Germany is a member of a currency union over which it has no monetary authority. So no one can accuse the country of ‘manipulating’ its currency. Yet, Germany is displaying huge current account surpluses that are illustrative of a dangerous imbalance, which, when corrected, will cause violent disruptions to trade and lead to populist and autarkic political rhetoric. This is what awaits us when the global economy slows further.
The John Maynard Keynes Plan of 1941 for dealing with trade imbalances is highly relevant to both east Asian countries with high current account surpluses accumulating US dollar reserves and to Germany, which is part of a fixed-rate currency union without monetary sovereignty. If you recall, Keynes saw British post World War I deflation as the result of an imbalance between a British debtor and US creditor though the gold standard was supposed to automatically correct current account imbalances by draining gold reserves from countries with international debtor positions. But unfortunately, there is an asymmetry in all creditor-debtor relationships including this one, because – As Keynes put it – adjustment is “compulsory for the debtor and voluntary for the creditor”.
Therefore, during the second world war, when a new currency system was being proposed, the Keynes Plan was to create a clearing union using an international currency, the Bancor, that would stop creditors from sterilizing their current account surpluses because they would be charged punitive rates of interest for doing so. Conversely, the debtors would be given cheap loans through a Bancor overdraft facility. This arrangement would, therefore, use market forces to create greater symmetry in the incentives for both debtors and creditors to stop imbalances.
But of course this plan did not win the day because at the battle of Bretton Woods, the US representative Harry Dexter White won the day, installing a system with the US anchored to gold and everyone else anchored to the US dollar. If we fast forward to today, the US dollar is still the world’s main reserve currency. And so the desire to accumulate it for reserve balances requires the US run a current account deficit to match the current account surpluses of reserve-accumulating countries. Clearly this causes tension in a post-Asian Crisis world in which emerging market countries of all stripes are desperate to avoid the fate that befell Asia in the late 1990s when countries were caught short of US dollar reserves. The US sees this imbalance legacy of the crisis and of the US dollar’s reserve status as currency manipulation. And when the US economy turns down, it leads to anti-trade rhetoric that will eventually end in restrictions.
At the same time, we have a different actor with a similar policy agenda in Europe, namely Germany. The Germans – and to an even greater degree, the Dutch, have export-led economies. But since Germany is much larger and has more pull within the eurozone, most economists focus on Germany. Pre-financial crisis, the export-led model resulted in a sort of intra-European vendor financing scheme between the core and the periphery. Here’s how I put it in 2010:
“The first thing to realize is that government deficits are balanced by imports and private savings. I’m talking here about the financial sector balances, of course.
“The chart to the left from the FT shows you that the collective financial balances in each individual Eurozone country must sum to zero. Where there is a government surplus it is matched by either the capital account or private balances. The same is true for deficits. Take Spain, for example. There, the government’s budget was in surplus in 2006 and it had a very large capital account surplus (the financial sector equivalent of a current account/trade deficit). This was matched by a substantial private sector deficit. By 2009, due in large part to an unprecedented housing bust, the government’s finances were in tatters. Look at the chart. This is matched by net private sector savings and a capital account surplus. The financial sectors must balance.
“This brings me to the second thing to realize. Spain is to Germany as the United States is to China. In a fixed exchange rate environment, the U.S. is running an astonishing current account deficit while China runs an equally outsized surplus. Similarly, you can’t have Germany and Spain both running current account surpluses, unless the EU as a whole runs a current account surplus. So, if Germany (or the Netherlands) wants to be the export juggernaut and run a massive current account surplus, this has intra-EU ramifications. The most important is that Germany’s (or the Netherlands’) current account surplus (capital account deficit) is matched by current account deficits (capital account surpluses) in Spain (Portugal, Greece, Ireland and Italy). That’s how it works, folks. You sell more to me than I do to you and I get more cash than you do. There are always two sides to every transaction. It’s right there in the data.”
But that was then. With the periphery’s downturn came austerity and internal devaluation. And this has meant two adjustments. First, the EU as a whole has moved from a roughly balanced external position to a net creditor position as the German and Dutch export-led model is forced onto the periphery via internal devaluation used to achieve export competitiveness. Second, the Germans and Dutch have been forced to turn elsewhere to maintain their mercantilist trading stance. And they have found willing buyers in Asia and the emerging markets writ large.
The thing to realize about multilateral trade is that the imbalances do not necessarily build up as bilateral imbalances between two countries. Rather, imbalances build multilaterally, with some countries – particularly the reserve-currency holding US – taking on the net debtor position. And we see that now, with the UK showing record trade deficits at the same time Germany is sporting huge surpluses. The IMF faults Germany for the surplus. Martin Wolf faults Germany for this too. Irrespective, there is no mechanism in the current global currency system to correct these imbalances except through balance of payments crisis and the rise of protectionist populist politicians.
And so my conclusion here is that these imbalances will only shift in a crisis – like the one we experienced within the eurozone. Except next time, the crisis will be global. It would be nice to think that world leaders would understand that dangerous imbalances are building that feed a populist and violent political response. Alas, there is no indication that the Germans or any other net surplus country gets this. And while the Swiss and the Dutch are small trading nations, Germany is a global behemoth. Like China, it will attract negative attention when the economy turns down. And the Germans will get the blame when the trade barriers go up. Right now, it seems only a matter of when not if.