Germany: arch currency manipulator?

26 May 2016 - By Robert Sierra

Last week’s US Treasury report into potential currency manipulators was fairly predictable in naming Japan and China as countries that in the past have sought to weaken their currencies in aid of their export competitiveness. Both countries have also been notoriously unfriendly to imports. What came as a surprise was Germany’s inclusion in the report, a tag that could ultimately result in the three countries (along with South Korea and Taiwan) facing extra scrutiny and potential retaliation by Washington.
Germany’s inclusion is perplexing given that it can’t manipulate its currency since it doesn’t have one! It also can’t discriminate against imports because trade policy is under the European Union’s purview. However, what the US Treasury objects to is Germany’s “material” current account and “significant” bilateral trade surpluses. According to the Trade Facilitation and Trade Enforcement Act of 2015, the US Treasury needs to undertake “an enhanced analysis” of each of its trading partners if “an economy has a material current account surplus of more than 3% of GDP”. With a surplus at nearly US$300bn or 8.5% of GDP, Germany is among the world’s largest (Figure 1).
To some, like ex-Fed chairman Bernanke, Germany could help shorten the period of adjustment in the Eurozone and support economic recovery in the region by taking steps to reduce that large external surplus. Berlin could, he suggests, undertake substantial investments in public infrastructure to counter the declining quality of its roads, bridges and airports by borrowing cheaply using ten year Bunds at a cost of less than one fifth of a percent. The government could also raise wages; higher German wages would both speed up the adjustment of relative production costs, increase domestic income and consumption and hence reduce the trade surplus. It could increase domestic demand though targeted reforms, including for example increased tax incentives.
Yet, for columnist Greg Ip at the Wall St Journal, meaningfully shrinking the current account surplus through fiscal policy would require much bigger deficits than Germany can justify. With unemployment at a post-reunification low of 4.2%, an economy operating above normal capacity, zero interest rates and a weak euro, fiscal stimulus is arguably unnecessary. Running fiscal deficits given Germany’s ageing and shrinking labour force, which erodes its capacity to repay debt and raises future pension expenses, risks pushing public debt from 70% of GDP today to 220% of GDP by 2060, according to the government. Quoting an earlier IMF study, Ip argues against fiscal loosening by pointing out that a 1% a year increase in public investment would only reduce the current account by 0.6% of GDP.
But to respected blogger and academic Brad Setser (Council on Foreign Relations) that projected impact on the current account is actually quite large since most policy changes, in fact, have a much smaller impact on the external account – see for instance the IMF’s global model for the current account where recent updates show that a 1 percentage point change in the fiscal balance has an impact of 0.4% on the current account.
Whichever is the correct magnitude, the whole discussion presupposes that Germany would be prepared to increase public spending. Germany’s commitment to the schwarze null, or fiscal balancing, is central to the governing coalition and deviating from it would mean a significant political shift. Since Germany is projected to move from a fiscal surplus of just over half a per cent of GDP to zero, even a 1 percentage point increase in public investment would seem to be off the table. Others such as the DIW Berlin think tank argue that Germany’s problem isn’t in the public sector but the private sector. In a recent study, it found that between 1990 and 2012, the value off the stock of buildings, equipment and other capital grew more slowly in Germany than in Britain, the US and the rest of the Eurozone. A preference for investing abroad seems to be the driving force here with companies deterred by Germany’s “excessive regulation, shifting energy policy, skilled shortages and inadequate public infrastructure”.
For Germany to be able to solve its large external surplus it may need to opt for a combination of higher wages, increased German consumption, private sector investment and a relaxation of fiscal policy. None seem palatable, not least the fiscal option, but doing nothing is a recipe for further annoyance and unwanted advice from Capitol Hill.

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