US and Germany trade blows over macro policy, but is Germany's export focus really to blame for the woes of the eurozone?

Another dispute arose last week between the US and Germany. This time on macroeconomics. Maybe not quite as glamorous (or controversial) as spying, but interesting nonetheless. The new disagreement was set off by the US Treasury’s semi-annual Report on International Economic and Exchange Rate Policies which said (and reiterated numerous times):

“Germany has maintained a large current account surplus throughout the euro area financial crisis...Germany’s anaemic pace of domestic demand growth and dependence on exports have hampered rebalancing at a time when many other euro-area countries have been under severe pressure to curb demand and compress imports in order to promote adjustment. The net result has been a deflationary bias for the euro area”.

Germany (unsurprisingly) took offence to this and hit back that its surplus was simply a result of competitiveness and global demand for German products.

Numerous commentators have weighed in to add to the criticism of Germany with Paul Krugman, Martin Wolf, the Atlantic and the Economist Free Exchange blog all lambasting Germany, albeit to varying to degrees. (See Bruegel here for a good round up). The WSJ's Richard Barley attempts to provide some much needed balance to the discussion.

The thrust of the argument is: Germany should boost domestic demand to provide a demand boost for the struggling eurozone economies (via imports). It should also allow wages and prices to rise (reflate) to reduce its advantage over these other countries, allowing them to take over some of Germany's market share.

So, who is in the right? We’ll leave that up to you to decide, but we do feel the debate has been rather one sided in its criticism of Germany. With that in mind, below are a few points to ponder.

1) Germany is not as big a source of demand for peripheral economies as assumed: As we have noted before, the assumption that if Germany imported more, the peripheral countries would benefit seems overstated. We have already pointed out that the eurozone and particularly the periphery make up a declining source of Germany’s trade.

Importantly, Germany is also a limited source of demand for these countries. In 2012 exports to Germany from Greece, Italy, Portugal and Spain amounted to 0.9%, 3%, 2.9% and 2.25% of their GDPs respectively. So, if Germany did boost its domestic demand and consumption only a small amount would filter through to imports from these countries and this would amount to a very small boost in GDP. To have any real impact then, Germany would consciously need to direct an increase in imports from these countries - not a realistic proposition. Also, keep in mind as well that it could do little to offset the massive collapse in domestic demand, investment and government spending which in many cases amount to double digit percentages of GDP.

2) ECB’s one-size-fits-all policy: As the Economist Free Exchange blog points out, the issue of reflating probably has as much to do with the ECB as it does with Germany. But as we have pointed out the ECB faces a tough time in tackling low growth and low inflation due to numerous technical, legal and political constraints. Furthermore, if Germany did start reflating quickly, with wages and prices going up, significant problems could be created for the ECB and its middle of the road, one-size-fits-all monetary policy. It would find it even harder to marry its single policy for a fast growing Germany and other countries.

3) Even if Germany became less competitive or exported less the periphery would not necessarily pick up the slack: Again as we noted before, Germany and the periphery have very different areas of expertise and specialisation – if Germany lost competitiveness due to reflating, the periphery may not fill the gap for cheap exports, particularly in manufactured and industrial goods. Chances are that emerging markets would reap the benefits or at least a large share of them. It's also worth noting that increasing wages may not be as simple a prospect as it sounds given that it cannot be done directly by the government and requires an agreement from both unions and businesses.

4) A less competitive eurozone: This is a point the German government has raised previously and it has some merit. Although a German reflation would aid the adjustment in other countries (as the adjustment needed to become competitive relative to Germany would be less) the competitiveness of the eurozone as a bloc would be relatively decreased since the average unit labour cost would be higher. This can be offset somewhat by a weakened currency, but given that the ECB takes no specific action to influence the euro, it is far from guaranteed.

5) Germany has had an excess of savings for a decade: While Paul Krugman is right to point out that Germany has not always run a current account surplus, it has done so for nearly the entire time the euro has existed. So why was the excessive saving in Germany not an issue previously? Obviously, global demand has fallen and domestic demand in many periphery countries has collapsed, but previously German savings were heavily invested in the southern economies (through the banking system). This no longer happens, in a large part due to concerns over the stability of the euro and these countries economies and governments. This highlights the need to address the structural flaws in the euro, improve the business climate in these economies and create a banking union.

6) You cannot have a currency with 17 Germanys: All the above said, you clearly cannot have a bloc of countries, which trades significantly with each other, all focused on creating an export model. Where would the demand come from? Clearly, Germany alone cannot provide it and being entirely reliant on external global demand is a risky strategy.

Other points to keep in mind include:

•  An obvious point which seems to be missed is that, the current account deficits of these countries have decreased while Germany's surplus has not. If it was the flip side of these deficits then it would automatically fall. The relationship between the two has become detached as Germany and other countries have taken a more global outlook.
• A weaker euro which is often also targeted in this type of debate would probably aid Germany more than others given its export base. This is linked to the impact looser ECB monetary policy which would probably weaken the euro - as such it seems strange for certain politicians to push for such action.
• To be fair to the US, it is far from alone in raising this point - the IMF and Commission have both mentioned it. That said, a singular country, even one the size of the US, commenting on another’s economic policy is different to an international institution or private sector commentator doing so.
• Germany is also not alone in coming in for flak, as has been happening for some time, the US also hits out at China's excessively weak currency.
• Martin Wolf makes a wider point, that Germany is hampering global demand. This seems more valid since it is increasingly turning away from trade with its euro partners to elsewhere.

We have pointed out many time that imbalances are a big problem in the eurozone. There is no doubt some rebalancing is needed. The Economist Free Exchange blog makes a good point, that this can be done through reforms such as tax cuts and opening up markets which would not impact competitiveness directly but would boost demand. There is also no doubt that Germany's and the eurozone's handling of the crisis has been less than stellar, as we ourselves have noted many times.

That said, pushing much of the blame onto Germany's current account surplus seems a bit misguided. Some correction is needed but it alone is far from enough to have a sizeable impact in reversing the crisis. That is exactly why more concrete progress on the banking union, structural reforms and reducing the democratic deficit is needed in the eurozone.

US-EU free trade deal could be collateral damage of latest NSA allegations

So we wondered what the big story of the European Council would be. Now we have the answer: Merkel’s cell phone. Der Spiegel today alleged that Merkel's phone may have been targeted by US security services. Merkel called President Obama to make clear that she "unequivocally condemns such practices” and was told that the US is not monitoring and will not monitor her communications (which as German media commentators have identified leaves open the possibility that this could have taken place in the past). The US Ambassador in Berlin was also summoned for a dressing down which follows similar action taken in France over allegations the US also spied on French diplomats.

Because this issue has been hyped-up by the media, this has the potential to be more damaging to Anglo-Saxon-Continental relations than arguably any other episode since the Iraq war - and there are lots of things going on here.

Civil liberties vs. security: As ever, this encapsulates the very sensitive trade-off between the obligation of the state to ensure the security of its citizens and the right of the citizens not to have the state arbitrarily snooping in their business. The Germans – given the painful memory of Stasi and Nazi surveillance – are particularly sensitive to this (and that the German Chancellor herself is the alleged victim adds fuel to the fire). Forget everything else on the agenda of the EU summit today, this is what really is creating the headlines in Germany.

Data protection - EU vs national: Some EU leaders and politicians - including Justice Commissioner Vivianne Reding (for whom this issue is like ideological steroids) are keen to use the long planned overhaul of EU data protection rules to enforce greater EU-level safeguards, though the link to the tapping of Merkel's phone isn't entirely clear. France and Poland are reportedly keen on fast-tracking this issue through the EU legislative process while others including the UK and Scandinavian countries countries are less keen. Germany has not committed itself either way (although German Interior Minister Freidrich said the current version would have to be revised).

The UK vs France: However, the same Data Protection Directive that France wants to pass also featured in the recent UK business taskforce report as an example of EU rules which hurt innovation and growth, and argument echoed by Rohan Silva in today’s Times. Medical research charities have also warned that the new rules - specifically a series of amendments tabled by the Green MEP Jan Philip Albrecht - could starve them of the data they need to work on new treatments. So this issue might also indirectly pit the UK versus France.

Germany vs. the Anglo-Saxon world: This is a critical one - any souring of relations between the US and Germany is bad news, and the UK could well be implicated by association (remember Tempora). The thing to watch out for will be the impact on the EU-US free trade deal currently under negotiation (TTIP) as Germany could now well insist on various complicated privacy safeguards and guarantees which Obama will have hard time delivering (not least since getting a deal past Congress perceived as undermining national security could prove very tricky). If TTIP were to fail, it would embolden those claiming that the UK needs to leave the EU to maximise global trading opportunities,

This is also putting Cameron in a very awkward position as he doesn't want to offend either the Germans or the US - but he'll most certainly be pressed on taking a position.

Secondly, the European Parliament – which also needs to approve the final deal – may see an opportunity here to hijack TTIP to exert its own power. The EP has form on privacy and civil liberty issues, as seen by its attempt to take SWIFT hostage. In fact, SWIFT itself could be complicated by the accusations against the US (we’re not saying that the EP doesn't have any valid arguments in this area).

So this is an episode that most certainly will reverberate for quite some time.

Frenchelon: Is France really shocked it might be spied on?

I am shocked to find that the US has been spying

Earlier in the week President Hollande was calling for the EU USA trade talks to be broken off following allegations of US spying.

Today Le Monde reports on "Révélations sur le Big Brother français" which details the French Direction générale de la sécurité extérieure (DGSE)'s world wide spying network nick named 'Frenchelon' which includes their own version of the US system PRISM, which, according to Le Monde, includes a giant computer storing data gleaned from phones. Interestingly their network also includes a base at Mutzig conveniently close to the German border!

So what do we make of this? Well obviously, unless they are very poor spies, the French and US/UK operations know what each other are up to. So why call for the trade talks to be stopped? Well perhaps you never wanted them in the first place... Will Hollande now go quiet?

French ship: Dupuy de Lôme - giant golf anyone?

Would an 'independent' UK get a better US trade deal than the EU?

Could the UK sucessfully negotiate a trade deal with the US?

Yesterday MEPs voted on a resolution to back defensive measures to exclude cultural and some agricultural products, such as genetically modified foods from a proposed free trade deal with the US (TTIP).

Understandably US farmers have already taken exception to what they see as EU protectionism. This raises concerns that the potential gain from an EU/US trade deal may be watered down, delayed or even blocked all together by vested interests on both sides of the Atlantic.

As a member of the EU the UK's foreign trade is governed by the EU's common commercial policy and so has to be done via an EU deal. After the EU the US is the UK's most important trading partner. Some involved in the UK-EU debate - particularly Outers - suggest that if the UK left the EU it could negotiate a deal with the US on better terms than it could potentially gain via the EU. But is that the case? Here are some of the factors that could be important.

UK exports to the US in £bn (ONS 2011) are big...

A mismatch in negotiating power. Although the UK exports a lot to the US, as a % of it's total exports, the US sends only 4% to the UK. So although a trade deal should be mutually beneficial, reaching a solution would be disproportionately in the UK's interests. Therefore, there would be an imbalance of negotiating power. For this the EU's weight could help on issues where the UK's interests are aligned with it.

Would the US want to go through the hassle? Given this asymmetry, and the relative small market the UK is for the US, one question is if the US would go through all the political hurdles -  approval in Congress, taking on the unions etc. Indeed, talk to people in Washington and there's some scepticism about this. (However, the US has signed agreements with 23 states, some very small, so perhaps it is more a matter of the terms you would get?)

But US exports to UK (US BEA 2011) are small...

Fewer protectionist hold ups. At the same time, the US and the UK are more compatible economies than are the US and EU. The UK negotiating on its own account would not be hindered by protectionist issues emanating largely from France and MEPs, that could hold up US agreement or require concessions, such as the protection of agriculture, genetically modified foods or geographical indicators. However the UK is still unlikely to wish to see the US allowed to subsidise its agricultural exports, so tough negotiations would still be required.

Access for financial services could be a tough negotiation. The UK negotiating with the US on financial services would come up against a powerful US lobby attempting to protect its banks from what is New York's main rival - London. However, the UK negotiating on its own would arguably have a better chance to strike a deal on 'reciprocity' with US funds, a more generous arrangement than that which currently exists under regulations such as the AIFM Directive or UCITS. Additionally the UK would not bear the burden of having risky eurozone banks getting in on the deal. In recent negotiations with Singapore the US gained a better deal than the EU on financial services, partly because while Singapore was happy with UK banks it was wary of giving access to all eurozone banks (a big untold story in all of this).

If the idea is that an 'independent' UK can automatically join some gigantic Transatlantic free trade zone, in place of its current EU membership, there will be plenty of hurdles and a good deal is by no means guaranteed. Added to that there's also the small matter of negotiating an equivalent free trade deal with the EU....

Lord Renwick: If Margaret Thatcher were Prime Minister today she would seek major reform of the EU before contemplating withdrawal

In a short piece for Open Europe's fortnightly bulletin, Lord Renwick, a key former advisor to Margaret Thatcher, argues that if the Iron Lady held office today, she would seek major EU reform before considering a 'Brixit'.

Margaret Thatcher argued relentlessly against the enterprise-stifling effects of EU centralism, hyper-bureaucracy and over-regulation.  She foresaw with critical clarity the economic disaster that would overtake the weaker members of the eurozone, unable to remain competitive by devaluing their currencies.  She would not accept that the British economy could not thrive outside the EU: that would depend on the policies British governments then pursued.  She would and did accept, however, that Britain’s influence would dwindle outside the system, both in Europe and beyond, including with the United States.

If reincarnated as prime minister today, it would be uncharacteristic of Mrs Thatcher not to make a huge effort to change the EU, before contemplating abandoning it. She would be certain to seek to launch a crusade with Angela Merkel, the Dutch and Swedish prime ministers and some of the Eastern Europeans to change the direction of EU policy. This would emphasise fostering growth and jobs, restoring competitiveness, and safeguarding the rights of the EU member states outside the eurozone. Only then, would she decide whether enough had been achieved to render continuing membership worthwhile.

Lord R. Renwick's “A Journey with Margaret Thatcher: Foreign Policy under the Iron Lady”, will be published by Biteback next week.

Seven reasons for optimism?

Swedish Finance Minister Anders Borg – top of the pile in Europe according to the FT – today gave the EU committee of the Swedish Riksdag the lowdown ahead of Monday’s meeting of EU finance ministers (in some countries, lo and behold, ministers are actually accountable to their parliaments for what they say and do at EU summits). Amid all the gloom and doom, Borg outlined seven reasons to now be more optimistic about the state of the European economy:

1. The risk posed by Greece to European banks has been substantially reduced

2. The ECB has taken strong actions

3. The talks with private creditors over a Greek debt write-down are about to be concluded

4. The Italian government is pushing ahead with reforms

5. The Spanish government is pushing ahead with reforms

6. A solid recovery in the US

7. The Chinese government believes that its growth will remain relatively strong in 2012

Enough to believe that the worst is behind us? You decide.

Ps. For some Friday 'entertainment', you may wish to check this out - a rather odd sample of Swedish humour....

Lessons from Europe

Last week, Open Europe participated in a discussion in Washington DC hosted by the Heritage Foundation, looking at the debt and deficit spiral haunting both the US and Europe. The discussion can be viewed here.

In a note published last week, in tandem with the Heritage Foundation’s Sally McNamara and J.D. Foster, we also outlined ten economic lessons from Europe. We noted,

The primary lesson from the Eurozone sovereign debt crisis is that running large deficits and accumulating debt with no indication of changing will always translate into higher interest payments and likely higher interest rates, meaning more tax revenue will be consumed just paying for past fiscal sins. Greece, Ireland, and Portugal are now facing interest rates of 13 percent, 10 percent, and 9 percent, respectively, and still face the very real possibility of defaulting.

The U.S. is on dangerous ground by not tackling its current and future deficits with enough urgency. The Obama Administration seems to be relying on markets continuing to provide it with near unlimited liquidity at reasonable rates. But this cannot last forever. Even absent a fiscal correction, interest rates are widely expected to rise substantially in the next few years as the global economy rebounds. For example, the Administration forecasts a rise in the 10-year Treasury rate of 230 basis points. Add in the ongoing deficits, and investors will eventually give the United States the Irish treatment, raising the cost of borrowing much more.

Read the full note here.

Eurotrashed

In a letter to today's International Herald Tribune, Former US ambassador Alfred Kingon summarises the situation facing the euro and the EU:

When I was the United States ambassador to the European Union (then the European Communities) in the late ’80s, as preparation for the advent of the euro was taking place, the crosscurrents were strong and visible. It couldn’t possibly succeed, as predicted by many, without a finance ministry for all of Europe, not possible then or foreseeable now.

A real look at European debt, which is far greater than the narrowly reported official deficits, bodes badly. Bailouts are being affected by the imposition of rising and unsustainable interest rates. Just look at recent bond yields in Portugal, Ireland and Greece. And what will happen when more onerous austerity programs are initiated to meet new budgetary targets? Will the E.U. survive? Of course it will. It has succeeded in quelling thousands of years of internal warfare. But the euro and current E.U. structure — well, that’s another matter.

Spot on.