A welcome debate seems to have started in the United States as to what should be done about Germany’s inordinately large external current account surplus. However, it is to be regretted that in this debate little attention is being focused on the free ride that Germany continues to get from tying itself to a weak Euro. Without a basic change in German exchange rate policy, there is every prospect that the German current account surplus will only get even larger in the period ahead.
That Germany is running a disturbingly large external imbalance is hardly open to question. According to the most recent official balance of payments data, in March 2016 Germany’s external current account deficit rose to the highest level on record. It is now on track to remain above 8 percent of gross domestic product (GDP) for the year as a whole, which would be more than twice China’s current account surplus. Making this surplus all the more troubling is the fact that it is occurring at a time when the German economy is cyclically in a very much stronger position than its European partners.
Germany’s maintenance of a current account surplus as large as that it now has would be damaging to both the global and the European economies. From a global perspective, at a time that there is insufficient global aggregate demand, a large German current account surplus would constitute a drain on aggregate demand in the rest of the world. Similarly, from a European perspective, at a time that countries in the European periphery are being required to balance their economies, the maintenance of a large German current account surplus would make that rebalancing all the more difficult.
While US analysts are now coming to focus their attention on Germany’s large external imbalance, as is the US Treasury in its latest currency report to Congress, the solutions that they are proposing to redress this imbalance are partial at best. As an example, Greg Ip of the Wall Street Journal proposes that the problem might best be addressed by having Germany somehow engineer a rise in its domestic wage level. He makes this proposal on the grounds that the German imbalance problem has its roots in excessive savings in the private sector. For his part, Brad Setser of the Council of Foreign Relations proposes that the German government take advantage of currently very low interest rates to finance a major boost to infrastructural spending.
The truth of the matter is that the very size of the German external imbalance makes it necessary to contemplate a comprehensive approach if a substantial reduction is to be made in that imbalance. Indeed, in much the same manner as the IMF would prescribe a comprehensive approach for a country to redress a large external current account deficit, so too would a comprehensive approach, albeit in reverse, be indicated for a country with a very large external current account surplus.
Two key elements would be required in such an approach. The first would be to require a substantial appreciation of the currency facing German exporters and importers. Such an appreciation would be needed both to switch resources away from Germany’s traded good sector as well as to reduce domestic savings by effectively increasing the real wage level through lowering the price of imports. The second element would be to substantially loosen German domestic fiscal and monetary policies to boost domestic demand to make up for the reduced support to the domestic economy from the external sector.
Sadly, so long as Germany remains tied to the Euro, there is little prospect that it will be faced with a stronger currency anytime soon. Indeed, with US and European monetary policies now out of sync and with the European economy still struggling, there is every prospect that the Euro will continue to depreciate. If that were to occur, there is every likelihood that Germany’s external imbalance would only increase.
It would seem that the only way that Germany can get a very much more appreciated currency would be if it were to exit the Euro. To be sure, such a move would represent a fundamental departure from current policy. However, if that move is not undertaken, the world should reconcile itself to a large German external imbalance for a protracted period of time while the European periphery should brace itself for continued tough sledding in its efforts to reduce its economic imbalances.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.
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