Germany is fighting with Europe. Can China be far behind?

Earlier this week Ambrose Evans-Pritchard had an article in the UK paper The Telegraph which starts off with “For the first time in my life, I am starting to feel twinges of anti-German sentiment.” The article goes on to lambaste the German government, and especially German finance minister Peer Steinbrück, for what Paul Krugman earlier called “boneheadedness” in refusing to participate in the European fiscal expansion and, worse, for calling British and French programs “crass Keynesianism.” According to Krugman:

The world economy is in a terrifying nosedive, visible everywhere. The high degree of European economic integration gives Germany a special strategic role right now, and Mr Steinbrück is doing a remarkable amount of damage. There’s a huge multiplier effect at work; it is multiplying the impact of German boneheadedness.

Evans-Pritchard explains why a number of European countries, led by France and England, are so angry:

Put bluntly, Germany is pursuing a beggar-thy-neighbour policy. It is not fulfilling its responsibilities as the world’s top exporter and pivotal power of Europe’s monetary union. It is leaching off global demand, even as it patronizes Anglo-Saxons, Latins, and Slavs. No doubt binge debtors in the Anglosphere are much to blame for this crisis. But Germany rode the boom too. It made those Porsches and BMWs driven by the new rich. Its banks are among the most leveraged in the world.

Nor should we not forget that the European Central Bank set interest rates at recklessly low levels early this decade to help Germany out of a slump. Can this be separated from the property bubbles in Club Med, Holland, Ireland, Scandinavia, and Eastern Europe now causing such grief? Within the EMU, Germany has gained a competitive edge against France, Italy, and Spain for year after year by screwing down wages. In pre-euro days the North-South rift did not matter. The D-Mark revalued. Balance was restored. In monetary union it is toxic.

The point he is making is that the imbalances were not created simply by “binge debtors in the Anglosphere” but also by those countries that subsidized directly or indirectly overproduction, which ultimately have had much to do with the very conditions that led to consumption binge. This includes not just Germany but any of the countries that created persistent and high trade surpluses. Evans Pritchard makes the comparison very explicit:

Germany now has a current account surplus of 7pc of GDP. It is hollowing the industrial core of Latin Europe. Yes, Club Med needs to pull its socks up, but the flip side of the coin is that Germany is in breach of EMU’s implicit contract. The rules of the game are that surplus countries should boost demand. The Gold Standard collapsed in the early 1930s because they – then the US and France – refused to do so. The burden of adjustment fell on deficit states, who had to tighten yet harder.

The downward spiral dragged everybody into depression. Germany and China are today’s violators. Their trade surpluses over the last 12 months have been $283bn and $279bn, respectively. They are exporting excess capacity.

What does all this have to do with China? The reasons I bring this up is because it is, I think, a foretaste of the type of nasty battles that are likely to erupt between the trade-surplus and trade-deficit countries as global demand continues to contract. The overconsuming trade-deficit countries cannot reduce their overconsumption except with a collapse in production (and sharply rising unemployment) if the overproducing countries do not also adjust. Furthermore, fiscal expansion aimed at generating employment in countries with large trade deficits will not be nearly as effective as they might be if they are not matched with programs in trade surplus countries (essentially demand boosting fiscal programs) that prevent domestic demand from bleeding out the trade account.

The French and the British (and much of the rest of Europe) are concerned that if their governments borrow to boost domestic demand and employment at home, they are also borrowing to boost demand and employment in Germany, which means that they bear the fiscal cost for the foreseeable future while Germany gets a substantial chunk of the benefit. This may be a great deal for Germany, but it is one hard for the rest of Europe to embrace.

In Europe it is clear to me that the economic debate is migrating rapidly towards consideration of the impact of trade, and it would be surprising if the debate does not quickly globalize. If Europeans, nominally members of one country (sort of), can get into such an acrimonious debate among themselves, what hope is there for a polite and statesmanlike discussion that involves countries less tied together? I believe that in the US there is a much stronger commitment to free trade and, in spite of Mr. Bush, multilateral cooperation on economic issues, then elsewhere, but politics is politics, and rising unemployment in the US will inevitably lead to the same confrontational attitudes as they seem to have in Europe.

By the way among the dozens of bankers, government officials, academics and businessmen I have met in the past few weeks to discuss trade issues, it seems to me that those of us who have spent the past several months warning about an imminent collapse in trade are getting more and more attention. This is undoubtedly going to become a hot issue next year.

It is not that China isn’t doing anything to address the problem. The slate of bad economic numbers this week and last (trade is down, we are racing towards deflation, investment and consumption growth is down, manufacturing output growth was only 5.4%, electricity consumption was down 8.6%) has confirmed what we all dreaded: things are slowing quickly. The government is trying to do all it can to boost the economy and, especially, employment, but I am afraid they still don’t understand their place in the global mayhem. They continue to see China as an innocent victim of the global crisis – not as one of the fundamental creators of the payments imbalance that led to the crisis – and much of their strategy seems to assume that China can adjust domestically without worrying about the impact on the global market.

For example two days ago I was part of a panel that included a prominent Chinese economist and think tanker who I know and like very much, and as we discussed what needed to be done I got the impression that he hasn’t considered global implications at all (although as we discussed them he acknowledged many of my arguments). For example, much of his currency focus was on how China can retain export competitiveness without encouraging hot money outflows. But that is not the right way to think about it. China needs to think not only about the domestic impact of its currency but also about the global impact of its currency policy, and how that affects the adjustment that trade deficit countries are undergoing. If it makes things worse for them, there is no reason to assume that they will remain indifferent to Chinese domestic policies, and there is even less reason that they will run policies that accommodate China’s needs.

China is making Herculean efforts to get out of this mess. It is doing everything it can to maintain growth and is clearly very worried about the pace of the slowdown. Bloomberg, for example, had this article today:

China’s government plans to lower taxes and reduce the lockup period for home sales to stem a decline in the nation’s property market. Home owners will be waived from paying a sales tax on properties sold after three years of purchase, compared with the previous term of five years, according to a statement today by the State Council, China’s cabinet. The tax will also be levied based on the profit from the sale, instead of the sale price, according to the announcement.

These are all good things because they are aimed at boosting domestic consumption, and to the extent they also affect production positively, they affect non-tradable goods. That is a start. But there must also be recognition that policies that do not bring the trade surplus down sharply are inevitably going to cause trade friction, and that is a game China cannot play. A collapse in trade would force a brutal adjustment here.

Just to get some sense of numbers, with a trade surplus equal to 10% of GDP, what would happen if external trade were to disappear? Even assuming that there are no transition difficulties, Chinese producers would suddenly be forced to deal with the fact that they are producing more than Chinese are consuming by an amount equal to 10% of GDP, and if domestic demand cannot be increased by that amount immediately, Chinese producers must fire enough workers to bring production down by that amount. Of course firing so many workers would also cause demand to contract further, so the country would race downwards and adjustment much worse than even these frightening figures imply.

Of course international trade will not disappear (or, more to the point, the trade account will not quickly balance), so this is not the scenario we need to worry about, but even a small move in that direction would be terrible for growth. Remember that Chinese overproduction today is roughly equal, in global GDP terms, to US overproduction in 1929, and the US had more than six times the share of global GDP then than China has today. This is a much bigger adjustment for China than that of the US in the 1930s.

It will be grim. In the last few weeks there have been lots of new numbers and stories about unemployment. Perhaps it is because I am a university professor but I find myself particularly worried by rising college unemployment. According to a story today in the South China Morning Post:

More than a million Chinese college graduates unable to find work could make coping with unemployment harder now than it was during the Asian crisis, the head of China’s largest vocational training organisation said

…“The employment situation may be worse than the 1990s … This time, college graduates are not finding work, and there are so many of them,” Mr Chen told Reuters. In the late 1990s, China’s government weathered mass unemployment as the Asian financial crisis and bankruptcies of state-owned enterprises slowed the economy to a crawl.

Many college graduates now lacked the skills needed to compete for jobs in a fast-changing economy and were unwilling to take less respected jobs, Mr Chen said. More than six million students will try to enter China’s workforce next year, half a million more than last year. Up to a quarter could have difficulty finding jobs, the Chinese Academy of Social Sciences said on Monday.

In another article today the same newspaper says:

Swarms of migrant workers driven back home by the economic downturn in eastern provinces are putting huge social and employment pressure on the governments in their hometowns. In Yunnan province authorities are not only facing the tough task of creating jobs for 510,000 returned workers, but are also struggling to secure enough food to feed the swelling population in some areas, according to the provincial government’s website.

“The hundreds of thousands of returned rural workers have increased grain consumption by the local population by 500,000 tonnes per day, and we are feeling the strain of preparing enough rice in the bowl,” Liu Guoquan, director of Zhaotong’s Rural Human Resources Development Office, told fellow officials at a provincial meeting to discuss the crisis.

12 Responses to "Germany is fighting with Europe. Can China be far behind?"

  1. Gloomy   December 17, 2008 at 3:01 pm

    Great post!! Smoot-Hawley rises from the grave in a different guise. Keep us posted.

  2. Anonymous   December 17, 2008 at 11:09 pm

    Boo-freaking-ho.. why should the Gemran tax payers bail out ignorant lackeys from the UK and France???? Stop asking for handouts from Germany and get a job and support yourself.How about not spending those moneys you earn?????Trust me, Most Americans are on Germany’s side on this one. That’s like asking for us Americans for money. Sorry we have enough problems of our own to care about your countries!!

  3. american pride   December 17, 2008 at 11:10 pm

    PS.. Ambrose Evans-Pritchard is a NOBODY.. LOL

  4. TR   December 17, 2008 at 11:29 pm

    I am surprised people who know so little about basic economics as Anonymous would afford a subscription to RGE. Shouldn’t you be using the money to buy the latest Guns N Roses CD?

  5. clintonk   December 18, 2008 at 7:57 pm

    Seems to me the U.S. knows it’s dollar is on the verge of collapse. Maybe not this year, or the next, but very soon. The ECB and some of the EU countries know this too. Sorry to tell U.S. economists, but much of the world will happily watch economic power redistribute. These articles are nothing more than an attempt to put pressure on the ECB to drop rates.

  6. Guest   December 19, 2008 at 7:50 am

    You know what´s funny. Every economist and every person I spoke to in the countries mentioned here over the last years was in the strong believe that wages in Germany are too high. Well, they came down. And it wasn´t very pretty. In the meantime the same advisers bought German limousines and ruined their own industries entirely by flooding their homes with goods from China, but not because they like the Germans or the Chinese so much. Those were openly talked about as the stupid who had not figured out how to run a modern economy without getting dirty hands.German-Bashing is for known reasons a popular thing esp. in Britain. To serve anti-German sentiment and make “the Germans” even look guilty now for the current mischief is downright irresponsible. People there start recognizing Merkels inability. They don´t think much about Britain or Spain messing it up. Let´s take that as a good thing.

  7. Guest   December 19, 2008 at 9:10 am

    Illustrating the “Intellectual Bankruptcy” of the Federal Reserve, even Businessweek admits that Bernanke’s failed economic strategy rests on re-inflating another Financial Bubble to bailout the economy from the deflated Housing Bubble. It won’t work. Greenspan inflated the Housing bubble to mitigate the impact from the collapsed Dot-com bubble. Even Greenspan was smart enough to recognize that you can’t reinflate a collapsed bubble so he inflated the larger Housing bubble. There isn’t another asset class big enough to inflate to prevent US economic collapse. Bernanke will attempt to inflate the money supply until we have an inflationary depression that was experienced by Germany during the 1930’s. No “real industrial economic” wealth is being created from Bernanke monetary money printing to bailout corrupt Wall Street banksters. a Dec. 17 research note, Yardeni wrote: “After one bubble bursts, the only way to get out of the resulting recession, and to avoid a depression, is to create another bubble.”What’s more, starting in early 2009, the Fed will pump money into markets for student, auto, credit-card, and small-business loans in hopes of helping those parts of the economy. All told, the Fed’s assets—a measure of how much the Fed has lent, directly and indirectly—could go as high as $5 trillion, says Ed Yardeni of Yardeni Research. That’s up from $2.2 trillion now. And the range of assets the Fed is permitted to acquire in an emergency is almost unlimited. “It could buy a herd of cattle in Texas if it so desired,” says Paul Ashworth, senior economist in the Toronto office of consultant Capital Economics.The central bank is running unacceptable risks of losses by itself and ultimately by taxpayers while propping up an unsustainable reliance on debt. “It’s 100% wrong. It’s going to make the situation worse,” says Peter Schiff of Euro Pacific Capital, a brokerage in Darien, Conn. “In the short run, it does postpone some of the pain, but the economy is going to be in worse shape a year from now. Eventually we will have hyperinflation, where the dollar loses almost all its value.”

  8. Guest75   December 19, 2008 at 10:23 am

    so what exactly is germany to be blamed for? they don t manipulate currency . are they hated for they productivity? the irresponsible should pay their dues now.

  9. Guest   December 19, 2008 at 12:59 pm

    The vast expansion of US-led globalized trade since the Cold War ended in 1991 had been fueled by unsustainable serial debt bubbles built on dollar hegemony, which came into existence on a global scale with the emergence of deregulated global financial markets that made cross-border flow of funds routine since the 1990s. Dollar hegemony is a geopolitically-constructed peculiarity through which critical commodities, the most notable being oil, are denominated in fiat dollars, not backed by gold or other species since President Nixon took the dollar off gold in 1971. The recycling of petro-dollars into other dollar assets is the price the US has extracted from oil-producing countries for US tolerance for the oil-exporting cartel since 1973. After that, everyone accepts dollars because dollars can buy oil, and every economy needs oil. Dollar hegemony separates the trade value of every currency from direct connection to the productivity of the issuing economy to link it directly to the size of dollar reserves held by the issuing central bank. Dollar hegemony enables the US to own indirectly but essentially the entire global economy by requiring its wealth to be denominated in fiat dollars that the US can print at will with little monetary penalties. World trade is now a game in which the US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produce goods and services that fiat dollars can buy at “market prices” quoted in dollars.Despite all the talk about globalization as an irresistible trend of progress, the priority for the United States in the final analysis has been to advance its superpower economic objectives, not its obligations as the center of the global monetary system. This superpower economic objective includes the global expansion of US economic dominance through dollar hegemony, reducing all domestic economies, including that of the US, to be merely local units of a global empire. Thus when the US asserts that a healthy and strong economy in Europe, Japan and even Russia and China is part of the Pax Americana, it is essentially declaring a neocolonial claim on these economies.The concept of “stakeholder” in the global geopolitical-economic order advanced by Robert B. Zoellick, former US Deputy Secretary of State and now president of the World Bank, is a solicitation from the US to emerging economic powerhouses to support this Pax Americana. The device for accomplishing this neo-imperialism is a coordinated monetary policy managed by a global system of central banking, first adopted in the US in 1913 to allow a financial elite to gain monetary control of the US national economy, and after the Cold War, to allow the US as the sole remaining superpower controlled by a financial oligarchy to gain monetary control of the entire global economy.

  10. Anonymous   December 20, 2008 at 8:40 am

    It seems rather strange to blame Germany or China for the financial and economic problems in other countries such as France and the UK. Are Germany or China responsible for a lack of constraint in other countries with extreme housing bubbles? Who is in charge of monetary policy in the UK? Are Germany or China to blame for a lack of discipline in other countries where people prefer to inflate assets and then consume by borrowing against these assets rather than getting their hands dirty and producing useful products wich can then be exported? Are they to blame for the costs to some countries caused by irresponsible goverments subsidising incompetence by taxing the competent? Who got France and the UK into the mess they are in? Not Germany or China. Perhaps France and the UK could take Germany and China as examples for how to run a country.

  11. Guest   December 22, 2008 at 8:17 am

    Germany’s reluctance against extensive fiscal stimuli is at least partly affected by animosities between Peer Steinbrück / Angela Merkel and Nicolas Sarkozy. With the end of the French EU presidency in next january, these discussions will very likely get new momentum under Czech EU presidency.I hope that our politicians are not going to overtrump each other with ever larger banking bailouts. I barely see any discussion on the question who is going to pay all that bills? Hardly anybody seems to be bothered by the implications on income and wealth distribution if bankers are bailed out and workers in ‘overcapacity’-industries will face job losses and declining wages. Banks have already unloaded so much scrap-assets on central banks sheets and received fresh money in return. Now, once the real economy is collapsing, they will be the ones who can grab a large share of the economy for descent discounts from credit-squeezed companies.Therefore, if banks shall get recapitalizations, they have to offer sharp cuts in dividends, bonuses, workforce and an exchange of all top executives who bear responsibility of past years excesses. In order to restore some responsibility legal actions against top managers should at least be considered. Perspectively, too large to fail financial institutions should be split into smaller parts. The goal must be that banking must become a normal economic sector.

  12. PHILIP   December 27, 2008 at 2:16 am

    What I wonder in reading this kind of article is if the writer knows the real world..I am producing goods that my customers want. If they do not order the goods to me I do not produce them. If i make a credit to my buyers its a 3 month credit financed with MY own funds.To make it simple, lets assume that there is only one world currency. So we will have no trade balance surplus or deficit but that will have not avoided the present mess !So I completely agree with the word of “crass Keynesianism.”