The Irrelevant German Consumer

MUNICH – With global rebalancing set to be high on the agenda at the next G-7 and G-20 meetings, Germany, with its persistent export surplus, will again come under pressure to boost domestic demand and household consumption. But the German consumer is a sideshow. What is needed is an investment surge in Germany and Europe, and a coordinated exit from ultra-loose monetary policies.

Massive external-account imbalances were a major factor behind the global financial and economic crisis that erupted in 2008, as well as in the eurozone instability that followed. Now the world economy is in the process of rebalancing – but not in a way that many people had expected.

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Asia’s formerly huge external surpluses have declined astonishingly fast, and Japan’s trade balance has even slipped into deficit. China’s current-account surplus has fallen to 2% of GDP, from 10% in 2007. Investment is still the Chinese economy’s main driver, but it has led to soaring debt and a bloated shadow banking sector, which the authorities are trying to rein in.

The European Union, however, has built up a large external surplus, owing mainly to positive trade balances in the eurozone. The EU’s current-account surplus in 2014, at around $250 billion, will be even higher than that of emerging Asia. With oil prices still above $100 a barrel, the combined surplus of oil-exporting countries is of a similar magnitude. The United States, meanwhile, continues to run a sizeable current-account deficit of around $350-400 billion.

The surprise here is the continued growth in the EU’s surplus. The collapse in imports suffered by bailed-out countries – Greece, Ireland, Portugal, and Spain – was entirely predictable, given how sharply their economies declined. But few economists expected that these countries’ exports would improve as quickly as they did, especially in a subdued international environment. While Germany’s current-account surplus is roughly where it was in 2007, the combined external balance of the bailout beneficiaries plus Italy (which has been part of the trade turnaround) has swung from a pre-crisis deficit of more than $300 billion to an expected surplus of around $60 billion this year.

Looking ahead, the appreciating euro (another surprise, especially to the many observers who doubted its survival less than two years ago) will compress the eurozone’s current-account surplus to some extent. An exchange rate of close to $1.40 poses a challenge for many European exporters, including German companies. And the euro has revalued even more against the yen and a number of emerging-market currencies.

Nonetheless, the European surplus is too large to ignore, and Germany in particular will be asked once more to rebalance its economy toward higher domestic demand, which for many people implies the need for a fiscal boost. But the government is not obliging: Finance Minister Wolfgang Schäuble has just presented a balanced budget for 2015 – the first since 1969. And, while some observers are calling for Germany to “end wage restraint” and thereby encourage higher household spending, this has actually happened already.

There is, however, a lot that the government could do about investment, which has fallen by almost four percentage points of GDP since 2000, to just over 17% in 2013 – low by international standards. The government could shift more government spending toward infrastructure investment. But, even more important, it should improve conditions for corporate investment at home, rather than watch German businesses move their capital expenditures abroad.

Germany’s attractiveness to investors would rise with simpler and more investment-friendly taxation, improved incentives for business start-ups and R&D, less bureaucracy and red tape, and no further energy-cost increases. Getting there will take time. But, given the favorable earnings situation and the corporate sector’s large cash balances, a rebalancing of the tax system could have a rapid impact. Investment from retained earnings should be as attractive as debt financing. And some temporary adjustments of depreciation allowances could kick-start capital spending.

The need for more investment in transport, telecoms, energy, and education certainly is not only a German issue. Given most European governments’ debt problems, the challenge is to attract more private capital into these areas. Improved regulatory conditions for long-term investments and savings would help. So would expansion of financing instruments for infrastructure investment – for example, by substantially increasing the supply of project bonds supported by the European Investment Bank.

Indeed, why not create “European Infrastructure Bonds,” backed by revenues generated by the investments or tax income from the countries that emit EIBs? This would not only spur jobs and long-term growth; it would also stem the rise in Europe’s external surplus.

But the challenge of rebalancing the global economy is also closely connected to central banks’ monetary policies. With credit and asset bubbles slowly but surely reappearing, the authorities’ goal should be to keep growth on a balanced and sustainable path – and thus to discouraging excessive risk taking.

This justifies the US Federal Reserve’s gradual exit from ultra-loose policies. Somewhat surprisingly, the Fed’s reduction of its monthly asset purchases has been accompanied so far by dollar weakness against the euro, which is fostering external adjustment. Looking forward, however, this may change. If the Fed remains alone in scaling back its monetary stimulus and bond yields rise further, the dollar will almost certainly strengthen.

Clearly, a coordinated effort to limit exchange-rate variations is advisable. If all countries try to keep their currencies weak, monetary expansion on a global scale will be over-extended. The fact that inflationary pressure is still low is not a reason to postpone planning an exit from ultra-loose policy; on the contrary, the time for such discussions is when inflation is low and markets are calm. Twenty years ago, markets panicked and bond rates soared as central banks hiked interest rates in the face of rising inflation. They should not repeat that mistake by waiting for inflationary pressures – fueled by rising oil and commodity prices and economic recovery – to return.