Choosing between disadvantages

It was a record that Germany would rather not have announced, at least not last week. On Thursday, official data showed that Europe’s über exporter racked up a current account surplus in 2016 of $281 bln, versus a mere $210 bln for China. With the US running by far the largest offsetting deficit, such data means that the temperature between Washington and Berlin is likely to get hotter. Consider the following points:

- Ever the diplomat, Donald Trump’s chief trade advisor Peter “Death By China” Navarro has accused Germany of using its euro membership to exploit an implicit deutschemark exchange rate that is “grossly undervalued”. This undervaluation, he said, allows Germany to take unfair economic advantage both of its European partners and of the US. He may have a point. Since 2009, Germany’s bilateral trade surplus with the US has ballooned from EUR 15 bln to almost EUR 50 bln.

- Perfidious Albion has decided to leave the Common Market and to renegotiate its trade relationship with the European Union. But the UK has a trade deficit with Germany of some EUR 50 bln. If the Germans echo French calls for punitive retaliation against the deplorable Brits for having the temerity to vote to leave the EU, then maybe the British will decide that the Germans are not the only people in the world who make quality motor cars.

- Meanwhile, the rest of the eurozone is running a hefty deficit of some EUR 80 bln with Germany. The bad news is that this deficit is increasing. Optimists had hoped that a consumer boom in Germany would lead to a progressive narrowing of that deficit. Fat chance. Nothing of the sort is happening. With interest rates at zero, the Germans are saving like squirrels in the fall.

- The rest of the world is also running an ever-increasing deficit with the industrious Germans. This explains why Germany’s overall trade surplus now exceeds China’s.

This grotesquely large German surplus is exercising an enormous recessionary influence on the rest of the world. And nowhere is the impact greater than in the eurozone.

To add insult to injury, German financial institutions are accumulating gigantic surpluses in their Target2 balances with the rest of the eurozone. These balances will never be settled. In effect, Germany is lending money to a bunch of guys in Europe who will never repay the loans. The Germans might as well load all their luxury cars onto a transport ship in Hamburg, sail it out into the middle of the North Sea and sink it to the bottom. The result would be the same.

Logically, the German currency should revalue massively. But if it did, the non German part of the eurozone would quickly go bankrupt. That is not, it must be said, what Mario Draghi and the European Central Bank is aiming for. Indeed, who has ever heard of an Italian central banker revaluing a currency upward? But if the German currency is not revalued, then America’s excitable new president could resort to attacking by Twitter. And who knows where that could lead? What if he proposes charging Berlin for the full cost of the US military protection that Germany currently enjoys for free? The bill could be somewhere around 2% of German gross domestic product each year.

As far as the UK is concerned, if the German government follows French advice and seeks to punish the British for Brexit, then the UK might decide the solution is to let in a lot more Swedish, Korean or Japanese cars, and a lot fewer from Germany. Wolfsburg, Stuttgart and Munich would be in trouble.

Moreover, if we look inside Germany, we discover that inflation is picking up. My diffusion index of German CPI components is currently registering an ominous cyclical high. This index tends to lead the official CPI by two months. This is not going to please the average German voter.

So, we are reaching a point where the euro is now the main obstacle to good relations between Germany and the US, the UK, and the rest of the world outside the eurozone. And it is not as if the Germans are immensely popular in Greece or Italy right now.

For Germany the choice is simple. It can choose to assume full responsibility for its own defense. This would cause considerable excitement in Poland, Hungary, and Russia, and even in France and Italy. And Germany’s current account surplus would shrink massively.

Alternatively, it could chose to remain under the cover of the US military umbrella. This would probably imply the end of the euro.

This may well be the “deal” that Trump and his advisors have in mind. The euro has already destroyed half of Europe. Now the single currency might be about to destroy NATO as well — just at a time when neither Russia nor Turkey are looking particularly friendly.

The time has come for Germany to choose. As Charles de Gaulle said: “To govern is always to choose among disadvantages.” The question is which disadvantage the next government of Germany will choose. If the next chancellor is Martin Schulz of the Social Democrats, I dare say he will choose to break with the US. If the new government comprises the Christian Democrats or the Alternative für Deutschland, it will likely opt for the Americans. The election campaign will be fascinating.