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German 6% Current Account Surplus Threatens Europe

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    August 15, 2012

    Germany’s current account surplus has reached six percent, an amount that bureaucrats in Brussels have decided is a threat to the entire continent. The EU commission will likely issue a warning to Germany with threats of sanctions if Germany does nothing about it.

    I picked up this story from Eurointelligence which writes “FT Deutschland reports that Germany’s current account surplus is likely to exceed 6% of GDP this year, the threshold which triggers a European Commission warning. The German government maintained its position that there was no problem with current account surpluses. On the contrary, the German economics ministry sees this a “very positive” development. The German government spokesman said yesterday that the problem of imbalances was a problem for a countries with large current account deficits.

    Mathematical Insanity

    Got that? Allegedly, large deficits are a problem but large surpluses are not.

    Given that surpluses and deficits must net to zero, the position that only deficits are a problem is ludicrous. Mathematically, both are problems or neither are problems, because you cannot have one without the other.

    Bear in mind it was not Eurointelligence that took a mathematically ludicrous position, but rather articles they referenced.

    Germany’s Surplus Could Trigger Collection Procedures 

    Let’s take a look at the Financial Times Deutschland article referenced above (translated from German and further modified by me for ease in reading)

     This year Germany recorded its highest trade surplus ever. This could crumble into the Federal Republic 2013 EU-collection procedures.

    The new macro-economic early warning system in Europe provides that a current account surplus over 6.0 percent of gross domestic product is a threat to the economic stability of the continent.

    The EU urges its members not to allow imports and exports fall apart too far. The early warning system developed Brussels to name mistakes and sanction if necessary. Since this year can be monitored in addition to the current account including private and public debt and the development of the real estate markets.

    As part of the EU early warning system Luxembourg and Sweden also have excessive surpluses. In Luxembourg, the current account surplus in 2011 was 6.4 percent of economic output – approximately $4 billion. For the same year, Germany had a surplus of over $200 billion.

    Only Deficits a Problem Says Frankfurter Allgemeine

    An article in German Daily paper Frankfurter Allgemeine, by business editor Philip Plickert says Only Trade Deficits a Problem.

     The very concept of “macroeconomic imbalances” is highly questionable.

    If countries have permanently high current account deficits and foreign debts pile up higher and higher, things may not go well. So the Euro periphery has slipped into crisis. Trade deficits were and are an expression of lack of competitiveness. Germany’s surpluses are high contrast to the special strength and structure of the local economy.

    Germany produces high-quality (investment) goods that are used in emerging countries. This is no cause for concern.

    Euro as Gold Standard

    In one of the silliest articles ever written about European trade imbalances, Joe Weisenthal writes Actually, There Is A Gold Standard Today, And It’s Causing An Economic Catastrophe.

     While it’s easy to talk about the endless crises under the gold standard days of the 1800s, the truth is that we don’t have to go back that far at all.

    Europe is a close analogue to a gold standard.

    • Remember, each European country lacks the ability to print their own money.
    • All the European countries have a fixed 1-to-1 exchange rate, with no ability to devalue their currencies to correct trade imbalances.
    • The currency is designed to keep governments accountable, acting as a check on uncontrollable spending.
    • Countries have to raise through taxation or the bond market a certain amount of Euros each year to spend.

    Bottom line, [the euro] is a hard money scheme in sheep’s clothing.

    Notion the Euro Acts Like Gold Standard is Ridiculous

    Equating the euro to a gold standard is ridiculous.

    The ECB’s (Emergency Liquidity Assistance) program acts exactly the opposite of a gold standard by allowing imbalances to accumulate to the point of crisis, a state the Euro is clearly in now.

    For further discussion, please see Target2 and the ELA (Emergency Liquidity Assistance) program; Reader From Europe Asks “Can You Please Explain Target2?”

    “The Trade Imbalance Dilemma and Soaring Chinese Debt” 

    Here are some comments from Michael Pettis that I wrote about in Hugo Salinas Price and Michael Pettis on the Trade Imbalance Dilemma; Gold’s Honest Discipline Revisited

     The strength of the German economy in recent years has largely to do with its export success. But for Germany to run a large current account surplus – the consequence I would argue of domestic policies aimed at suppressing consumption and subsidizing production – Spain and the other peripheral countries of Europe had to run large current account deficits.

    Trade Imbalances Lead to Debt Imbalances

    The funding by German banks of peripheral European borrowing, in other words, was a necessary part of deal, arrived at willingly or unwillingly, leading both to Germany’s export success and to the debt problems of the deficit countries.

    As long as Germany runs current account surpluses for many years and Spain the corresponding deficits, it is by definition true there must have been net capital flows from Germany to Spain as Germany bought Spanish assets (which includes debt obligations) to balance the current account imbalances. The capital and current accounts for any country, and for the world as a whole, must balance to zero.

    In the old days of specie currency – gold and silver – this meant that specie would have flowed from Spain to Germany as the counterbalancing entry, and of course this flow created its own resolution. Less gold and silver in Spain relative to the size of its economy was deflationary in Spain and more gold and silver in Germany was inflationary there – until the point where the real exchange rate between the two countries had adjusted sufficiently because of changes in domestic prices to reverse the trade imbalances.

    The Current Account Dilemma

    In today’s world things are different. There is no adjustment mechanism – specie flow or imperialism – that permits or prevents persistent current account imbalances.

    This means that if Germany runs persistent trade surpluses with Spain, there are only three possible outcomes.

    First, Spain can borrow forever to finance the deficit (of which the ability to sell off national assets is a subset). [Given the size of Spain], this clearly is not a possible outcome.

    Second, Spain can take steps to erode the value of those claims in real terms. It can do this by devaluing its currency, by inflating away the value of its external debt, by defaulting on its debt and repaying only a fraction of its original value, by expropriating German assets, or by a combination of these steps.

    [Third] Germany must accept a reversal of the current account imbalances or it must accept an erosion in the value of the Spanish assets it owns as a consequence of the current account imbalances. This is the important point.

    Once you have excluded infinite borrowing capacity there are arithmetically no other options.

    Given the limits, especially debt limits, it is irrational for anyone to expect that Germany can continue to run large current account surpluses while Spain does nothing to erode the value of Spanish assets held by Germans. I suspect that Germany is hoping and arguing that Spain can somehow reverse its current account deficit without the need for Germany to undermine current account surplus. But this won’t work.

    Problem in Europe is Arithmetic, Not Confidence

    I wrote about European math again, just a few days ago, also referencing Michael Pettis. In case you missed it, please consider Problem in Europe is Arithmetic, Not Confidence; Why the Eurozone Cannot Possibly Survive Intact

    The current problem most certainly is math, and mathematically “Germany must accept a reversal of the current account imbalances or it must accept an erosion in the value of the Spanish assets it owns as a consequence of the current account imbalances.

    Everyone is looking for magic bullets but there are none. One way or another, much pain is coming to Europe, including Germany. Mathematically it must be so.

    Root Cause of the Debt Crisis and Trade Imbalances

    The root cause of this mess (including the USA’s huge trade imbalance with the rest of the world) is twofold.

    • Fractional Reserve Lending
    • Lack of a Gold Standard (Or Other Enforcement Mechanism)

    No Better Enforcement Mechanism than Gold

    Rather than blaming this mess on the gold standard, one of the reasons for large trade imbalances is precisely because there is not a gold standard.

    Most of the problems people assign to the gold standard are not problems with the standard at all, but rather problems associated with fractional reserve lending that allowed more gold to be lent out than there was actual gold.

    Bear in mind that Pettis does not support a return to the gold standard. However, Pettis does believe an enforcement mechanism is needed.

    For further discussion, please see Michael Pettis Warns of “Virulent Political Turn Against Euro”, Adds Clarification to “Gold’s Honest Discipline”

    Certainly, lack of an enforcement mechanism regarding trade is an enormous problem. Debts pile up forever, with no way to pay them back.

    From my point of view, history suggests there is no better enforcement mechanism than gold.

    Unfortunately, Mitt Romney believes the solution to the US trade imbalance with China is labeling China a currency manipulator, to which he has promised massive tariffs.

    Should Romney do that, a collapse in global trade is likely, just as happened during the Great Depression following passage of the Smoot-Hawley Tariff Act. [rate]

    Mike “Mish” Shedlock
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    Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.  Visit Sitka Pacific’s Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

    You are currently viewing my global economics blog which typically has commentary every day of the week. I am also a contributing “professor” on Minyanville, a community site focused on economic and financial education.  Every Thursday I do a podcast on HoweStreet and on an ad hoc basis contribute to many other sites.

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