The US Treasury is too soft on Germany’s imbalances

The U.S. Treasury is to be complimented for now including Germany in its most recent currency report to Congress — along with China, Japan, Korea and Taiwan — on a new list of countries to be monitored by the Treasury for possible currency manipulation. However, it is to be regretted that the Treasury does not offer a real analysis of the underlying causes of the large German external current account surplus. More disturbing yet, the Treasury does not come up with real recommendations as to how Germany’s large external imbalance is to be corrected.

{mosads}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 in March 2016. 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. This cyclical strength would have argued for a weaker German surplus.

Surprisingly, the Treasury does not seem to view Germany’s persistently large external current account surplus as the result of an excess of that country’s domestic savings rate over its domestic investment rate. In particular, the Treasury does not draw attention to the fact that at around 26 percent of GDP, Germany’s domestic saving rate is some 10 percentage points higher than that in the United States and is significantly higher than that of its European partners. It also does not draw attention to the fact that this high overall saving rate is both a reflection of the combination of a very high household saving rate and a German government sector that is in broad budget balance.

More surprising perhaps is the fact that the Treasury does not emphasize that Germany has benefited in world export markets by tying itself to a weak euro while at the same time both improving its labor productivity and holding down its wage costs. This has consistently given Germany a cost advantage in global markets that has been a driving force for the country’s robust export sector.

The Treasury’s lack of emphasis about Germany giving its exporters a free ride in international markets by tying the country to the euro is all the more regrettable considering the euro’s immediate outlook. It is all too likely that the euro will continue to depreciate as the European Central Bank steps up its unorthodox monetary policy measures in an effort to jump-start an anemic European economic recovery and stave off the threat of deflation.

Having failed to make a real diagnosis of Germany’s external current account surplus problem, it was perhaps to be expected that the Treasury would be rather meek in its policy recommendations for that country. All that the Treasury seems to require of Germany is that it makes greater use of the fiscal space it has at its disposal to help add to global aggregate demand. If the past is any guide, the German government will strongly resist such recommendations on the grounds that this would run the risk of stoking up German inflation.

The truth of the matter is that a real solution to Germany’s large external imbalance would require a combination of domestic policy measures to reduce Germany’s very high domestic savings rate (both household and public) as well as to have the German economy have a very much more appreciated currency than it now has. Such an appreciation would be needed to eliminate the unfair competitive advantage the country now enjoys in world export markets.

Since there is virtually no prospect that Germany would get a more appreciated currency within the euro, one might have hoped that the U.S. Treasury would not have shied away from recommending that Germany should exit the euro and reintroduce a more appreciated Deutsche mark. Failing to do that, it is difficult to see how Germany’s external imbalance gets corrected without a burst of German inflation, which the country will continue to resist strongly.

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.