The relationship between German Chancellor Angela Merkel and the Trump administration appears to be going from bad to worse. An important factor underlying this souring relationship is a fundamental difference of view between Germany and the United States as to how Germany should manage its economy.
Absent an early resolution of that difference, the prospects for continued economic cooperation between the two countries do not appear to be promising.
One indication of the souring in German-U.S. economic relations came at last week’s G-7 Summit in Italy. At that meeting, President Trump labeled Germany’s trade surplus as very bad and threatened that he might soon impose restrictions on German car exports to the United States.
{mosads}Another indication came this weekend from Merkel. At a Bavarian beer-hall election rally, she warned that Europe could no longer rely on the United States as an ally and that Europe needed to take its fate into its own hands.
An important factor underlying the mounting tensions between the two countries is Germany’s ballooning external imbalance. According to International Monetary Fund (IMF) estimates, Germany is currently running the world’s largest external current account surplus. At $300 billion in 2016, that surplus was around 8.5 percent of its GDP. As Trump does not tire of reminding us, Germany also runs a very large trade surplus with the United States.
The main charge of the Trump administration is that Germany maintains too cheap a currency that allows it to enjoy an unfair competitive advantage in the global economy. Germany does so by being part of a currency arrangement — the euro — with a group of Southern European countries like Italy, Portugal and Spain, which have significantly weaker economies than does Germany.
Those countries drag down the euro’s value and, in so doing, give Germany an unfair competitive advantage in world markets. The Trump administration makes the valid argument that if Germany had its own currency, it would almost certainly be much stronger than the euro.
For its part, the German government maintains that Germany’s strong external position is a reflection of the very sound way in which it runs its economy and that it would be unfair to punish the country for sound economic management. It also argues that Germany certainly does not manipulate its currency since it does not have its own currency to manipulate.
Rather, all exchange rate decisions regarding the euro are made by the European Central Bank. The German government is also insistent in its view that leaving the euro is not an option for Germany since doing so would almost certainly leave financial and economic chaos to Europe in its wake.
A possible way for the U.S. and German governments to bridge their differences would be for them to recognize that the fundamental reason for a country’s trade imbalance is not so much the level of its exchange rate, as it is the difference between its savings and investment levels.
If a country saves more than it invests, it will have an external trade surplus, since it will be spending less than it produces. Conversely, if it saves less than it invests, it will have a trade deficit, since it will be spending more than it is producing.
Were the U.S. and the German governments to recognize that savings-investment imbalances are the main driving force for corresponding external imbalances, they might be able to fashion a cooperative solution to Germany’s large bilateral trade surplus with the United States. The German government could commit itself to the pursuit of a more expansionary budget policy than it is doing now with a view to reducing that country’s level of public savings.
For its part, the U.S. government might commit itself to a much more responsible budget policy than it is presently contemplating with the express purpose of increasing the level of U.S. public savings.
Hopefully, the U.S. and German governments will soon agree upon a mutually acceptable way of reducing Germany’s large trade surplus. The last thing that the world economy needs right now is a further drift toward more protectionism and a breakdown in U.S.-German cooperation.
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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