The German problem

Why Germany’s current-account surplus is bad for the world economy

The country saves too much and spends too little
 
THE battle-lines are drawn. When the world’s big trading nations convene this week at a G20 summit in Hamburg, the stage is set for a clash between a protectionist America and a free-trading Germany.

President Donald Trump has already pulled out of one trade pact, the Trans-Pacific Partnership, and demanded the renegotiation of another, the North American Free-Trade Agreement. He is weighing whether to impose tariffs on steel imports into America, a move that would almost certainly provoke retaliation. The threat of a trade war has hung over the Trump presidency since January. In contrast, Angela Merkel, Germany’s chancellor and the summit’s host, will bang the drum for free trade. In a thinly veiled attack on Mr Trump, she delivered a speech on June 29th condemning the forces of protectionism and isolationism. An imminent free-trade deal between Japan and the European Union will add substance to her rhetoric.

There is no question who has the better of this argument. Mr Trump’s doctrine that trade must be balanced to be fair is economically illiterate. His belief that tariffs will level the playing field is naive and dangerous: they would shrink prosperity for all. But in one respect, at least, Mr Trump has grasped an inconvenient truth. He has admonished Germany for its trade surplus, which stood at almost $300bn last year, the world’s largest (China’s hoard was a mere $200bn).

His threatened solution—to put a stop to sales of German cars—may be self-defeating, but the fact is that Germany saves too much and spends too little. And the size and persistence of Germany’s savings hoard makes it an awkward defender of free trade.

Imperfect harmony
 
At bottom, a trade surplus is an excess of national saving over domestic investment. In Germany’s case, this is not the result of a mercantilist government policy, as some foreigners complain. Nor, as German officials often insist, does it reflect the urgent need for an ageing society to save more. The rate of household saving has been stable, if high, for years; the increase in national saving has come from firms and the government.

Underlying Germany’s surplus is a decades-old accord between business and unions in favour of wage restraint to keep export industries competitive. Such moderation served Germany’s export-led economy well through its postwar recovery and beyond. It is an instinct that helps explain Germany’s transformation since the late 1990s from Europe’s sick man to today’s muscle-bound champion.

There is much to envy in Germany’s model. Harmony between firms and workers has been one of the main reasons for the economy’s outperformance. Firms could invest free from the worry that unions would hold them to ransom. The state played its part by sponsoring a system of vocational training that is rightly admired. In America the prospects for men without college degrees have worsened along with a decline in manufacturing jobs—a cause of the economic nationalism espoused by Mr Trump. Germany has not entirely escaped this, but it has held on to more of the sorts of blue-collar jobs that America grieves for. This is one reason why the populist AfD party remains on the fringes of German politics.
But the adverse side-effects of the model are increasingly evident. It has left the German economy and global trade perilously unbalanced. Pay restraint means less domestic spending and fewer imports. Consumer spending has dropped to just 54% of GDP, compared with 69% in America and 65% in Britain. Exporters do not invest their windfall profits at home. And Germany is not alone; Sweden, Switzerland, Denmark and the Netherlands have been piling up big surpluses, too.

For a large economy at full employment to run a current-account surplus in excess of 8% of GDP puts unreasonable strain on the global trading system. To offset such surpluses and sustain enough aggregate demand to keep people in work, the rest of the world must borrow and spend with equal abandon. In some countries, notably Italy, Greece and Spain, persistent deficits eventually led to crises. Their subsequent shift towards surplus came at a heavy cost.

The enduring savings glut in northern Europe has made the adjustment needlessly painful. In the high-inflation 1970s and 1980s Germany’s penchant for high saving was a stabilising force.

Now it is a drag on global growth and a target for protectionists such as Mr Trump.

The shift from thrift
 
Can the problem be fixed? Perhaps Germany’s bumper trade surplus will be eroded as China’s was, by a surge in wages. Unemployment is below 4% and the working-age population will shrink, despite strong immigration. After decades of decline, the cost of housing is rising, meaning that pay does not stretch as far as it used to. The institutions behind wage restraint are losing influence. The euro may surge. Yet the German instinct for caution is deeply rooted. Pay rose by just 2.3% last year, more slowly than in the previous two years. Left to adjust, the surplus might take many years to fall to a sensible level.

The government should help by spending more. Germany’s structural budget balance has gone from a deficit of over 3% of GDP in 2010 to a small surplus. Officials call this prudence but, given high private-sector savings, it is hard to defend. Germany has plenty of worthwhile projects to spend money on. Its school buildings and roads are crumbling, because of the squeeze on public investment required to meet its own misguided fiscal rules. The economy lags behind in its readiness for digitalisation, ranking 25th in the world in average download speeds.

Greater provision of after-school care by the state would let more mothers work full-time, in an economy where women’s participation is low. Some say such expansion is impossible, because of full employment. Yet in a market economy, there is a tried and trusted way to bid for scarce resources: pay more.

Above all, it is long past time for Germany to recognise that its excessive saving is a weakness.

Mrs Merkel is absolutely right to proclaim the message of free trade. But she and her compatriots need to understand that Germany’s surpluses are themselves a threat to free trade’s legitimacy.


Will Trump Fire Yellen or Vice Versa

By: Michael Pento


Citigroup’s Economic Surprise Index just hit its lowest level since August 2011. But this level of disappointment has ironically emboldened the Fed to step up its hawkish monetary rhetoric.

The truth is that the hard economic data is grossly missing analyst estimates to the downside as the economy inexorably grinds towards recession. This anemic growth and inflation data should have been sufficient to stay the Fed's hand for the rest of this year and cause it to forgo the unwinding of its balance sheet.

But that's not what’s happening. Ms. Yellen and Co. are threatening at least one more rate hike and to start selling what will end up to be around $2 trillion worth of MBS and Treasuries before the end of the year--starting at $10 billion each month and slowly growing to a maximum of $60 billion per month.

But why is the Fed suddenly in such a rush to normalize interest rates and its balance sheet?

Perhaps it is because Ms. Yellen wants to fire Trump before she hears his favorite mantra, “you’re fired,” when her term expires in early 2018. It isn’t a coincidence that these Keynesian liberals at the Fed started to ignore the weak data concurrently with the election of the new President.

A Q1 GDP print of just 1.4% has not dissuaded the FOMC from a hawkish stance. And a lack of evidence for a Q2 rebound in the data hasn’t done so either. April housing data was very weak: New home sales in the single family category were down 11.4%, existing home sales were also down 2.5%. And even though there was a small bounce back in housing data in May, Pending Home Sales have fallen three months in a row and were down 0.8% in May. Retail sales dropped, 0.3% and durable goods declined 1.1% during May; while the key metric for business productivity, core capital goods orders, fell 0.2%.

It’s not just economic growth indicators that are disappointing, but also evidence of disinflation abound everywhere. Measures of Consumer Price Inflation and the Personal Consumption Expenditure price indexes are falling further away from Fed's 2% target. Commodity prices are also illustrating signs of deflation. The CRB Index is down 14% so far this year and WTI crude oil is in a bear market. Further evidence of deflation is seen in the fact that the spread between long and short-term Treasury Yields are contracting. There has been a six-month decline in C&I loan growth and the household survey within the Non-farm Payroll report turned negative in May. The Household Survey is a leading indicator for the Establishment Survey and the overall employment condition.

Wall Street’s currently favorite narrative is one of strong earnings growth. But according to FactSet, nearly half of Q2's projected 6.5% EPS growth is from energy. Excluding this sector, EPS growth is projected to be just 3.6%. The projected average price of WTI crude for Q3 is $54.29. With the oil price now hovering around $43 per barrel, the hoped-for boost to EPS growth from energy will turn into a big drag unless crude turns around quickly.

The economy should continue to move further away from the Fed’s growth, and inflation targets as its previous monetary tightening starts to bite. But one last nail in the coffin for Fed hawks will be an NFP report sub 50K. The odds are very high that such a weak print on jobs will occur before the next hiking opportunity on Sept. 20th. In addition, if the S&P falls more than 15% from its high the turn in Fed policy from hawkish to dovish is virtually assured. From there it will turn to panic as the economy and stock market meltdown.

I say meltdown because, at 25x reported earnings, the S&P 500 is the 2nd most expensive in history.

But this particular overvalued market exists in the context of a weak and slowing economy; coupled with a tightening monetary policy that has been in place since the Fed started to reduce the amount of its $85 billion per month worth of bond purchases back in Dec 2013. And, most importantly, the coming market crash and recession will occur with the balance sheets of the Treasury and Fed already extremely stretched. Hence, an extrication from this recession will not happen quickly or easily.

All of the above makes this the most dangerous market ever. This crash and ensuing economic downturn, which given history, logic and the data should happen soon; will alter the Fed's current stance on monetary policy. But it will happen too late to preclude a very steep decline in GDP.

Therefore, if Mr. Trump cannot push through his tax cutting agenda rather quickly it may be both Ms. Yellen and the Republicans that find themselves moving out of D.C. in 2018; and move the Donald back to the Apprentice after just one term.


From the Intermarium to the Three Seas

By George Friedman


The Intermarium is a concept – really, an eventuality – that I have spoken about for nearly a decade. I predicted it would rise after Russia inevitably re-emerged as a major regional power. Which makes sense, considering it would comprise the former Soviet satellites of Eastern Europe: the Baltic states, Poland, Slovakia, Hungary, Romania and possibly Bulgaria. Its purpose would be to contain any potential Russian move to the west. The United States would support it. The rest of Europe would agonize over it. What was once inevitable may soon be here.
 
Challenges, Intentional or Otherwise
The two foundations of the Intermarium (now frequently referred to as such in the region) are Poland and Romania, which have developed close military ties. The Baltics are already involved. The major holdout, unsurprisingly, has been Hungary, which has had to court Russia and the United States at the same time.

But there are strong signals that Hungary is prepared to join. The government recently announced that it would join a Black Sea military exercise with Romania and Bulgaria – an annual exercise in which Hungary has never before participated. If this happens, then an eastern flank of the European Peninsula will have a cohesive group, backed by the global power, forming a line of demarcation between Russia and the rest of Europe.
 
 
Some are understandably worried about its formation. Few in Europe want to revert to Cold War politics; most Europeans believe they can accommodate Russian interests without creating a new containment line. U.S. sponsorship, moreover, directly challenges one of Europe’s most defining institutions, NATO. The Intermarium is not formally outside of NATO, but functionally it is, since NATO can’t really provide military assistance without U.S. help. In a military alliance, those with militaries tend to carry more weight than those without.
 
It also challenges the European Union, albeit unintentionally. Most the Intermarium’s members are outside the eurozone but constitute the most economically dynamic part of Europe. Eastern Europe’s economies are growing, and they boast extremely well educated, highly skilled and relatively cheap laborers. The region challenges the economic status quo, represented by the hegemony of the 1950s-style corporations that dominate European economics.
 
As NATO showed, military alliances employ the logic of economic cooperation. The Intermarium sets the stage, in my view, of a more integrated economic drive. It will be in the EU, but it will behave differently from the EU – more entrepreneurial, more closely resembling the United States. This will create stress in the EU, which does not need any more stress.
 
It will also necessitate political evolutions outside the EU’s ideology. The governments in Poland and Hungary are anathema to the multilateral, collectivistic framework of the EU, and Brussels has criticized them accordingly. But neither Warsaw nor Budapest has given in to EU demands. The Intermarium therefore is more than a military Alliance.
 
Map vs. Geopolitics
 
That the Intermarium has only recently begun to coalesce hasn’t stopped it from conceptually expanding. The bloc runs from the Baltic Sea to the Black Sea, but its logical extension goes southwest to the Adriatic Sea. The so-called Three Seas model would add Austria, Slovenia and Croatia to the Intermarium’s ranks. (And the Three Seas summit is taking place in Poland at the same time as a visit by Donald Trump. He has not rejected the idea of the Intermarium.)
Romanian frigate “Regina Maria” is inspected during a military drill on the Black Sea. DANIEL MIHAILESCU/AFP/Getty Images)



The extension is explained in part by the growth of Turkey. There is no question that Turkey will become a major regional power. When it has been powerful in the past, its influence has reached the Balkans and, in more extreme cases, to Budapest and Vienna. The countries of Eastern Europe are particularly concerned with immigration, an issue that Turkey naturally abuts. But Turkish power is a deeper concern, and if Ankara realizes its potential, the Intermarium will have to block not just Russia but Turkey too.

The extension is also explained by nostalgia for the Austro-Hungarian Empire, a significant multinational success that united small countries and largely gave them a degree of autonomy. Many believe the EU, which proved incapable of managing Europe after the 2008 crisis, encroaches on national self-determination just as much as the empire did. By expanding to Austria, Croatia and Slovenia, the old empire is recreated, if only in a geographic sense.

The Intermarium is just an idea, a vehicle for regional cooperation. It is not an alliance, at least not right now. But as conceived it is meant to evolve, and its evolution creates some problems. Multinational institutions are difficult to create. They require time, money and political will, and rarely do members have the same of any of these as the others.

Another problem is timing. Russia is a threat now, albeit a mild one, considering the state of the Russian economy. Turkey, meanwhile, is not a threat at all. Once it becomes a regional power it will project its power into the Balkans, but that’s a long way off. Sequence is important, and the Three Seas expansion is a little premature.

Last, the inclusion of Balkan countries changes the Intermarium’s complexion. Adding Slovenia and Croatia will alarm the Balkan Peninsula’s largest power, Serbia, historically a dangerous thing to do. (Croatia and Serbia have fought many wars over the years, most recently in the 1990s.) Drawing the members of the Intermarium into Balkan conflicts creates a drain on resources and a potential loss of popular support. The bloc may separate Turkey from the rest of Europe, but it also encourages Serbia, already close to Russia, to pull closer to Turkey. The geopolitics and the map work against each other. If this expansion is to take place, and in due course it likely will, then Serbia must be brought into the fold. Otherwise, the danger of Turkey is enhanced, not mitigated. Even then, we should remember that Serbia did not get along with the Austro-Hungarian Empire, and if the Intermarium bears its likeness, it could create problems down the road. (It’s also worth noting that Austria’s comparative affluence changes the dynamics too.)

One of the failures of the EU was its casual expansion without careful consideration of how new countries could work with older members in times of economic duress. The impulse to expand has been one of the EU’s greatest mistakes. Expansion is fine, but history shows that it has to be systematic and thoughtful. Disciplining intentions is the hardest of things.




Brexit to Nowhere?

Joschka Fischer
. Donald Tusk and Theresa May



BERLIN – Politics brings out strong emotions in everyone. Even the British, despite their reputation for pursuing their interests in a cool and calm fashion, apparently are not immune.

Perhaps that reputation is merely a holdover from the long-gone British Empire. It surely does not apply to the United Kingdom of 2017.
 
Consider the political decisions Britons have made over the past year. Last June, they decided – albeit narrowly – to withdraw from the European Union. And in last month’s snap general election, they delivered an outcome that only reinforces the impression that British pragmatism is in retreat.
 
The election – in which the Conservative Party lost its majority, resulting in a hung parliament – suggests how far removed from the rest of the country the political class in Westminster has become.
 
Indeed, the UK appears to be undergoing not just a political and identity crisis, but also a crisis of confidence in its political and economic elites, which began with the 2008 global financial crisis.
 
This will not make the ongoing Brexit talks any easier. The EU’s counterpart in the negotiation is a severely weakened government in a state of crisis. But the EU’s negotiators cannot lose sight of the fact that the UK will still be important to Europe outside of the EU. One of the biggest risks now, for the EU as much as for the UK, is that the latter will leave with nothing, and end up in an even worse state than it is already in.
 
Future historians will probably look back at 2016 and 2017 with great interest. It is unprecedented for a country to abandon a highly advantageous geopolitical and economic position simply because it is experiencing a prolonged identity crisis. Before Brexit got underway, the UK had a very strong hand to play within the EU, and thus on the world stage, owing not least to its special relationship with the United States.
 
Moreover, the UK has a tradition of liberalism and global engagement, especially with Europe and the eurozone. London has long been a financial center for the entire continent. And the British economy is – or, at least, was – a gateway for many international corporations seeking access to the EU single market and the eurozone, despite the UK’s refusal to join the single currency.
 
Still, it is worth remembering that by the early 1970s, the UK had lost its empire and the political clout that went with it; and that it only managed to reverse its economic decline by joining the European Community (the precursor to the EU) in 1973. Regrettably, Britons rarely acknowledge this fact. Instead, a vocal segment of Britain’s political class and electorate has long blamed the EU and its institutions – some of which require member states to cede part of their sovereignty – for all the evils of this world.
 
But now that the UK is withdrawing from the EU, it is becoming increasingly clear that it stands to lose a great deal, economically and politically. And for what?
 
The UK’s Brexiteers demand “sovereignty,” but without considering what that could possibly mean in an era of ever-advancing globalization and market integration. Given the Trump administration’s protectionist rhetoric, the importance of maintaining access to Europe’s single market would seem to be more acute than ever.
 
But the UK will not be the only loser from Brexit. The EU will lose its second-largest economy and primary guarantor of security. One hope now is that Emmanuel Macron’s election to the French presidency will blunt some of the pain from Brexit. Macron’s election, along with positive economic news from the eurozone, represents an unexpected opportunity for a fresh start within the EU, which could begin as soon as Germany holds its general election in September.
 
As it happens, the UK might very well be leaving an EU that is quickly moving toward renewed political stability and economic growth – which is, ironically, what the Leave camp imagines that it can achieve with Brexit.
 
Fortunately, the UK’s recent election may have provided a starting point for negotiations. To many observers, the outcome showed that British voters oppose a “hard Brexit,” whereby the UK would quit the single market and customs union with no deal in place, and revert to World Trade Organization rules.
 
Divorce proceedings are rarely pleasant. But they are far worse when the parties involved do not behave like adults. When emotions run free, former affections can quickly turn into spite and a desire to inflict deep wounds.
 
But for countries, as for people, life goes on after divorce. The EU and the UK will remain geographically close, and thus geopolitically dependent on one another. Ongoing issues relating to security, terrorism, and refugees will force both sides to work together; and trade will continue, even if it faces more hurdles.
 
It is thus in both sides’ interest not to inflict deep wounds, instigate confrontations, or embarrass and threaten the other side. Above all, issues relating to common UK-EU security should not be part of the negotiations. Both sides need to acknowledge their mutual dependence and be prepared to show generosity.
 
The EU, for its part, should be generous with respect to the timeframe for withdrawal, new trade regulations, and any transitional arrangements that could soften the impact of the separation. And the UK should be mindful of the many EU citizens currently residing in Britain, and honest about its financial commitments to the bloc.
 
If there is one thing to keep in mind, it is that people change theirs. And, because people’s sentiments change, countries change direction. No possible future should be ruled out, including one in which both parties say, “Let’s try again.”