Recent budget policy decisions in both the United States and Germany would suggest that the two countries are on a collision course regarding Germany’s outsized trade surplus.
This would seem to be especially the case since the divergent budget policies between the two countries are almost certain to increase Germany’s U.S. bilateral trade surplus. All of which does not bode well for the long-run maintenance of an open global trading system.
{mosads}While the Trump administration’s current trade policy focus is primarily on China’s bilateral trade surplus with the United States, Germany’s large trade surplus has not escaped its notice. This is hardly surprising considering how very much larger Germany’s external imbalance is than that of China.
Whereas China has now reduced its overall external current account surplus to some 2 percent of GDP, Germany’s overall external current account surplus has ballooned to around 8 percent of GDP.
If there is one point on which almost all economists can agree, it is that a country’s external balance is arithmetically the difference between its savings and investment rates. The United States has a large external deficit because it saves less than it invests. Germany has a large external surplus since it saves more than it invests.
The Trump administration’s budget policy makes it all too likely that the U.S. external deficit will keep widening irrespective of the country’s move to a more protectionist trade policy. This is because U.S. savings are likely to decline appreciably.
They will do so as a result of the combined effect of an unfunded tax cut, which the Congressional Budget Office estimates will increase the U.S. budget deficit by a cumulative $1.5 trillion over the next decade, and a Congress-approved $300 billion public spending increase over the next two years.
At the same time that the U.S. budget deficit is set to widen to over 5 percent of GDP in the next two years, Germany’s budget balance is set to strengthen to a surplus of at least 1 percent of GDP over the same period.
It will do so as a result of German Finance Minister Olaf Scholz’s decision last week to cut German public investment, defense and aid expenditures.
All of this this goes in exactly the opposite direction of the desired coordination of U.S. and German budgetary policies to reduce the U.S. trade deficit and the German trade surplus. At a time that the U.S. should be aiming at a narrower budget deficit, the Trump administration’s tax and public spending policies will widen it.
At a time that Germany should be following a more expansionary budget policy to correct its large external surplus, it insists on further tightening its belt to keep the government’s budget permanently in surplus.
All of this has important implications for the prospects of the world drifting toward a trade war. Already, the U.S. has threatened to make Germany, the world’s fourth-largest economy, permanently subject to the 10-percent aluminum and 25-percent steel import tariffs that it has recently announced and for which Germany has been given a temporary exemption.
At the same time, President Trump has been making noises that Germany should voluntarily restrict its automobile exports to the United States.
The clear and present danger is that, should the U.S. trade deficit widen and the German trade surplus increase, as is all too likely to occur because of divergent budget policies, the Trump administration may very well double down on its planned policy of imposing restrictions on German imports.
That is bound to invite German retaliation, which would only increase the odds that the world will drift toward a destructive trade war.
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.