While the United States has the largest trade deficit in the world, Germany boasts the largest trade surplus. The Trump administration, which aims to reduce U.S. trade deficits, views German economic policy as deeply unfair. There is considerable merit to the new administration’s criticisms of Berlin, notably in the context of currency devaluation and deflationary economic policy. German economic leadership would be well-advised to consider the new administration’s concerns in formulating its international economic policy.
Germany’s current account surplus—the balance between the country’s savings and investment, including the difference between total exports and imports—reached a record high of €270 billion ($300 billion), its highest since the end of the second world war. According to the most recent data, Germany’s current account surplus constitutes eight percent of its gross domestic product (GDP), five percentage points above the U.S. Treasury’s target when it examines the exchange rate policies of major trade partners in its biannual currency report. Even China has a surplus equal to only 2.4 percent of its GDP, while on the contrary the United States has a deficit equaling 2.4 percent of its GDP.
Although this surplus reflects Germany’s strong export performance, it also underlies a weak domestic demand that plagues its economy and a euro membership that supports its export sector. If Germany were not a part of the eurozone, its currency would have soared to reflect its increased productivity since the euro’s introduction in 1999. However, low productivity of the southern European countries—notably Italy, Spain and Greece—has kept the euro low, despite strong growth in German productivity.
In addition to the euro, Germany benefits from wage bargaining, in which companies agree not to increase the annual wages of their employees. Following a decade of wage bargaining, the German exchange rate is now strongly undervalued, even compared to the rest of the eurozone. Indeed, International Monetary Fund (IMF) researchers found that the Germany’s real effective exchange rate is undervalued by 5 to 15 percent. As a result, German exports are significantly cheaper than what they would have been otherwise, paving the path for a strong trade surplus, even by German standards.
This surplus comes at a time when the German economy is cyclically in a much stronger position relative to the rest of the eurozone: Italy and Spain have still not recovered from the financial crisis, while Greece continues to struggle under the crippling weight of its debtors’ claims. As these countries try to rebalance their budgets, the deflationary pressure that Germany’s current surplus causes makes it all the more difficult to boost and recover their economies.
There are two major mechanisms by which German economic policy exacerbates the eurozone economy. Firstly, by pushing up the value of the euro, Germany’s trade surplus compounds deflationary pressure in the eurozone. Whereas, previously, Germany’s trade surplus was offset by the deficits of other member states, the trade deficits of these other countries are now on the decline. Essentially, this means that the eurozone is moving into a large external surplus, leading to an appreciation of the euro. This appreciation has been harmful for the demands of eurozone exports, particularly from Italy, Spain, and Greece. Secondly, by insisting that other countries follow the German model of balanced budget and by imposing austerity, Germany is contributing to a chronic shortfall in the eurozone aggregate demand.
Given that the eurozone is the largest trading partner of the United States, and that trade with the eurozone is of growing importance to U.S. companies, Washington is rightly concerned with Germany economic policy and its impact on U.S. trade deficits and eurozone finances. The Trump administration should insist that Berlin undertake key steps to reduce its trade surplus and adopt a more active role in improving eurozone finances.
First, German economic leadership should consider substantially loosening fiscal and monetary policies to boost domestic demand. In a recent report, the U.S. Treasury recommended that Germany undertake a greater degree of public infrastructure spending and encourage higher wages from the corporate sector to boost wages and make Germany less competitive. The IMF makes similar recommendations: cuts in taxes, particularly for the low-income Germans, publicly financed expansion of educational programs, and deregulation of the service sector.
Although well-intentioned, these recommendations alone will not be enough to address Germany and the eurozone’s problems. Over the long run, Germany must undertake bolder currency reforms. Specifically, German economic leadership needs to reflect about the euro and the future of Germany’s currency.
Because Germany’s exchange rate is significantly undervalued, it should face a substantial appreciation of its currency. However, the euro is already strongly overvalued for southern European countries. A further appreciation of the euro might be disastrous for these European countries and their international competitiveness. Yet, if the euro were to depreciate, this would surely drive German surplus even larger.
In light of this dilemma, a number of experts, including Mervyn King, formerly the Governor of the Bank of England, and Ashoka Mody of Princeton University, suggest that Germany should abandon the euro. A German return to the deutsche mark would surely lower the value of the euro, providing the European periphery a much-needed boost in competitiveness. Conversely, in light of its high productivity and trade surplus, the deutsche mark would gain significant strength relative to the euro.
German current account surplus and its austerity policies constitute a major drag on the eurozone and the global economy. Given the Trump administration’s objective of reducing deficits and the eurozone’s growing importance to the U.S. economy, the Trump administration is right to criticize Berlin’s international economic policy. If Germany is to maintain its status as a global economic leader, it should undertake substantial economic reforms and ensure an equitable playing field for its partners in Europe and across the Atlantic alike.