A striking feature of a US election campaign focused on the supposed ills of globalization is how little attention is being drawn to Germany’s extraordinarily large external current account surplus. This is all the more surprising considering how much larger are Germany’s external imbalances in relation to those of China.
While the IMF now estimates that China’s external current account surplus might be some 1 to 3 percent of GDP above an appropriate level, it estimates that Germany’s is some 3 to 6 percent of GDP too high. Similarly, while the IMF considers that after years of appreciation China’s exchange rate is now approximately at an appropriate level, it considers that the exchange rate Germany faces is now between 10 and 20 percent too low for that country.
That Germany is running a disturbingly large external imbalance is hardly open to question. According to the most recent official balance of payments data, Germany’s external current account deficit rose to the highest level on record. It is now on track to remain above 8.5 percent of gross domestic product for the year as a whole, which would be around three times the size of 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 constitutes 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 makes 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. Such solutions range from requiring of Germany to undertake a greater degree of public infrastructure spending to boost investment or having the German government encourage higher wages from the corporate sector to boost consumption and to make the country less competitive.
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 overall 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 current account imbalance for a protracted period of time. Meanwhile countries in the European periphery should brace themselves for continued tough sledding in their efforts to reduce their economic imbalances.
This piece was published originally in Economics 21, a website of The Manhattan Institute.