False premises

Look Closer to Home

Donald Trump
Source: AP

The US president has criticized Germany’s enormous current account surplus and claimed it is the result of German currency manipulation. That is simply not true. It is true that the surplus is big – too big, even. But to say it came about through manipulation is wrong.

At 8 percent of GDP, the German current account surplus is indeed extremely high, and it would be even higher, a good 10 percent, if, during the years of crisis, Germany had earned the same interest on its net foreign wealth as it had in the year 2007. President Trump is right about one thing: The surplus exists because Germany sells its products at extremely favorable prices. The euro is too cheap versus the dollar and Germany is too cheap in euros versus its trading partners. The undervaluation encourages high demand for German products abroad and a German reluctance toward imports back home.

The euro is currently trading at around $1.07, whereas the level calculated by the OECD’s purchasing power parity (PPP) measure should be at $1.29. That implies the euro is undervalued by 17 percent. Furthermore, Germany is 19 percent too cheap within the euro, based on a 2013 calculation by the economic analysts of Goldman Sachs, which takes into account Germany’s slightly above-average inflation rate. Overall, Germany is undervalued by about a third. The question is, how did that come about?

One has to admit this is indirect currency manipulation...decided by a majority on the ECB's governing council over fierce opposition from Germany's Bundesbank.

The undervaluation of the euro has its roots in an inflationary credit bubble, which was first triggered by the euro’s introduction at the Madrid summit in 1995. The euro led to a series of dramatic interest rate cuts: In Italy, Spain and Portugal, interest rates fell by a good 5 percentage points, and in Greece by as much as 20 percentage points after it became clear that the country was also joining the single currency.

Cheap credit, thanks to the euro, enabled the government and construction industry to finance wage increases far and beyond what productivity justified. That drove up the price of goods and undermined the industrial competitiveness of these countries. This made Germany, where inflation remained low to comply with the Maastricht treaty (a series of rules governing the euro zone), increasingly cheaper, relatively speaking.

There are two reasons for the undervaluation of the euro today. One has to do with the ECB’s quantitative-easing program, which over three years will have flooded the euro zone economy with €2.3 trillion of freshly-printed money through bond purchases. Part of that money flows abroad and leads to a devaluation of the euro. One has to admit this is indirect currency manipulation. However, we should also remember that this program, as well as the ECB’s other expansive measures, were decided by a majority on the ECB’s governing council over fierce opposition from Germany’s Bundesbank.

President Trump should look more to Wall Street than to Germany when he complains about the high exchange rate of the dollar,

The other reason for the undervaluation of the euro is to be found in the United States itself. By pushing the dollar as the world’s reserve currency, the US financial industry was able to offer global investors a potpourri of attractive financial products. This drove up the dollar exchange rate to a level that undermined the competitiveness of US exports.

That is why President Trump should look more to Wall Street than to Germany when he complains about the high exchange rate of the dollar, which has cost America so many manufacturing jobs. And he should also bear in mind that the attractive financial products, which came from his country and damaged the US export industry, occasionally seemed more like fool’s gold than serious investment products.

With their Community Reinvestment Act, Mr. Trump’s predecessors Jimmy Carter and Bill Clinton made brokers help the country’s poor buy homes with generous loans, although it was clear they would not be able to repay the loans. The brokers sold their credit claims to banks, which repackaged them in opaque asset-backed securities and sold them all over the world. The game was up with the 2008 financial crisis.

As a result, in the year 2010, the German government had to inject €280 billion into its banking system to finance two “bad banks” that had taken on these problematic financial products from America. So, in this sense, a considerable number of the Porsches, Mercedes and BMWs delivered to America have not actually been paid for. That is what the new American president should bear in mind before starting a trade war, or spreading unjustified accusations via Twitter against other countries.

To contact the author: gastautor@handelsblatt.com

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