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Sleepwalking towards a US-German trade war

Sleepwalking towards a US-German trade war

Friction over Germany's current account surplus

by Desmond Lachman in Washington

Thu 26 Jul 2018

Countries tend to go to war with one another when they have irreconcilable differences on a big issue, on which they entertain very different points of view. The same would seem to be true of trade wars.

This is why I believe the dialogue between the US and German governments on Germany’s outsized external current account surplus will eventually end in a full-scale trade war between the two nations.

If we are fortunate, the temporary truce negotiated this week by European Commission President Jean-Claude Juncker and US President Donald Trump, suspending further US import tariffs while a new round of trade talks proceed, may grant some respite. The International Monetary Fund may perhaps find a way to mediate an acceptable solution to the two parties.

At the heart of US-German trade frictions is Germany’s massive external current account surplus. At almost $300bn, it is the world’s largest. Measured as a proportion of GDP, at 8%, the surplus is four times as high as China’s less than 2% of GDP surplus.

Trump has been vocal about Germany’s allegedly unfair advantages, and is threatening increased automobile tariffs to reduce the surplus. Yet he is not the first US president to raise this issue.

Already under the Obama administration, the US treasury placed Germany on the list of countries like China, Japan and South Korea that needed to be monitored for possible currency manipulation.

Among the more telling indications of these seemingly irreconcilable is the highly charged moral tone of the discussion.

The US administration sees the surplus as indicating Germany is free-riding the global economic system and stealing jobs from the US and the rest of the world. The German government regards the surplus as a sign of virtue and a reward for highly disciplined macroeconomic policies.

The US and German governments have very different views about Germany’s exchange rate policy.

The US administration believes Germany has artificially suppressed the value of its currency since 1999 by abandoning the D-Mark in favour of the euro. By sharing a single currency with the weaker economies of southern Europe, the US considers that Germany has been enjoying the benefits of a more competitive exchange rate than it would otherwise have had.

The German government says there is no going back from monetary union. And it proclaims that the European Central Bank, not the Berlin authorities, determines the value of the euro. 

The German government is equally resistant to suggestions that Germany should adopt a less restrictive their budget policy.

Further putting an amicable solution of the German external surplus problem out of reach is the Trump administration’s pursuit of a highly expansionary budget policy at this late stage in the US economic cycle.

The Trump administration is raising the chances that the US will revisit the twin deficit problem of the 1980s. This could cause the dollar to rise in response to higher US interest rates.

The IMF has the opportunity to mediate between two major countries with diametrically opposite views on a central economic issue. A full-scale German-American trade war would be highly destructive to international economic prosperity.

However, Trump is antipathetic to international organisations. Germany upholds its moral conviction of the correctness of its policies. So I am not holding out much prospect that the IMF can intervene in a constructive way. Instead I am bracing myself for the US and Germany to sleepwalk their way to a trade war.

Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund's Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.

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