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Analysis
German 'encirclement' fears

German 'encirclement' fears

Trump broadside should weaken euro, not sterling

by David Marsh in Berlin

Tue 17 Jan 2017

After weeks of pot shots at allegedly unfair Chinese exporters and Americans’ supposed corporate misdemeanours, it was only a matter of time before Donald Trump aimed his invective at the country of his grandfather’s birth: Germany.

The US president-elect’s broadside against Chancellor Angela Merkel’s refugee policies and motor giant BMW’s Mexican car-making plans will intensify German fears of ‘encirclement’ by fluctuating friends. These worries were already stirring before Britain’s European Union referendum last June.

While other factors were important in weaking sterling on Monday, notably the expectation of another ‘hard Brexit’ statement by Theresa May, it is still surprising that the currency to feel the brunt of Trump’s spleen after the weekend interview with The Times and Bild-Zeitung was sterling and not the euro. Whatever happens precisely when Trump enters the White House – and we can assume not all of his bellicosity will survive the move – a good outcome for Germany appears unlikely. And this will hit the euro.

Trump claimed the EU is a ‘vehicle for Germany’ and said other countries were likely to leave after Britain. These are perhaps the most belligerent public remarks about European nations by an American leader since the second world war.

Even before he takes office, Trump has brought Germany close to the ‘nightmare of coalitions’, the much-feared hostile combination of international powers that haunted Otto von Bismarck, the first chancellor of united Germany, in the closing decades of the 19th century. Worries about coordinated adversarial manoeuvring against Germany also worried Konrad Adenauer, the first post-war chancellor, as well as Helmut Kohl, leader when the Berlin wall fell.

Trump is ostentatiously backing the UK’s EU withdrawal, promoting the British to a new-found helmsman’s role among countries preparing a trade accord with America. He is courting Russian President Vladimir Putin. And almost any possible French president taking over from François Hollande in May will not be too well-disposed to Germany.

This places Berlin in a supremely unenviable position. Historically minded Germans will be quick to point out that the four countries that finished on the winning side in 1945 could, if developments turn nasty, for various reasons be aligned against Germany in coming months.

The president-elect’s labelling of Merkel’s immigration stance as ‘catastrophic’ may win her support from sympathisers in Germany, particularly on the left. But they will be seized upon by opponents on the right, both within and outside her Christian Democrat party, who have been saying the same thing since the migration wave started in 2015.

If the euro comes under pressure against the dollar, which seems probable, this will boost German exports and boost the domestic economy – already operating at near full employment. Yet pressure on the euro will have multiple negative effects.

It will further boost the German current account surplus, 9% of GDP last year. This will make it well-nigh certain that Trump’s administration will brand the Germans ‘currency manipulators’.

Positive German economic figures when Greece is still in the economic doldrums will strengthen demands from the Greeks and the International Monetary Fund that Berlin gives in to wishes for Greek debt rescheduling. This near-inevitable outcome is bound to strengthen an anti-euro backlash against Merkel ahead of her own elections in September. And a quickening economy and higher German inflation will intensify German dissatisfaction with the European Central Bank’s negative interest rates and continued large-scale government bond purchases.

The Bundesbank is preparing for fresh criticism, when it announces its 2016 results in March, of its very large built-in losses on purchases of negative-yielding German bonds.

The UK is benefiting from a better-than-expected rebound from the anti-EU vote. The IMF yesterday upgraded forecast UK growth this year to 1.5% from 1.1%. Yet a positive showing is likely to make EU negotiations harder, not easier. Under a rule advanced by Charles Grant, director of the Centre for European Reform, the better the UK’s performance, the more difficult its exit process – since the other Europeans will fight to ensure that UK withdrawal does not become a ‘success story’ others will wish to emulate.

David Marsh is Managing Director of OMFIF.

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