Weak currencies don't cause trade surpluses
I’m seeing a lot of people claiming that Germany benefits from the euro’s impact on its trade balance. The argument seems to be that the euro is weaker than the Deutschmark would be, and that this explains Germany’s big trade surpluses. At the risk of sounding like a broken record, this is reasoning from a price change.
It would be more accurate to say the trade surplus causes the exchange rate. The current account (CA) surplus is equal to domestic saving minus domestic investment. And these two variables reflect deep fundamental factors in the German economy. Like other northern European countries, Germany saves much more than it invests. But this has nothing to do with whether a country is in the euro or not:
Country ** CA/GDP ** Exchange rate
Norway **** 10.4% ** float
Netherlands * 9.0% ** euro
Switzerland * 8.0% ** float
Germany *** 6.7% ** euro
Denmark *** 5.9% ** pegged
Sweden **** 5.8% ** float
Austria ***** 1.6% ** euro
Belgium **** 0.6% ** euro
The simple truth is that northern European countries tend to be high savers, and they run CA surpluses. It makes no difference whether they are in or out of the euro. Now for a few misconceptions:
1. What if the government “artificially” pegs the exchange rate?
That makes no difference; the price level will adjust until the real exchange rate returns to its long run equilibrium. This happened in Germany after 2005, when the actual euro exchange rate was too high and Germany had 11% unemployment. Then the German price level then fell relative to other countries. The only way a government can control the real exchange rate in the long run is by affecting saving or investment. (Norway’s high government saving might help explain their large CA surplus, but it’s not clear the public of that rich country wouldn’t have saved almost as much.)
2. OK, but what about the short run, before the price level adjusts? Surely a weaker currency temporarily boosts the trade surplus? Not necessarily, as there are both the income and substitution effects to consider. In April 1933, the US devalued the dollar and the trade balance worsened for the remainder of the year, as fast growth in the US sucked in imports.
In any case, it makes no sense to provide “short run” explanations for Germany, or any northern European country. These surpluses have persisted for a long time, and there is no sign of inflation in Germany pushing the economy back toward CA balance. There is nothing desirable about CA balances, and (thank God) governments can’t really do much about the “problem” anyway.
PS. Is there any field outside of macroeconomics where the so-called experts make more elementary errors in opinion pieces?
PPS. Data was from the Economist magazine.
Jul 16 2015 at 9:21am
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Jul 16 2015 at 10:15am
The more fundamental problem is that people think a trade surplus is “good” or a trade deficit is “bad.”
Jul 16 2015 at 10:47am
If one was still intent on blaming government policies for CA surpluses, does Northern Europe tend to have pro-saving policies? And if they do, are they actually responsible or contributing to savings rates, or is this simply reflecting a cultural bias?
Jul 16 2015 at 11:26am
I have always considered that currency exchange rates are simply a function of the Hume price specie flow mechanism – with currency instead of gold.
A CA surplus – net accumulation of currency- leads to changes in interest rates, prices, exchange rate – until the equlibrium is reset.
Jul 16 2015 at 11:35am
a little more..
In the Hume model, gold accumulates where there is productive activity. So there can be long term CA surplus, as in Germany..and the long term, incrementally rising productivity, alows persistent CA surplus thus postponing the time to the new equalibrium.
I think this fits with Prof sumner’s point.
Jul 16 2015 at 12:23pm
I was taught that the immediate impact of a currency depreciation was to worsen the current account balance, since the cost (in local currency) of imports goes up, while the receipts (in local currency) from exports goes down.
Jul 16 2015 at 12:41pm
Levi, I agree.
Paul, I’d guess partly culture and partly policy, but I am not certain.
emerson. No, Hume’s PSF mechanism is unrelated to the CA, it deals with monetary flows. Most the the CA reflects flows of assets like stocks and bonds, not cash.
Brian, Yes, I saw that “J-curve” model too.
Jul 16 2015 at 8:26pm
RE the errors by economics experts:
I think when you know a lot more about a topic you’re more likely to see the errors. It’s something that makes me less likely to believe a writer on a topic I don’t know much about, since writers who discuss topics I know plenty about seem to get it wrong so often. David Friedman often talks extensively of this effect.
Jul 17 2015 at 12:46am
Norway is an CA outlier because it is the Saudi Arabia of Scandanavia.
I know macroeconomists like to think everything is about money, but I think the German unemployment reduction was due to the Hartz labor reforms more than anything else.
Jul 17 2015 at 6:06am
Or even more fundamentally, as Adam Smith put it in Book IV, Chapter 3, paragraph 31 of The Wealth of Nations:
Jul 17 2015 at 10:36am
The point is that without the possibility of an exchange rate adjustment, it is difficult to have a monetary policy in Greece that restores the pre-crisis level of NGDP and allows the government to run a primary surplus. Perhaps Germany does not benefit from Greece’s (and other’s) lack of exchange rate flexibility, but it appears to believe it does.
Jul 18 2015 at 3:23am
Thanks for this post. I learned something new.
Capt. J Parker
Jul 18 2015 at 5:50am
Bummer, Dr Sumner, looks like Ben Bernanke doesn’t read your blog. Here he is on July 17:”What about the strength of the German economy (and a few others) relative to the rest of the euro zone, as illustrated by Figure 2? As I discussed in an earlier post, Germany has benefited from having a currency, the euro, with an international value that is significantly weaker than a hypothetical German-only currency would be. Germany’s membership in the euro area has thus proved a major boost to German exports, relative to what they would be with an independent currency.” http://www.brookings.edu/blogs/ben-bernanke/posts/2015/07/17-greece-and-europe
Jul 18 2015 at 1:56pm
I’m not sure I understand the point. Of course Germany’s situation will depend on savings minus investment. But once in a particular situation (CA surplus), a change in exchange rates due to external factors (for example the collapse of the Greek economy) will boost exports.
Seems like the Euro helped Germany, even if Germany didn’t need to be helped. It allowed expensive social programs that would have been more difficult without it.
Sure other Northern European countries also have positive CA accounts, regardless of currency (floating or pegged), but that doesn’t mean that being in the Eurozone wouldn’t widen that surplus further.
What am I missing?
Jul 18 2015 at 3:14pm
Check out chapter 4. The IMF case studies contradict some of your arguments.
Jul 18 2015 at 3:38pm
I think Too Late has it right. Surely it’s a ceteris paribus thing? Germany might have a CA surplus even outside of the Euro due to savings habits sure: but doesn’t it have an even bigger one in the Euro?
Jul 19 2015 at 12:40pm
Put another way:
Sure, if the D-Mark were undervalued, Germany would experience inflation
And yes, if the Drachma were overvalued, Greece would experience (severe) deflation.
But because Greece and Germany use the same currency (the Euro), both these effects are muted. In a way, Germany exported its inflation to Greece.
Jul 19 2015 at 10:09pm
The analysis is spot on.
Take this Gedankenexperiment: I have a personal current account surplus, for age related reasons. Suppose all my surplus is financed by the return on past accumulations of wealth. I then move to Germany: The US current account deficit rises, now missing my savings, and the German current account surplus rises equally, on account of my saving there now, while NOTHING REAL HAS CHANGED.
US savings go down and German saving goes up equally, all at the current exchange rate!
Yes, we can complicate this to our hearts’ content. Negative or positive conclusions will hinge on what the optimum adjustment variable is: nominal and real wages or the exchange rate. That wage adjustment is a poorer candidate than exchange rate adjustment depends on one hell of a lot of assumptions. Me,I’m a floating rate guy. But none of that matters–the adjustment has to be made.
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