Street, not Germany.
He should also consider that those alluring US financial products, which have so afflicted America’s export sector, have sometimes been pie in the sky rather than legitimate investment opportunities. Both President Jimmy Carter and President Bill Clinton prompted brokers with their Community Reinvestment Act to help the US poor achieve home ownership by means of generous loans, even though it was clear from the outset that many of these borrowers would never be able to repay the money.
The brokers sold their claims to the banks, which in turn cunningly packaged them in opaque asset-backed securities that they then palmed off to the world with sham AAA ratings. “Stupid German money” was the term used on Wall Street for the funds that flowed in to finance America’s social policy.
That scam was exposed during the financial crisis. In 2010, Germany’s government had to support its banks with €280 billion, by establishing two bad banks to take over these problematic financial products. Viewed from this perspective, a large number of the many Porsches, Mercedes, and BMWs delivered to America have never been paid for at all. The US president should take this into consideration before threatening a trade war – or even indulging in a Twitter spat – with Germany.
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