The Financial Times’ Martin Wolf gives a cogent and sober assessment of what he deems to be a destructive refusal to adjust policies on behalf of the world’s two biggest exporters, China and Germany. The problem is that both simultaneously want to have their cake and eat it too.
As we stressed in a recent post, large foreign exchange surpluses, beyond what is useful to defend a currency, is NOT a sign of strength. They cannot be spent without causing the currency to appreciate, something that surplus-dependent countries are unwilling to do. Thus these holdings, which were incurred by acting as de facto export subsidies, cannot be utilized without serving as import subsidies. As Wolf elaborates:
China and Germany are, of course, very different from each other. Yet, for all their differences, these countries share some characteristics: they are the largest exporters of manufactures, with China now ahead of Germany; they have massive surpluses of saving over investment; and they have huge trade surpluses.
Both also believe that their customers should keep buying, but stop irresponsible borrowing. Since their surpluses entail others’ deficits, this position is incoherent. Surplus countries have to finance those in deficit. If the stock of debt becomes too big, the debtors will default. If so, the vaunted “savings” of surplus countries will prove to have been illusory: vendor finance becomes, after the fact, open export subsidies.
Wolf stresses that this posture is a threat to open trade and the eurozone. Wolfgang Munchau parsed the so-called Schäuble proposal yesterday:
I was confused when Wolfgang Schäuble, German finance minister, proposed a European Monetary Fund….. I realised that the EMF is just a smokescreen. The real bullet in his proposal is that countries could leave the eurozone without leaving the European Union. This is not about helping countries in trouble. This is about helping them to get out.
The political message of the Schäuble plan is that Greece will be the last bail-out ever. As preparations for a bail-out reach an advanced stage, the German public reaction has become progressively more hostile. If the Schäuble plan had already been in place, Greece would already have headed to the exit. It is hard to conceive of a situation under the plan where a country simultaneously fulfils the criteria for aid, and needs it.
Wolf today teases out the implications:
Three points can be drawn from this démarche from Europe’s most powerful country: first, it will have an overwhelmingly deflationary impact; second, it is unworkable; and, third, it might pave the way for Germany’s exit from the eurozone.
I explained the first point last week. If Germany gets what it wants, the world’s second-largest economy would play an altogether negative role in the search for a way out from the global slump in aggregate demand. The eurozone would not be exporting the demand the world now needs. It would export excess supply, instead.
Imagine that weaker eurozone countries were forced to contract their fiscal deficits sharply. This would surely weaken the entire eurozone economy. But the result would also be fiscal deterioration in Germany and France. Imagine that Germany then did don the hair shirt. Would it instruct France to do the same? After all, France already has a general government deficit forecast by the Organisation for Economic Co-operation and Development at close to 9 per cent of gross domestic product this year. Does Mr Schäuble imagine France could be fined? Surely not. Yet it is not Greek public finances that threaten the stability of the eurozone. These are a mere bagatelle. The threat is the public finances of big countries. Since Germany could not force such countries to behave and has no chance of expelling any member it disapproves of from the eurozone, it would have to leave itself. That is the logic of Mr Schäuble’s ideas. This must be obvious to him, too.
Yves here. Rob Parenteau, in a series of posts (here and here) explained longer-form, in the case of Spain, why adhering to austerity targets looked certain to produce a sharp economic contraction. Back to Wolf:
Germany is in a supposedly irrevocable currency union with some of its principal customers. It now wants them to deflate their way to prosperity in a world of chronically weak aggregate demand. Mr Wen has the same idea. But the economy he wants to pursue this goal is the US. Fat chance!
Speaking at the end of the National People’s Congress, Mr Wen declared: “What I don’t understand is depreciating one’s own currency, and attempting to pressure others to appreciate, for the purpose of increasing exports. In my view, that is protectionism.” He also insisted he was worried about the safety of China’s dollar investments.
What, I wonder, does Premier Wen mean by this, apart from telling the US to leave China’s exchange rate policies alone? If the US desire for a weaker dollar is “protectionist”, how much more so is China’s determination to keep its currency down, come what may? There is nothing evidently “protectionist” about asking a country with a huge current account surplus to reduce it, at a time of weak global demand. If I understand China’s declared position correctly, it wants the US to deflate itself into competitiveness, instead, via fiscal and monetary contraction and, presumably, falling domestic prices. That would be dreadful for the US. But it would be dreadful for China and the rest of the world, too. It is also not going to happen. China surely knows that.
Yves here. I am not sure Wen does. Per Upton Sinclair: It is difficult to get a man to understand something when his salary depends upon his not understanding it. Back again to Wolf:
Behind all this is a fundamental divide. Surplus countries insist on continuing just as before. But they refuse to accept that their reliance on export surpluses must rebound upon themselves, once their customers go broke. Indeed, that is just what is happening. Meanwhile, countries that ran huge external deficits in the past can cut the massive fiscal deficits that result from post-bubble deleveraging by their private sectors only via a big surge in their net exports…..
In this battle, the surplus countries are most unlikely to win. A disruption of the eurozone would be very bad for German manufacturing. A US resort to protectionism would be very bad for China. Those whom the gods wish to destroy, they first make mad. It is not too late to look for co-operative solutions. Both sides have to seek to adjust. Forget all the self-righteous moralising. Try some plain common sense, instead.
Yves here. This battle of wills is rooted on every front in domestic politics, plus a collective inability to recognize that our current version of globalization is no longer workable. But we appear likely to test the current system to destruction rather than come up with less drastic ways out.