Project Syndicate, July 21st, 2017
It stands to reason that Germany cannot simultaneously reduce its current-account surplus and continue to extend loans to other countries that have run deficits, and failed to maintain fiscal discipline. If all parties involved could reach this basic understanding, that alone would be a major step in the right direction.
The Economist was right when it recently reported that Germany’s current-account surplus is too high. But why is the German surplus too high? Some say that Germany has a high export volume because it manufactures high-quality products, while others argue that Germany imports too little, because its wages are too low.
Still others point out that, by definition, a country’s current-account surplus is equal to its capital exports. Germany thus has a surplus of savings over investments, and needs to save less and invest more.
Of course, the German current account surplus also reflects deficits in other countries, not least the United States, which accounts for about one third of the value of current-account deficits worldwide. So, one could just as soon call on deficit countries to increase their competitiveness, reduce wages, and save more while investing less.
Consider Southern Europe’s heavily indebted countries. Although they have managed to balance their current accounts, owing to lower interest rates on their foreign debt, they could be running substantial surpluses to pay off their debts.
But ad hoc recommendations won’t take us very far. To decide where adjustments should be made, we first need to understand why excess capital is flowing from Germany to the rest of the world.
In my view, the US federal government’s extreme indebtedness and budgetary profligacy is a major source of the problem. The US Federal Reserve’s loose monetary policy has artificially sustained the US economy, which itself is built on limited-liability consumer and home loans. The US has been able to live beyond its means by selling dollar-denominated debentures to the world, because the dollar is the world’s main reserve currency. But this approach has produced a retail-based economy and a weak domestic manufacturing sector.
Another problem lies in the eurozone. The introduction of the euro dramatically improved the creditworthiness of southern European countries, as it seemed inconceivable that euro countries could ever go bankrupt. After all, they have the right to print money that other countries accept as legal tender. The result of this artificial sense of security was that abundant private capital flowed into Southern Europe until around 2008, creating inflationary credit bubbles that destroyed those countries’ competitiveness.
When the financial crisis hit, the southern euro countries took advantage of their right to print money, effectively borrowing from the euro system what they could not borrow in the markets. They used that money to redeem old debt, to continue buying goods, and to purchase real estate and other assets abroad.
Moreover, the ECB promised free protection, through outright monetary transactions, for private investors who dared to continue putting their money in the south. Not surprisingly, all southern European countries saw their debt-to-GDP ratios continue to increase, despite the pledges made in the enhanced fiscal compact of 2012 to reduce the ratios year-on-year, in order to approach gradually the limit of 60% established in the Maastricht Treaty.
The excessive Keynesianism used to legitimize indebted eurozone countries’ lack of budgetary constraints during the crisis also caused capital to be sucked out of Germany, when investors actually tried to retreat from southern Europe. This has stimulated imports, thereby contributing to the increase in the German current-account surplus.
But Germany hardly profits from the situation, as the debentures and promissory notes that it received from deficit countries hardly bear interest anymore, and their repayment is increasingly uncertain. In fact, roughly half of the net foreign assets that Germany has accumulated through its past current-account surpluses now comprise mere Target claims on the Bundesbank’s balance sheet, which currently stand at €861 billion.
The Target claims reflect the financing that, according to the rules of the euro system, the Bundesbank has been forced to extend to the eurozone’s deficit countries, by crediting their payment orders. The Bundesbank will never be able to declare these claims due and payable, and the ECB Governing Council has set the interest due on them at zero.
Against this backdrop, a two-prong approach for reducing the German current-account surplus seems appropriate. First, Germany could introduce depreciation allowances for private investments, as the president of the Ifo Institute has suggested. This would help to redirect some of the capital currently flowing to other countries back toward domestic uses.
Second, southern eurozone countries and the US could finally return to a policy of disciplined debt management. This would reduce their imports from Germany and hence capital outflows from Germany, which is measured by the current-account surplus. In particular, the Fed and the ECB need to end their loose monetary policies – especially the fiscal bailout packages and ECB guarantees that are artificially redirecting capital into Southern Europe.
Logic dictates that Germany cannot simultaneously reduce its current-account surplus and continue to extend cheap public and private loans to other countries. Much would be gained if politicians understood this basic reality.
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