The EU's single currency, the Euro, is being unbalanced by the strength of the German economy. The undervalued Euro is used by Germany in a beggar-thy-neighbour policy to expand its exports; hurting not just the other members of the Eurozone but also countries further afield, including the United States. If the USA forces Germany to abandon this policy, it will mean Germany leaving the Euro. This will either be the end of the single currency experiment, or its salvation.
4th January 2017
During the election campaign Donald Trump highlighted a structural flaw in the US economy, namely, the country’s huge structural trade deficit, which he claimed is hurting many Americans. Trump’s message was very simple: if instead of importing products the US exported them there would be more highly paid jobs in the US. Trump claimed that not all of the US’s trading partners are trading fairly with the US. The implication being that some countries are taking US jobs unfairly. Angela Merkel was clearly worried about this rhetoric. Although Trump did not name Germany, she is clearly concerned that Germany will be exposed as having an unfair trading advantage with the US because it is benefitting from an under-valued Euro.
Although no one would claim that Germany abandoned the Deutschemark in favour of the Euro in 1999 to gain an unfair trading advantage, this is undeniably what has happened. As can be seen from the following table this has increased Germany’s current account surplus with the rest of the world.
Germany’s exports are now 30-35% cheaper in US dollars than they would have been if the country had retained the Deutschmark. This calculation is based on the assumption that the Deutschmark would have maintained its value against the Swiss franc. And, it ignores the fact that Switzerland has intervened in the foreign exchange markets from time to time to depress the value of the Swiss franc against the US dollar and other currencies. The Euro has become a disguised form of protectionism for the German economy, by making its exports cheaper and imports more expensive. Moreover, this is not a problem that is likely to disappear. The longer the Euro exists, at least in its current form, the greater the problem will become. The question is what, if anything, will the new Trump Administration do about Germany’s unfair trading advantage and its ever growing current account surplus with the US.
Under the Obama administration, the US enacted the Trade Facilitation and Trade Enforcement Act 2015. One of the purposes of this Act is to identify those countries which are trading unfairly with the US. This Act focusses on individual EU member states rather than on the EU as a single entity. Title VII focuses on currency manipulation (sections 701-2). Section 701(a)(2)(A)(ii) seeks to identify any major trading partner of the US that has:
(1) a significant bilateral trade surplus with the US (economies with a bilateral goods surplus of at least $20 billion (roughly 0.1 percent of U.S. GDP) are regarded as having a “significant” surplus);
(2) a material current account surplus (current account surpluses in excess of 3 percent of GDP to be “material”); and
(3) engaged in persistent one‐sided intervention in the foreign exchange market (net purchases of foreign currency, conducted repeatedly, totalling in excess of 2 percent of an economy’s GDP over a period of 12 months to be persistent, one‐sided intervention).[i]
In its October 2016 report, the US Treasury Department identified seven countries as satisfying the first criterion (China, Germany, Japan, Mexico, Korea, Italy and India), four countries as satisfying the second criterion (Germany, Japan, Taiwan and Switzerland) and two countries satisfying the third criterion (Switzerland and Taiwan).
Germany satisfies the first two criteria because it has a bilateral goods surplus with the US of $71.1bn, which represents 9.1% of its GDP, well above the thresholds of $20bn and 3% respectively. Germany would only fall foul of the third criterion if the ECB sold Euros on a persistent basis in the foreign exchange markets. Germany would fail to satisfy the third criterion even if the Euro conferred a much greater advantage to the Germany economy than it does today. This is because the Obama administration has adopted the definition of currency manipulation which is used by the IMF. This definition predates the formation of the Euro zone. It assumes that the only way in which a country is able to artificially reduce the value of its currency to gain a trading advantage is by intervening in the foreign exchange markets. This fails to recognise that another way of achieving the same objective is to join a currency union, such as the Euro. What is important is not how a country achieves an under-valued currency, but rather whether it has one, or not.
Ideally, the IMF would take the lead in addressing the deep seated structural problems of the Euro zone, and the serious threat which the Euro zone will ultimately pose to the global economy. Unfortunately, this is a problem that the IMF is unable to view objectively. This is because European countries enjoy a disproportionate share of the votes on the IMF’s board. This is illustrated by the fact that the IMF is currently headed by Christine Lagarde, a former French politician, and the previous ten managing directors of the IMF have all come from EU countries, with many being former politicians.
The new Trump administration, namely, Steven Mnuchin (Treasury Secretary), Wilbur Ross (Commerce Secretary) and Robert Lighthizer (US Trade Representative) cannot expect any help from the IMF in addressing the unfair advantage that Germany has in its trading relations with the US, and other countries. This is most unfortunate because it means that if the US wishes to address this problem it would have to take unilateral action on what would be a politically sensitive subject with an important European ally. However, if the new Trump administration is able to show beyond any reasonable doubt that Germany is benefiting unfairly in its trading relationship with the US from being part of the Euro zone it will have the moral authority to take action. In such circumstances, Donald Trump is also more than capable of highlighting the shortcomings of the IMF in not addressing this problem. The question is: what action could a new administration take to address this problem?
An obvious answer is for the new administration to change the definition in the third criterion of section 701(a)(2)(A)(ii), so that it captures any country that is benefiting from a persistently under-valued currency against the US dollar. If this change were made Germany would fall foul of all three criteria. In such circumstances the Act states (section 701(b)(1)(A-D)) that the “President, through the US Treasury Secretary, shall:
(A) urge implementation of policies to address the causes of the undervaluation of its currency, its significant bilateral trade surplus with the United States, and its material current account surplus, including undervaluation and surpluses relating to exchange rate management;
(B) express the concern of the United States with respect to the adverse trade and economic effects of that undervaluation and those surpluses;
(C) advise that country of the ability of the President to take action under subsection (c); and/or
(D) develop a plan with specific actions to address that undervaluation and those surpluses.”
If the US is unable to persuade Germany to take steps to address this problem the President is able to take the following limited action under the Act (section 701(c)(1)(A-D)), and in particular (C) and (D):
(C) instruct the US’s Executive Director of the IMF to call for additional rigorous surveillance of the macroeconomic and exchange rate policies of that country and, as appropriate, formal consultations on findings of currency manipulation, or
(D) instruct the US Trade Representative to take into account, in assessing whether to enter into a regional trade agreement with that country or to initiate negotiations with respect to a regional trade agreement with that country, the extent to which that country has failed to adopt appropriate policies to correct the undervaluation and surpluses described in subsection (b)(1)(A).
As mentioned, the new US administration cannot expect any assistance from the IMF in this matter. The subject of Germany benefitting from an under-valued currency could be another reason for the Trump administration not signing T-TIP, as to do so would undermine its bargaining position on this subject.
More generally, if both President Trump and Congress wished to escalate this dispute they could take the ultimate sanction of increasing duties/tariffs on German goods to counter the benefit which this country is receiving from an under-valued currency. Although the President and Congress do not currently have the requisite authority to take this action they could acquire this authority by passing the necessary legislation. It has been suggested that the US might target currency manipulation by imposing a countervailing duty. Germany and the EU would no doubt complain to the WTO about the US’s action, but such disputes tend to take a long time to resolve. Furthermore, there is some ambiguity as to how such a dispute would be settled.
If the Trump administration were to focus on Germany’s unfair trading advantage it is likely to negotiate in a tough, but realistic manner with Germany and the EU. They know that Germany and the EU are unable to solve the problems associated with the Euro zone overnight. They will no doubt want Germany to make concrete proposals that will address the problem of the country’s every growing trade surplus with the US. At present, the IMF is doing Germany’s bidding and only requiring the Club Med countries in the Euro zone to embrace structural reforms. The US will no doubt want Germany to also make structural reforms, because its current economic policies are supressing domestic demand, which means that its economy is overly dependent on the demand from other countries such as the US. It can be expected that the US will urge Germany to adopt policies to boost domestic demand. Initially, Angela Merkel and Wolfgang Schäuble will no doubt resent the interference from the Trump administration into their domestic affairs and will find their proposals deeply unpalatable. However, on reflection they will hopefully see these proposals as a constructive way of easing the tensions in their trading relations with the US, and also benefitting their EU partners. Angela Merkel being a pragmatist will appreciate that the Trump Administration could force Germany to leave the Euro. This could be achieved by either imposing a countervailing duty on German goods or by removing Germany’s most favoured nation status and imposing tariffs on German goods. Germany would then be faced with a choice of either remaining in the Euro and suffering a duty/tariff on their exports to the US, or leaving the Euro. In either event, Donald Trump’s intervention on the issue should be welcomed as addressing an unsustainable structural flaw in the global economy.
[i] https://www.congress.gov/114/plaws/publ125/PLAW-114publ125.pdf (Trade Facilitation and Trade Enforcement Act 2015)
https://www.treasury.gov/resource-center/international/exchange-rate-policies/Documents/2016-10-14%20(Fall%202016%20FX%20Report)%20FINAL.PDF (Foreign Exchange Policies of the Major Trading Partners of the United States, Report to Congress, US Department of the Treasury Office of International Affairs, October 2016)