President Trump’s Necessary German Lessons
MUNICH – 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.
Hans-Werner Sinn, Professor of Economics and Public Finance at the
University of Munich, was President of the Ifo Institute for Economic
Research and serves on the German economy ministry’s Advisory Council.