Peter Navarro, the new U.S. trade advisor under President Trump, has lashed out at Germany for exploiting the U.S. with its trade surplus. While Navarro is right that Germany runs a massive surplus with the U.S. (in 2016, Americans spent €49 billion more on German goods than vice versa), he’s wrong about who’s exploiting whom. Because it’s entirely uncertain if the bulk of the money that America owes Germany for all those goods will ever be repaid.
But first, consider this basic lesson from Econ 101: Germany not only has a trade surplus from shipping many more goods abroad than it imports. It must also send all its export earnings abroad that it cannot invest domestically – that’s known as a capital surplus. In fact, the trade and capital surpluses are equal in a world of free exchange rates.
In other words: Germany is exporting its savings to the U.S., which then allow Americans to purchase German Porsches, designer kitchens and gummy bears. The U.S., meanwhile, runs up debt to afford itself more private and public consumption. Over time, Germany’s claims on U.S. assets grow. Each year, the money the world owes to German corporations, banks, insurance companies and retirement savers grows by the amount of Germany’s annual trade surplus, or €253 billion in 2016 (plus changes in asset values of course). America’s total foreign debt, in turn, rises according to its annual trade deficit, or $480 billion in 2016 alone.
In theory, all those assets that Germans are accumulating will at some point be repaid – including America’s running tab for German imports. That’s exactly what happened in the 1990s following German reunification, when Germany repatriated substantial foreign assets to pay for the reconstruction of the former East Germany.
But it’s a very different story when those foreign assets are devalued. Take the German publicly-owned Landesbanken: During the U.S. mortgage crisis in 2008 and 2009, their bad investments vanished into thin air like so many Lehman Brothers certificates. Similarly, some very large German companies have run up spectacular losses from ill-fated foreign takeovers, like Daimler’s disastrous purchase of Chrysler, BMW’s expensive foray into Britain, and steelmaker ThyssenKrupp’s heavy losses in Brazil.
Even without such costly mistakes, Germany’s massive assets in the U.S. are subject to devaluation. That’s because America’s foreign liabilities are mainly denominated in dollars, not in the euros that matter to Germans. If the U.S. dollar falls – for example, because the Federal Reserve decides to run an inflationary monetary policy – the real value of America’s foreign debt falls. Every American asset held by other countries in the form of U.S. Treasury bills, stakes in companies or asset-backed securities now incurs losses in terms of those other countries’ own currencies.
In the past, the U.S. has frequently undertaken such devaluations with interest rate cuts. By pumping money into the economy, low interest rates create financial market bubbles (such as the 2000 dotcom bubble and the pre-2008 U.S. mortgage-loan boom), which devalue liabilities when they burst. Low interest rates also devalue the dollar. As a result of both types of devaluation, foreign holders of American assets lose repayment of a considerable part of their holdings.
While America has run up current account deficits (or net capital imports) totaling $10.8 trillion since 1980, net foreign liabilities today are around $3 trillion lower. Back in the 1960s, the then-president of France, Charles de Gaulle, already criticized America’s ability to slash the value of foreign-held debt to its own advantage as an “exorbitant privilege.”
Unfortunately, Germany hasn’t invested its gigantic surpluses very well. The country’s accumulated current account surpluses have increased to $2.6 trillion since the start of the millennium, while its current net foreign assets amount to only $1.6 trillion. That difference is lost, never to return. A large part of German savings invested abroad went up in smoke during the U.S. mortgage market boom. A similar thing happened in southern Europe, where German savings resulting from the trade surplus financed everything from Greek government bonds to inflated Spanish real estate. Ditto for Ireland during that country’s financial-sector collapse, and many other places around the world. Total losses to Germany have reached almost $1 trillion. Gone. Poof. Auf Wiedersehen.
In other words: It’s the U.S. that exploits its trading partners, not the other way around. America’s biggest paymasters are Germany, Japan and China. Trump would be mad to abandon his “exorbitant privilege” by bringing his deficit down. If anything, it is Germany that should reconsider whether net capital exports on such a scale make sense in a world of highly volatile and speculative financial markets. They could probably be better invested in Germany – in new roads, better bridges, faster rail links, more kindergartens and smart new inner cities for blighted industrial towns like Duisburg and Dortmund. At least these investments wouldn’t disappear without a trace, like so many of Germany’s assets do now.
This article first appeared in the Spring 2017 issue of Handelsblatt Global Magazine. Schnabl is a professor of economics at the University of Leipzig. To contact the author: firstname.lastname@example.org