At the NATO meetings late last month, the German media reported that President Trump had called the Germans “bad” for running trade surpluses with the U.S. The president threatened trade restrictions, focusing on German automobiles. Needless to say, this comment caused a minor international incident.
Although such incidents come and go, it did generate a more serious question…are German policies causing problems for the world? In this report, we will review the saving identity we introduced in last month’s series on trade and discuss how Germany has built a policy designed to create saving. We will move the discussion to the Eurozone and show the impact that German policy has had on the single currency. From there, we will try to address the question posed in the title of this report. We will conclude, as always, with market ramifications.
The Saving Identity
In the month of May, we published a four-part report on trade that is now combined into a single report. In that report, we introduced the saving identity.
(M - X) = (I - S) + (G - Tx)
The saving identity states that private sector domestic saving (I - S) plus public sector saving (G - Tx) is equal to foreign saving. If a country is running a positive domestic savings balance, either by investing less than it saves or by running a fiscal surplus, it will run a trade surplus (X>M). In public discussion, trade appears to be all about jobs, relative prices, trade barriers, etc. However, regardless of how nations interfere with trade, the saving identity will always be true. As we noted in the aforementioned report, tariffs, exchange rate manipulation and administration barriers will, in the final analysis, be explained through the saving identity.
In the process of economic development, nations must build productive capacity through investment. Both public and private investment are necessary for success. Public investment in infrastructure, roads, bridges, canals, etc., are critical to supporting private investment. In capitalist societies, a legal framework to adjudicate contract disputes and support the enforcement of agreements is also necessary and mostly provided by the public sector. Private investment usually occurs along with public investment. But, all investment requires funding, which comes from saving. That saving can come from both domestic and foreign sources.
Usually, nations that are building productive capacity create policies that either generate domestic saving or attract foreign saving. There are various policies that can support the effort to build saving. Trade restrictions can restrain consumption by raising import prices. High taxes are sometimes used to create public saving; savings schemes to funnel household saving into the private market are also used. And, through a trade deficit, foreign saving can be acquired.
The process of development is fraught with risk. Investment is always hard because it involves making projections about the future and it’s easy to make mistakes. Malinvestment can slow economic growth and lead to financial crises; after all, most investment is funded by debt.
As a nation achieves developed status, the need to restrain consumption declines. Clearly, there will always be a need for investment regardless of the level of development even if it is nothing more than to offset depreciation. An example is the U.S. interstate highway system; although it is being constantly repaired and upgraded, the need to build another highway system is unnecessary.
Thus, over time, as a nation becomes increasingly developed, one would expect to see rising levels of consumption relative to overall GDP. However, this process can become stalled if political constituencies, who have benefited from consumption-constraining policies of development, prevent the transition from occurring. If this happens, policy can become “stuck” and such a nation will continue to promote exports, which means they are capturing demand from abroad.