Germany’s domination of the EMU is clear both in political and economic terms. The current political impasse within Germany will not change that. Once resolved the on-going government will continue in the same vein – running excessive fiscal surpluses and huge external surpluses. It can sustain those positions because it dominates European policy and can force the adjustment to these overall ‘unsustainable’ positions onto both its own citizens (lowering their material living standards), and, more obviously, onto citizens of other EMU nations, most noticeably Spain and Greece. If it couldn’t bully nations like Greece, Italy, Spain and even France, Germany’s dangerous domestic strategy would be less effective. If all EMU nations followed Germany’s lead – then there would be mass Depression throughout Europe. This dangerous and ridiculous nation is a blight. Only by exiting the Eurozone and floating their currencies against the currency that Germany uses can these beleaguered EMU nations gain some respite. When the Europhile Left come to terms with that obvious conclusion things might change within Europe.
I have written about Germany several times and the following blogs are a selection as background to today’s blog:
2. Wolfgang Schäuble is gone but his disastrous legacy will continue (October 16, 2017).
3. The chickens are coming home to roost for Europe’s so-called powerhouse (August 10, 2017).
4. More Germans are at risk of severe poverty than ever before (July 6, 2017).
5. German trade surpluses demonstrate the failure of the Eurozone (April 24, 2017).
6. The European Commission turns a blind eye to record German external surpluses (October 31, 2016).
The following graph (using IMF WEO data) shows the sectoral balances for Germany from 1991 to 2017 (the last year is estimated).
It is an extraordinary graph really in the context of Germany’s integral role in the Economic and Monetary Union (EMU). Germany is part of a currency union and its outcomes are much more closely tied to the fortunes of its EMU partners than say a nation, such as Australia, which has its own currency and floats it on international markets.
What you see are two distinct EMU periods, when Germany was in gross violation in one way or another of the Treaty rules (laws).
The first violation came soon after the EMU started.
Germany violated the Stability and Growth Pact fiscal rule (maximum deficit 3 per cent of GDP) along with France.
Germany was one of the first nations to transgress the rules along with France. By early 2002, German economic growth was fairly subdued with a further slowdown likely. It was also absorbing the fiscal consequences of German reunification.
On January 30, 2002, the European Commission, acting under the Excessive Deficit Procedure (EDP) rules, gave Germany an early excessive deficits warning and demanded a balanced budget position be met as soon as possible despite understanding that if the German economy slowed any further, the deficit would rise further.
A similar narrative was followed for France, which was also enduring recession.
Sure enough, the mindless fiscal austerity that Germany adopted within the recession-biases of the SGP caused its economy to slow further. Millions lost their jobs as a result, while others increasingly found their jobs becoming more precarious and their wage prospects suppressed.
If there was ever a time for reflection on how damaging the EMU structure could be, then this period should have been it.
I document in detail what happened as the European Commission and Council came into conflict over this issue in November 2003 in this blog – Options for Europe – Part 97.
I also covered the history of these violations in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale.
Essentially, Germany conspired with France (Schröder and Chirac) to set the Council (via Ecofin) against the Commission to force the latter change the rules relating to the SGP (forced through via the Treaty of Lisbon), which avoided Germany being punished for three consecutive years of Treaty violation.
The point was that the violations were sensible – the deficits were above the 3 per cent threshold because of the impacts of Germany reunification and recession – and it was the application of the rules were irresponsible.
It was the rules that made no sense, and endure today even more perniciously – just look at Greece. But Germany’s position showed its own hypocrisy (being a major agent in establishing the harsh, unworkable rules in the first place) and the untenable nature of the core EMU policy infrastructure.
The second violation has emerged since the GFC in the form of the external surpluses combined with fiscal surpluses, which have created serious imbalances within the Eurozone.
It is not overstating the case to say that the increased poverty and hardship for citizens within Europe is directly related to the German government’s obsession with fiscal and external surpluses and its intransigence when confronted about this.
Germany has become a dangerous yet ridiculous nation.
While the Financial Times article (December 22, 2017) – The fiscal surplus that Germany should spend – referred to “Germany’s fiscal surplus” as an:
… a chronic embarrassment of riches …
I would prefer to refer to it as an embarrassing example of policy vandalism and an illegal assault on the rules that Germany has signed up to follow.
Why illegal? Because it is directly related to Germany’s violation of the Macroeconomic Imbalance Procedure, which specifies under its so-called Scoreboard Indicators that the “major source of macroeconomic imblances” includes a:
3-year backward moving average of the current account balance as percent of GDP, with thresholds of +6% and -4%
So the upper warning threshold (for an external surplus) is 6 per cent of GDP.
Imbalances are meant to trigger “the alert mechanism report (AMR)” – the latest being issued on November 22, 2017 – 2018 European Semester: Alert Mechanism Report.
We read that “large current account surpluses persist … in Germany and … continue to exceed the threshold as they have done for several years … Germany, Denmark and the Netherlands are currently recording surpluses well above what can be explained by economic fundamentals”.
Relatedly, we read that “The growth in unit labour costs in a number of net-creditor countries … remained overall moderate in 2016, having cooled somewhat in Germany against the backdrop of subdued wage dynamics, despite the tightening labour market.”
Further, “The combined large surpluses of Germany and the Netherlands account for almost 90% of the current level of the aggregate euro-area surplus”.
Some Member States are characterised by large and persistent current account surpluses that while reflecting their strong competitiveness reflect also, to a varying degree, subdued private consumption and investment … The large and persistent surpluses may imply forgone growth and domestic investment opportunities. In addition, the shortfalls in aggregate demand bear consequences for the rest of the euro area in a context of still slack in activity and below-target inflation.
Germany was experiencing macroeconomic imbalances, in particular related to in its large current account surplus reflecting excess savings and subdued investment.
The facts from the graph above are obvious:
1. Germany has been running current account surpluses above the allowable threshold since 2011 – averaging 7.5 per cent of GDP since then and averaging 8.3 per cent of GDP over the last three years.
2. It has been running fiscal surpluses since 2014, 0.6 averaging per cent of GDP since then.
3. The two aggregates are intrinsically linked via national income changes (see below)
4. There are no policy shifts foreshadowed that would suggest anything is going to change much.
The causal links between the balances is clear.
By suppressing domestic demand – public and private consumption and capital formation investment – through its attacks on wages growth and fiscal austerity, Germany stifles imports.
For example, since the German mark disappeared (March 2002), exports have grown by 106.7 per cent while imports have grown by 101.4 per cent (noting that in the March-quarter 2002, there was already a substantial external surplus – 1.9 per cent of GDP).
What happens if a nation exports more than it imports (ignore, for simplicity, the income side of the current account)?
The net outflow of real goods and services would be accompanied by accumulating financial claims against the rest of the world.
This is because the demand for the nation’s currency to meet the payments necessary for the exports would exceed the supply of the currency to the foreign exchange market to facilitate the import expenditure.
How might this imbalance be resolved? There are a number of ways possible.
A most obvious solution would be for foreigners to borrow funds from the domestic residents. This would lead to a net accumulation of foreign claims (assets) held by residents in the surplus nation.
Another solution would be for non-residents to draw down local bank balances, which means that net liabilities to non-residents would decline.
Thus a nation running a current account surplus will be recording net private capital outflows and/or the central bank will be accumulating international reserves (foreign currency holdings) if it has been selling the nation’s currency to stabilise its exchange rate in the face of the surplus.
Current account deficit nations will record foreign capital inflows (for example, loans from surplus nations) and/or their central banks will be losing foreign reserves.
Large current account disparities emerged between nations in the 1980s as capital flows were deregulated and many currencies floated after the Bretton Woods system collapsed.
European nations such as Germany, the Netherlands and Switzerland were typically recording large and persistent current account surpluses and with a significant proportion of their trade being with other European nations, the imbalances grew within Europe as well as between Europe and elsewhere.
Think about the sectoral balances arithmetic. If a Member State achieve a balanced fiscal outcome and is sitting on the current account surplus threshold (6 per cent), then its private domestic sector will be saving overall 6 per cent of GDP.
Where will those savings go?
I have discussed how Germany maintained its external competitiveness once it could no longer manipulate the exchange rate in previous blogs.
The savings may go into the domestic economy if there are profitable opportunities to invest. But in Germany’s case, its whole strategy was based on suppressing domestic demand (Hartz reforms, wage suppression, mini-jobs etc), and so profitable investment opportunities were limited in the German economy.
As a result and capital sought profits elsewhere.
The persistently large external surpluses which began long before the crisis (and 6 per cent is large) were the reason that so much debt was incurred in Spain and elsewhere. German investors pushed capital externally.
Germany is clearly supplying large flows of capital to the rest of the world.
The combination of domestic demand suppression and huge external surpluses means that Germany’s outflow of capital is ridiculous.
Have a look at the following graph, which show the evolution of Germany’s real GDP and domestic demand (consumption and investment) since the March-quarter 1995 to the September-quarter 2017 (Eurostat National Accounts data).
They are indexed to 100 at the March-quarter 2000.
Since that time, GDP in Germany has grown by 25.3 per cent, whereas domestic demand has grown by just 16.5 per cent (in real terms).
There are two very interesting things about the graph apart from the divergence between total spending (GDP) and domestic-based spending (domestic demand).
First, you can see the suppression of domestic demand began soon after the inception of the euro – the Hartz devastation.
Second, look what happened after 2011, as the fiscal austerity moved into top gear. While real GDP grew on the back of the growing exports, domestic demand fell between June 2011 and June 2013, further exacerbating the Eurozone crisis.
That evolution was the result of deliberate policy positions taken by the German government.
By deliberately constraining the standard of living of its citizens and undermining its own public and private infrastructure, the German government has also damaged its EMU partners.
To resolve this problem (which is a massive imbalance between domestic saving and investment), Germany requires higher domestic demand and faster wages growth both to boost the very modest consumption performance and to attract investment into the domestic market.
It also could stimulate public spending – say, to start the long process of restoring quality to its public infrastructure which has been seriously degraded by the austerity mentality of successive German governments.
But such a change would be at odds with the mercantile mindset that dominates the nation because it would reduce the competitive advantage that Germany enjoys over other nations that have treated their workers more equitably.
And, the European Commission has not acted to stop Germany gaming the system even further.
The European Commission’s – Macroeconomic imbalance procedure – is an integral part of its economic and fiscal policy coordination governance and:
… aims to identify, prevent and address the emergence of potentially harmful macroeconomic imbalances that could adversely affect economic stability in a particular Member State, the euro area, or the EU as a whole.
But, as we have learned, the European Commission is good at bullying the weaker nations, who feel inferior members of the
‘European Project’, but won’t lay a glove on Germany.
That is why realistic progressive reform in the Eurozone will not be possible.
On May 10, 2017, the German Finance Ministry took the (extraordinary) step of publishing an English-language article on their WWW site (under Financial Markets) – The German current account in the context of US-German trade.
The article was an attempt to deflect criticism of its export-led obsession and was published in tandem with the German Ministry of Economic Affairs.
The Finance Ministry wrote:
Germany’s current account surplus has been garnering criticism for years … [this] … joint position paper … explains the reasons behind Germany’s current account surplus and outlines the fiscal and economic policy options.
It states that:
As a member of the European Union, Germany does not pursue independent trade policy: Trade policy falls within the competency of the EU. The German government’s policy is in line with all international trade agreements and treaties; in particular Germany policy complies with WTO requirements.
Which gives the impression that they are passive adherents to externally set rules – depoliticisation in action here.
No mention of the aggressive internal devaluation policy (so-called Agenda 2010) that Gerhard Schröder followed in the early days of the Eurozone (Hartz attacks on social welfare and the creation of Minijobs).
We read that “Fiscal and economic policy in Germany aims at strengthening domestic growth and creating favourable conditions for a competitive economy.”
Clearly, if that was true then the external surplus would decline as imports rose and rising wage levels altered real exchange rates (measures of international competitiveness).
But the German government is always keen to massage facts.
For example, it claims that:
… domestic demand has been the main driver of German growth for several years now.
Which belies reality.
Since Germany resumed growth in the June-quarter 2009, real GDP has grown by 19.1 per cent up to the September-quarter 2017. The contribution of domestic demand to that growth has been just 5 percentage points.
Further, household consumption spending, which in many nations is above 65 per cent of total spending (GDP), in Germany it is now down to 52.8 per cent in real terms.
Since 1995, it has dropped by more than 5 percentage points.
Capital formation (investment in productive capacity) has also fallen significantly over recent years as a share of total spending.
The huge external surpluses are then not reinvested domestically because home sales growth is suppressed.
The impact on other nations is clear.
The huge German external surpluses are mirrored in other nations as external deficits, which drain spending and growth. To ensure employment and output growth is maintained, the non-government sectors in these nations then have to increase their external debt levels and run fiscal deficits.
While that is not necessarily an issue for currency-issuing nations (depending on private debt levels), it is a really huge issue for Germany’s EMU partners, such as Spain, Italy, Greece, Portugal etc.
The external and fiscal deficits for those nations are unsustainable within the shared currency zone. We have all seen the consequences of that as the GFC unfolded.
It is true that the “the German current account surplus is mainly the result of market-based supply and demand decisions by companies and private consumers on global markets.”
But it is equally true that government policy that deliberately suppresses wages growth and creates precarious employment, while at the same time, cutting expenditure growth in areas of public infrastructure development, also reduce imports and create few local private investment incentives.
While the German Finance Ministry claims that “German fiscal and economic policy have no direct influence on, such as temporary factors including the euro exchange rate or global commodity and energy prices” it ignores the fact that Germany’s trade is so dominant in overall Eurozone relations with the rest of the world that it influences on the trajectory of the euro is clear.
If the German government embarked on a large infrastructure project and significantly pushed up wages growth, then imports would rise, the current account would fall and the euro would fall somewhat.
Even the majority of German people think that would be desirable.
In a Deutsche Welle report (November 11, 2016) – Merkel pledges budget increases for infrastructure in election year – we learn that:
In a poll carried out by public broadcaster ARD in September, 58 percent of the electorate supported spending additional tax revenue on infrastructure, while only 22 percent favored debt reduction and 16 percent called for tax cuts.
I have previously written about the infrastructure crisis in Germany – Massive Eurozone infrastructure deficit requires urgent redress.
As the Financial Times article (cited above) notes:
Within a single currency area, where the peripheral economies have had to undertake a real depreciation to restore competitiveness, a relative rise in German prices means the adjustment can be achieved without painful reductions in prices and nominal wages elsewhere.
Which negates the arguments of the likes of Wolfgang Schäuble and the vast majority of German economists that inflation would accelerate if the fiscal surplus was lower or wages restraint was relaxed.
And, the FT concluded:
But in a country desperate for investment it would be better all round for Germany to ease back on public finance surplus fetishism and make more creative use of its bounty.
Germany’s domination of the EMU is clear both in political and economic terms.
The current political impasse within Germany will not change that. Once resolved the on-going government will continue in the same vein – running excessive fiscal surpluses and huge external surpluses.
It can sustain those positions because it dominates European policy and can force the adjustment to these overall ‘unsustainable’ positions onto both its own citizens (lowering their material living standards), and, more obviously, onto citizens of other EMU nations, most noticeably Spain and Greece.
If it couldn’t bully nations like Greece, Italy, Spain and even France, Germany’s dangerous domestic strategy would be less effective.
If all EMU nations followed Germany’s lead – then there would be mass Depression throughout Europe.
This dangerous and ridiculous nation is a blight.
Only by exiting the Eurozone and floating their currencies against the currency that Germany uses can these beleaguered EMU nations gain some respite.
That is enough for today!
(c) Copyright 2017 William Mitchell. All Rights Reserved.