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Wednesday, November 13, 2013

Reviewing Germany's surplus

As expected, the European Commission today announced a review into Germany’s current account surplus under its Macroeconomic Imbalance Procedure (MIP).

This has been a topic of hot debate recently and has the potential to become a very important debate in the future of the euro and Germany's role in it. We laid out our thoughts on the issue in a detailed post last week. We recommend re-reading it, but the thrust is that, while rebalancing is needed, boosting imports in Germany or cutting exports would do little to help the peripheral economies because they simply do not produce goods and services which Germany want and do not produce the same exports to replace Germany’s if it lost competitiveness.

That said, by the letter of the law the Commission was right to launch the procedure given that Germany has broken its threshold on the current account surplus (over 6% of GDP since 2007, see graph below). The key point is for the Commission to judge it on its merits not as a political process – to be fair the Commission itself stressed this point but there have been hints that it takes a bit of a dim view of the large surplus.

What happens now? It’s early days yet. The Commission will begin its review and complete it by spring next year. The recommendations will then be included in next year’s European Semester and country specific economic recommendations. The key will be how hard the Commission goes on the arguments and how Germany responds. If it fails to implement the reforms the Commission does have the option of imposing a fine or even sanctions on Germany.

Signs on this front so far show the potential for conflict. German reactions have already been quite hostile with CSU General Secretary Alexander Dobrindt warning that, “You don't strengthen Europe by weakening Germany” and CDU General Secretary Hermann Gröhe adding, “Our export strength is the corner stone of our prosperity”. Bundesbank President Jens Weidmann added that expanding Germany fiscal policy is also not the answer, saying, “The positive knock-on effects would be limited”.

There are also a few points in the Commission’s report which are worth picking up on:
Emphasis on euro strength: Numerous times the report argues that Germany’s long standing surplus is helping push up the euro exchange rate, making the periphery’s adjustment harder. This seems a strange point to focus on given that it’s not Germany’s job to manage the exchange rate. There are also plenty of other factors which influence the euro, including but not limited to: actions of other central banks (notably the Fed weakening the dollar) and the repatriation of funds to Europe as banks and business refocus on core European operations. The report also says that Germany’s real effective exchange rate (REER) has come down due to a weaker euro, which seems a tad contradictory.

Causality between deficits and surpluses: The Commission highlights that defining a clear link between one country’s deficit and another’s surplus is not as simple as first seems. This is a point we made in our previous blog. While Germany may have previously been the flip side of other countries deficits, these deficits have now closed and Germany has maintained a surplus by trading with non-euro countries. The Commission also notes that countries such as Germany can play a key role in the supply chain – this means its exports create demand of imports of inputs from other countries, it also highlights that Germany is not always the source of the final demand for imports. The German government itself flagged this up, saying that “40%” of its exports rely on intermediate goods imported from EU partners.

Germany did play a role in previous peripheral deficits: As mentioned above Germany did play a role in sustaining the large deficits in the peripheral countries which helped cause the crisis. However, as touched upon in the report, this is more a failure of supervision (both financial and macroeconomic) and a failure on the part of the periphery to invest the money into factors which would promote long term economic growth. After all these investments were helping to drive significant growth at the time and these countries did reap some benefits, but failed to make them lasting. This dynamic was also almost inevitable as a result of pushing such different economies into a single interest and exchange rate policy.

Germany has troubling demographics: Countries such as Germany, with an ageing population, are always going to be inclined to save more. Judging what level of saving is warranted or needed given such constraints is tough, but it’s clear that German businesses and people have already made up their mind to save more.

Germany does need to unblock obstacles to domestic demand: The report is correct to highlight that Germany can do more to promote demand, notably by liberalising its services sector and reducing the level of taxation.

Germany above the threshold for public debt: the Commission will review this imbalance as well, highlighting constraints to any demands for further public spending.
All in all, the Commission does try to cover both sides of the argument but the tone still seems to lean towards asking Germany to do more to boost demand. If this is through liberalising measures it will be welcome (at least by us), however, if it calls further jumps in spending and wages it could find a very hostile reception in Germany.

In any case, the scene is set for what could become a crucial debate over the structure of the euro. The crux of the argument comes down to – what is Germany expected to do to save/aid the euro and what is it willing and able to do (politically, legally and economically)?


David Green said...

I am glad to see you moving towards the position that the Euro is the problem that needs discussing. If Germany holds true to its view that it can only provide moderate help in alleviating imbalances within Europe, it is for other Euro countries to decide whether they wish to remain attached to a currency that is largely an extension of the old Deutschmark writ large. One would have thought that most of them would, on rational grounds, not think it worth the candle, once strict German conditionality is imposed on any bail-outs. Draghi can, of course, precipitate the fall-out by goading the Germans beyond endurance with large-scale QE of dubious legality. Perhaps, for Europe's sake, that would be the cleanest and quickest route out of the current impasse.

Jesper said...

I'm fairly sure that the commission isn't naive and therefore I find what appears to be naivety in this particular suggestion odd: Reducing social security contributions to increase employment and wages.
Additional hiring and/or increases in wages done by altruistic businesses will be so insignificant that it would not be measurable. The one thing that will happen is that companies will get a one-time boost in profitability.

Increase deficit by lowering taxes is ok? Increase deficit by increasing spending is not ok?
Lowering taxes for low income people is the first step in reducing spending for the very things that low-income people have no choice but to band together to be able to collectively and therefore individually afford.
In which countries does the poor have the best roads, schools, hospitals etc? Where low-income people pay taxes to get them themselves or where their 'liberal elite' (look a bit like feudal lords) 'pay' for such things?

Is there some poll to confirm that the majority of Germans are against higher wages in Germany? Or is there some confusion and that is in fact only the opinion of a wealthy and tiny minority?

& how are wages to be increased when eurocrats and liberals keep making suggestions that effectively reduce the bargaining power of workers?

Rik said...

You missed one very important one.
The Hols (and a few other relative minos) are having an even larger (or similar for the real minos) surplus.

First of all it is a clear indication that we are dealing with a bunch of amateurs at EU level who react like Pavlovs dogs on news and not think things over.
If you see it as a problem attack all main offenders not just one.

Second. It is hard to see how you can start a procedure against Gerry and not one against the much worse offending Hols. Simply a bit of moronic. Clearly Olli has found his highschool economic books, but before doing policy things/getting public it might have been wise to have a look at recent stats as well.

Third. In Holland this has a much larger potential for causing damage than in Germany (where it won't happen either btw). Basically although the surplus is 10%ish their economy goes horrible, simply zero growth stuff.
Anyway any corrections will hit hard there. And the last 3% stuff already brought the Eurosceptic vote in the polls to around 50%.
Anyway increasing labourcosts is will not be doing a lot of good. Their RRE looks somewhat to bottom out which is a large positive, but 'compensate' this with negative growth by wage rises is hardly a way to get EU/Euro support on the rise.
You run into another contradiction. Wages cannot rise (costwise) so the spending power injection should come from lower taxes. Which means a higher deficit and you can finish the story yourself. Simply too many unbalances never properly adressed in the Dutch and many other economies. Solve unbalance A make unbalance B worse.

Anyway discipline in the ranks looks like it is close to collapsing now. Basically when stupid things and contradictory stuff starts to get the forefront, like now that is a real good indication thereof.
PR campaign everything is rosy vs ECB interest policies (which indicate the opposite). Official reports about Spain cooking the books on websides and subsequently being removed. All sorts of moronic PR/popular platform eroding stuff like this. With a very low probability of ever seeing the real world and if so already not before a couple of years.

Good to watch when the plug goes out of the stockmarket (will not be that far (few months at the most imho). Just watch if larger market parties start to get really nervous (they clearly already are nervous already). Basically wait for the first major one to start selling, the rest is almost certain to follow.
This could be the trigger for a new episode in the Euro disaster.
Will be difficult for the ECB to hold the fort (or they should throw all their legal limitations out of the window, which cannot be excluded of course. Desperate people.....).
Market is now riding the wave and bad news is simply largely ignored. But things like that never last for ever.

Rik said...

This is not only/mainly a macro thingy.
Imho for the largest part it is not. Germany makes stuff everybody wants (and has pricing power) and the South is making crap at overinflated prices (and the worldmarket is flooded by cheap crap with 3 Bn EM social economic climbers).
It is also about the brand (see Sober Look had an interesting post on this).
Anyway it would take years to make the correction work. The South simply doesnot have the infrastructure to produce stuff that people really want (better much too little). And new investments won't take place as the growth perspectives are horrible and for Europe the East is much cheaper anyway (next to has better growth potential).

Basically the mess you get by not fragmenting markets (and see it as one big market) and miss time delays.
Cutting things in smaller pieces always gives more accurate results. The art is to know when to do it (like now) and not to rely on a more easy less time consuming rougher model (like the mainstream is doing now).

The problem with the South is they are catched up by the China/India fraternity as far as the stuff they make and these are competing on price. Something the South is never able to do.
For the UK as said many times before it looks by far the best strategy to stay away from these basically dysfunctional countries as far and as much as possible. Never tie yourself to someone who is likely to drown. You will make less and less money from them and in Welfarestate Europe the closer you get the more solidarity will be demanded (possibly even required). Next to make cutting things in case of emergency much more difficult.

Rollo said...

It is stupid to vilify Germans for hard work and good housekeeping. The villain is the Euro, not a currency but a political construct so designed as to create divergence, poverty in some places, excess in others.

Denis Cooper said...

Off-topic, I wonder whether the German Constitutional Court will ever deliver a verdict on the OMT ... it was going to be after the elections in September, on a quick google the most recent news I find is this from October 23rd:


"Remember the German Constitutional Court’s (GCC) hearings last June on the European Central Bank’s (ECB) outright monetary transactions programme (OMT)? The GCC is expected to announce its ruling towards the end of October — perhaps already this week."

and here we are on the middle of November, and nothing; maybe it will be after Christmas, after Easter, some time next autumn, or never?

Not that this is much more than idle curiosity on my part, about how they will manage to reason their way out of their assigned task of defending the German constitution, once again; I'm expecting that this most recent development in the EU will take the present German constitution to the limits of what it will bear, that is until the next EU development which go even further but still only take the present German constitution to the limits of what it will bear ...

But maybe I will be surprised.

Anonymous said...

In a nutshell the above dialogue can be summarized by the words: "Not an Optimal Currency Area" The EZ always has been and will always remain so, until it's self destruction. @PaulHenriCadier