Recently global trade balances and free trade enjoyed the undivided attention of policymakers, economists, businessmen, and voters all around the globe. With the G20 summit just ended in Hamburg, leaving the city in devastation, it seems that global trade just got new champions. While in the second half of the twentieth century Washington was the main advocator of open trade borders, it seems that the EU with Germany in the lead and China take the role. As the baton is getting passed, even free trade advocators made an outcry about imbalances in international trade.
The gold standard revisited
As my good friend pointed out, Germany’s trade surplus doesn’t primarily flow to the EU periphery. In fact, if any members should be blamed for destabilising the monetary union it should be the Dutch. However, the Netherlands runs the biggest surpluses against the German and the British. Using the logic of the Economist, the former one cannot complain, while the latter is not in the monetary bloc, hence currency movements should be able to offset imbalances.
The main issue of critics regarding the monetary bloc is that in its current form the Eurozone is technically a fixed exchange rate system, where the fixed ratio happens to be one to one. We have seen fairly similar circumstances in the 1920s, after European countries tried to return to the gold standard. Due to different implementations of the return – fixing exchange rate or returning to pre-war price levels – some countries gained a competitive advantage compared to their peers trying to curb inflation by conducting pro-cyclical policies. Such imbalances does not necessarily imply a modern way of mercantilism, as long as the nations, foreign institutions and individuals are willing to lend to each other. The problem – just as in the case of a domestic crisis – is the ebb of liquidity or lost trust in the counterparty… and when the tide goes out we discover who’s been swimming naked, as we know.
So why is Germany’s surplus a problem? Not because it might leave Southern members in debt, but because German companies and states are reluctant to lend to the periphery. What remains is either paying in cash, leading to effective mercantilist trends and deepening deflationary forces on the periphery, or selling capital (real estate, companies, etc.) to German counterparties. While to former one seems unattractive since it demonetizes the economy, the latter one rather receives resistance due to populist arguments.
The back-up plan
As exchange rates have fixed relative prices, real effective exchange rates must adjust through internal devaluation. Expressing it using human language: Germany must become more expensive compared periphery prices if we want to equate trade balances. The ECB got a plan for that, namely conducting idiosyncratic monetary policy. Supporting the periphery with cheap euro and low rates, while also overheating the German economy with the same measures.
The problem is German financial culture is anti-debt. Despite the ultra-low rates nor the government, nor the private sector rushes through the door to get new loans. However, the rest of the Eurozone has no problem with hoarding debt.
Gresham’s law with a twist
Bad money drives out good. It’s not any different when it comes to ‘Italian Euros’ and ‘German Euros’.
The ECB’s monetary policy resulted further undesirable consequences on top of the counterproductive debt trends. As part of the QE programme private investors government bonds are getting purchased by the ECB and local arms, meanwhile they receive deposits in exchange. The problem is that it is not central bank deposit, but belongs to commercial banks. As some periphery investors don’t trust these banks over solvency issues, they rather take their money and put it into a core bank. Eventually this fund will flow back to the periphery, using interbank channels involving ECB guarantee. Not even the rest of the Eurozone wants to fund itself, why would the Germans?
Balance of payments?
As a result of general rejection of taking debt of the protestant business culture, Germany was not as good at ramping up non-financial debt as the remaining of the Eurozone. High savings rate can simultaneously keep wages competitive and the trade balance in surplus. At the same time, German businesses and institutions are struggling to find an acceptable counteroffer, as they don’t really want consumer goods or periphery debt. Capital account redemptions – currency or physical capital – only offer temporary solution, just as the inter-state lending.
Who to be blamed? Nobody. You cannot blame the lender if they are not willing to lend to a client with deteriorating credit rating. Nor can you accuse the upper-middle class with being careless if they don’t want to bail out the economy using their savings during a recession, and say ‘they should consume more’.
The gold standard broke down once countries ceased to be willing to lend each other. Today is not different. The Eurosystem helps to mitigate the risk for now, but the first bank failure could undermine the trust if (among others) German taxpayers had to recapitalise the ECB. The only accusation you can make is against German ignorance towards the realisation that in one form or another Germany has to foot the bill sooner or later.