Trump shouldn’t buy Merkel’s euro excuses

When German Chancellor Angela Merkel visits Washington next week, she must be expected to argue that Germany’s large trade surplus is beyond her control and that her country has little influence over the euro’s exchange rate.

President Trump should not buy that argument. However, he should recognize that his administration’s policies could have an important influence on the exchange rate between the dollar and the euro and on the U.S.-Germany trade balance.

At the heart of the rising trade policy tensions between the United States and Germany is the latter’s external current account surplus. The International Monetary Fund estimates that during 2016, Germany had the world’s largest current account surplus, which amounted to almost $300 billion, or around 8.5 percent of gross domestic product (GDP).

This current account surplus well exceeded that of much-maligned China, which amounted to around $245 billion, or around 3 percent of GDP.

{mosads}The Trump administration is arguing that an important factor underlying Germany’s very large trade surplus is the relatively cheap value of the euro. It is arguing that by linking its currency via the euro to that of the weaker Southern European countries, Germany is gaining an unfair competitive advantage vis-a-vis the rest of the world.

The Trump administration correctly points out that had Germany not been in the euro, the Deutsche mark would almost certainly have appreciated substantially against the dollar.

Merkel is now disingenuously arguing that her country has little influence over the euro’s value. She points out that the euro’s value is largely determined by the policies of the independent European Central Bank (ECB), over which Germany has little influence. She is also bound to point out to Trump the enormous damage that would be caused to the global financial system by any suggestion of Germany leaving the euro.

The weakness in Merkel’s argument is that she chooses to gloss over the influence that Germany’s over-restrictive budget policy has on the ECB’s monetary policy decisions. By insisting both on balancing its own budget and on imposing budget austerity on the rest of the eurozone, Germany is contributing to a situation in the eurozone in which there has been a persistent shortfall in aggregate demand.

It is precisely due to this demand shortfall that the ECB has been forced to engage in its highly unorthodox monetary policy that has had the effect of substantially reducing European interest rates and weakening the euro’s value.

In his meeting with her next week, Trump should call out Merkel on her country’s very restrictive budget policies. He should point out that looser budgetary policies on Germany’s part, coupled with less insistence on budget austerity in countries in the eurozone’s periphery, would go a long way toward allowing the ECB to phase out its current quantitative easing policy. That, in turn, would help support a euro appreciation and the reduction of Germany’s outsized trade surplus.

However, before Trump goes down that route, he should recognize that the highly expansive budget policy his administration is proposing for the U.S. would have the effect of causing the dollar to appreciate and the U.S. trade deficit to widen. Hopefully, that recognition will lead him to the conclusion that the best way to address Germany’s large bilateral trade surplus with the U.S. is not by beating up on Germany for its alleged currency manipulation.

Rather, it would be by seeking budget policy coordination between Germany and the United States that would involve a more expansionary budget policy for Germany and a more disciplined budget policy for the United States.

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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