Germany—from Invincibility to Vulnerability


Over the course of the last 15 years. Germany has gained the reputation of being an economic powerhouse, with the leadership of Angela Merkel lionized and Germany’s preeminence in the EU rarely questioned.

 Germany has used its stature to criticize other nations—Greece and Italy, in particular—and to push its own formula of fiscal discipline and export-led growth as a wider model for the European Union. It has only grown since the Euro-zone debt crisis as Germany has sought to impose its brand of austerity onto its Euro-zone partners at the expense of economic growth.

Yet Germany’s prosperity has been built on a vulnerable foundation, namely its huge net export/current account surplus. At 7.5%, its current account surplus is far higher than any other major country, and that gigantic surplus has been achieved at the detriment of many of its neighbors. That has left it more vulnerable than any other major nation to a global slowdown and to trade disputes. And indeed, its growth in the last two quarters has fallen below most other Western nations.

Where did that massive surplus come from?  It comes from the fact that Germany entered the Euro with an extremely favorable exchange ratio versus the other Euro-zone nations, which it was able to negotiate in exchange for agreeing to join the Euro-zone. That agreement meant its trade was at an immediate and ongoing advantage versus the other major Euro participants. 

The impact came quickly and was deeply felt. From 2000 to 2005, the period in which the euro came into use, Germany’s current account surplus rocketed from 0.27% to 5.07%, while the average current account deficit of France, Spain, Italy, and Greece alone plunged from -0.74% to -2.34%.

More astonishingly, Germany gross exports went from 31% of GDP to a staggering 47% of GDP, which brings extraordinary short term benefits but is done at the expense of other countries and leaves Germany more exposed than others to the vicissitudes of trade.

To put it in perspective, gross exports in the US are 12% of GDP, gross exports in most other large EU nations roughly 31% of GDP, and even in China, who we think of as a massive exporter, gross exports are only 18% of GDP.

Today Germany’s current account surplus is off the charts, with great risk to both itself and other EU countries as a result, In fact, its massive net export position is a large part the discontent that is at the center of populist revolt against the Euro-zone.  Germany’s surplus is somebody else’s deficit – and problem. The only way to have for these net importing countries to sustain a multi year deficit is through increased borrowing, largely private sector borrowing—which as we know is a path to a sustained attrition of their well–being. Gilets jaunes anyone?

If the other nations were not locked into the EU, they would have simply devalued versus Germany to fix the import/export disparity. In fact, in the years after the global crisis, a number of economists recommended a modification of the Euro to achieve exactly that. Alan Melltzer, for one, recommended cleaving the Euro into a Northern Euro and a Southern Euro and devaluing the latter. Since they cannot devalue, there is little else they can do to alleviate the problem. They are stuck.

In a currency union, exchange rates are fixed.  They do not adjust upward or downward to correct current account imbalances.  Adjustment takes place through what is called internal appreciation or internal devaluation—mainly through changes in wages and other factors affecting competitiveness and internal demand.   As a current account surplus economy, Germany should have taken steps to raise wages and increase its spending while others were taken steps to improve their own competitiveness.  But Germany did the opposite, undertaking ambitious labor reforms that suppressed wages.  From 2000 to 2008, German unit labor costs barely increased while those of many of the other Euro-zone members increased by more than 20 percent. The result was that Germany was gaining a double competitive advantage: one from a favorable entry point into the Euro-zone and the second from the suppression of wages.

But then Germany turned to a third tool of policy to further hyper-extend its export position.  It introduced what is called in Germany a debt break—a constitutionally mandated constraint on running government budget deficits except in times of extreme emergency.  As a consequence, Germany has been running budget surpluses the last several years—the exact opposite of what it should be doing given its large current account surplus.

Over the next few years, Germany will continue to struggle with the adverse trends in trade. And its massive net surplus will continue to exacerbate discontent in other EU nations.

This is just one of the many reasons the EU will continue to struggle, and one more issue to which the EU turns a largely blind eye.


Add your comment

Your email address will not be published. Required fields are marked *