Is Germany Really a ‘Weight on the World’?

Martin Wolf Complains About Germany

By Pater Tenebrarum

Few writers produce erudite-sounding nonsense with such unwavering regularity as Martin Wolf, an establishment-approved scribbler for the Financial Times. When he is not screeching for more money printing, he is belly-aching about 'trade imbalances', which allegedly condemn the world to economic hell. The latest example is his article 'Germany is a Weight on the World'.

This was written after the misguided Mercantilists apparently still populating the US treasury department (after decades of US trade deficits that have somehow completely failed to matter all this time) decided to complain about Germany's allegedly unconscionable trade surplus.

So here we are, more than a century after the fallacies of Mercantilism have been disproved by a plethora of economists, and people still allege that there is something evil in trade that requires even more government intervention than there already is.

Wolf writes: 

“The criticisms that hurt are those one suspects might be fair. This might explain the outrage from Berlin last week over the criticism by the US Treasury of Germany’s huge and vaunted trade surplus. But the Treasury is to be commended for stating what Germany’s partners dare not: “Germany has maintained a large current account surplus throughout the euro area financial crisis.” This “hampered rebalancing” for other eurozone countries and created “a deflationary bias for the euro area, as well as for the world economy”. The International Monetary Fund has expressed similar worries.” 

(emphasis added)

It took him just one paragraph to mention the tiresome deflation bogey again, but allow us to point out that all these 'worries' about 'Germany's surplus' implicitly and quite wrongly assume that countries are somehow equivalent to acting human beings. This is not the case.

If, say, an American spends $50,000 to buy a car from BMW, then what this trade tells tells us that an individual residing in the US valued a German-built BMW more than $50,000, while the managers of the company BMW valued the $50,000 more than the car they offered in exchange. Both parties to the exchange have gained, otherwise no trade would have taken place. Win-win!

But no, says Martin Wolf, wagging his finger, accompanied by a chorus of bureaucrats from the US treasury to the IMF, something evil has occurred! See, due to this misguided American individual buying a car that the misguided Germans have built so well that he prefers it not only over his $50,000 but also to cars built by others elsewhere, the US now has a $50,000 deficit with Germany! This is terrible! Someone must do something!

This reminds us that we have a large, and constantly growing, trade deficit with a local groceries chain. Following  Martin Wolf's theory, this evil grocer is busy impoverishing us. Woe!

As Murray Rothbard wrote in “Man, Economy and State”: 

“One very popular subdivision of economics has been “international trade.” In a purely free market, such as we are analyzing in the bulk of this work, there can be no such thing as an “international trade” problem. For nations might then possibly continue as cultural expressions, but not as economically meaningful units. Since there would be neither trade nor other barriers between nations nor currency differences, “international trade” would become a mere appendage to a general study of interspatial trade. It would not matter whether the trade was within or outside a nation.” 

(emphasis added)

We intersperse this quote here because it makes one very important point clear: there is one, and only one, reason why 'international trade', and trade deficits and surpluses are even discussed by anyone: it is the fact that we do not live in a free unhampered market economy. It is only due to government intervention in the realms of money and trade that this topic is even worth pondering.

Mercantilist and Underconsumption Fallacies

Wolf continues: 

“The German finance ministry responded that its current account surplus was “no cause for concern, neither for Germany, nor for the eurozone, or the global economy”. Indeed, a spokesman stated that the country “contributes significantly to global growth through exports and the import of components for finished products”. This reaction is as predictable as it is wrong. The surplus, forecast by the IMF at $215bn this year (virtually the same as China’s) is indeed a big issue, above all for the future of the eurozone. 

Export surpluses do not reflect merely competitiveness but also an excess of output over spending. Surplus countries import the demand they do not generate internally. When global demand is buoyant, this need not be a problem provided the money borrowed by deficit countries is invested in activities that can subsequently service the debts they are incurring. Alas, this does not happen often, partly because the deficit countries are pushed by the supply of cheap imports from surplus countries towards investing in non-tradeable activities, which do not support the servicing of international debts. But in current conditions, when short-term official interest rates are close to zero and demand is chronically deficient across the globe, the import of demand by the surplus country is a “beggar-my-neighbour” policy: it exacerbates this global economic weakness.”

(emphasis added)

Ludwig von Mises wrote in 'Human Action' that these issues have long been settled by economic science – all that remains is to explain why the cranks are still spouting the same nonsense anyway – which is the task of historical investigation: 

“All the teachings of economics concerning the effects of the international division of labor and of international trade have up to now failed to destroy the popularity of the Mercantilist fallacy, "that the object of foreign trade is to pauperize foreigners." It is a task of historical investigation to disclose the sources of the popularity of this and other similar delusions and errors. For economics the matter is long since settled.” 

(emphasis added)

As you can see above, the Mercantilist fallacy that “the object of foreign trade is to pauperize foreigners” continues to live on. Its vitality seems even more pronounced than Germany's trade surplus. Not only that, it is augmented by additional fallacies marshaled in its support. Contrary to Wolf, the German finance ministry is exactly correct: by producing things the whole world wants, Germany is contributing to the well-being of people across the world. What would Wolf have the Germans do? Produce shoddy stuff no-one wants to buy?

Wolf then accuses Germany of engaging in a 'beggar-thy-neighbor' policy. However, that implies that Germany is somehow trying to deliberately lower the exchange value of the euro, which it cannot even do if it wanted to. The ECB, it may be remembered, is a supra-national central bank that has pursued a policy of loose money expressly against the wishes of its German board members which have been outvoted regularly since 2010. In spite of the ECB's loose monetary policy, the euro has actually strengthened against both the US dollar and the yen, because the central banks of the US and Japan pursue an even looser monetary policy!

If anything, one could level such an accusation against the Japanese, for having deliberately driven down the yen. We can however safely assume that Mr. Wolf isn't worrying about that, since the BoJ's inflationary policy is something that Wolf has both demanded and supported, given that it is aimed to vanquish the 'deflation' bogey that worries him so much. The contradictions inherent in this stance obviously don't bother him, but that should be no surprise. Keynesian theory is brimming with contradictions, so he is merely emulating his intellectual inspiration in this respect.  

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The euro against the US dollar. Who's begging whom? – click to enlarge.

The euro against the Japanese yen – if the euro gets any stronger against the yen, the Germans could well begin to complain – click to enlarge. 

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As to the inability of 'deficit countries to service their international debt' allow us to point out that it would be wise not to incur debts one cannot hope to service. None of this alters the basic fact that it is not 'countries' that trade with each other, but individuals.

Now let us briefly discuss the fallacy Wolf uses to support his Mercantilism-inspired stance on trade: 

“But in current conditions, when short-term official interest rates are close to zero and demand is chronically deficient across the globe, the import of demand by the surplus country is a “beggar-my-neighbour” policy: it exacerbates this global economic weakness.”

First of all, the fact that central banks have pushed their administered interest rates to zero is an excellent reminder that these institutions are harmful and urgently need to be abolished. The natural interest rate cannot possibly be at zero. Time preference is a universal category of human action. As Mises pointed out: 

“If acting man, other conditions being equal, were not to prefer, without exception, consumption in a nearer future to that in the remoter future,  he would always save, never consume.” 

In other words, time preference simply cannot be 'zero', and it follows from this that 'zero interest rate policies' are a distortion that will inevitably harm the economy. However, Wolf's biggest clunker here is the related warming up of the Keynesian 'underconsumption' theory, according to which there is now a 'deficiency in aggregate demand'. Hayek refuted this nonsense very elegantly in his essay 'The Paradox of Saving' in 1929 already,  several years before Keynes' 'General Theory' was published (Keynes was unfamiliar with much of the economic literature of his time, especially from non-English speaking countries, which may explain why he failed to consider Hayek's arguments).

As Hayek pointed out, the main problem of underconsumption theories is that they proceed from incorrect and rigid assumptions – they lack a theory of capital. New investment always leads to changes in the structure of production, i.e., in the methods of production. Hayek showed that even with an unchanged money supply, the new arrangement of production into a more capital-intensive and longer production structure after an act of saving allowed for the profitable sale of the greater output of consumer goods that would result (interested readers may want to check out Hayek's instructive essay in toto, which begins on page 131 here).

The by now rather hoary underconsumption theory is an example of putting the cart before the horse. It assumes that economic growth is driven by spending and consumption, but this is simply incorrect. Consumption is an effect of economic growth, it cannot be the cause of it. There simply is no such thing as 'deficient demand' -  as long as there remain human wants that are not satisfied, there will always be 'demand'. The main question is if the means to satisfy this demand exist, i.e., if people can pay for their demand out of their production.

What Wolf worries about is of course that people 'save too much', but that wrongly assumes that savings are somehow 'lost' to the economy, when in reality, they are the sine qua non precondition for investment and production. It is literally impossible to produce anything without prior saving. 

Germany's Trade Surplus Destroys Economic Growth?

Frankly, we lack the energy to go through the entire Wolf article, but there are  two more paragraphs we want to comment on: 

It is no surprise, therefore, that in the second quarter of 2013 the eurozone’s gross domestic product was 3.1 per cent below its pre-crisis peak and 1.1 per cent lower than two years before. Its highly creditworthy core economy is subtracting demand, not adding to it. Not surprisingly, the eurozone is also stumbling towards deflation: the latest measure of year-on-year core inflation was 0.8 per cent. Since demand is so weak, inflation may well fall further. This not only risks pushing the eurozone into a Japanese deflationary trap but thwarts the necessary shifts in competitiveness across the eurozone. The crisis-hit countries are being forced to accept outright deflation. This makes ultra-high unemployment inescapable. It also raises the real value of debt. The policies pursued by the eurozone, under German direction, were certain to have this outcome, given the demand-destroying impact of the all-round fiscal austerity.” 

(emphasis added)

So Wolf's theory is that because individuals in non-German nations are eager to buy German products, 'demand' and 'growth' are somehow destroyed. This once again begs the question what would he have the Germans do? Would economic growth benefit if German producers were to stop producing? Would it benefit if they were to start producing inferior products? WHAT?

He doesn't say, because there is in fact nothing to say. Allow us also to ask:  if there really is so little 'demand' out there as Wolf keeps repeating, then how come the Germans can sell so much? Are their sales not the result of strong demand for their products?

The assertion that 'deflation' (falling prices) results in 'ultra-high unemployment' is a complete non-sequitur. If it were true that falling prices 'cause' unemployment, then why did Japan always have one of the lowest unemployment rates in the world? How was it possible for real economic growth in the US to reach what hitherto has been its historical pinnacle during the mildly 'deflationary' Gilded Age? The reality is of course that falling prices have absolutely nothing to do with employment. Computer prices have declined by 99% in real terms since 1980, but we never hear of unemployment problems in the hi-tech industry specifically, do we?

Moreover, Wolf contradicts himself when on the one hand, he asserts that the peripheral economies are failing to become 'competitive', and in the same breadth bemoans that prices in these countries are finally falling! Should not declining prices and wages help them to regain competitiveness? This is in fact precisely what needs to happen, as the preceding inflationary boom (i.e., the true cause of the crisis) has pushed prices to far too high levels in all of these countries.

We may concede that the servicing of existing debt becomes more onerous if nominal incomes decline. However, this merely underscores that much of this debt is unsound and should be written off. The notion that 'fiscal austerity' is 'demand-destroying' has only validity in the context of tax increases. Here Wolf  would have a point, if only he were making it, which he isn't.

He does not even once mention the fundamental difference between austerity achieved by the tax hike route (completely misguided and very popular in Europe) and expansionary fiscal consolidations that could be achieved by cutting both spending and taxes. Note here that his argument is based on yet another fallacious notion – namely the idea that governments somehow exist outside the ambit of the economy, that they possess some secret stash of resources that can be deployed at will. In Human Action, Mises writes about this fallacious argument in his discussion of tariffs: 

“At the bottom of the interventionist argument there is always the idea that the government or the state is an entity outside and above the social process of production, that it owns something which is not derived from taxing its subjects, and that it can spend this mythical something for definite purposes. This is the Santa Claus fable raised by Lord Keynes to the dignity of an economic doctrine and enthusiastically endorsed by all those who expect personal advantage from government spending.

As against these popular fallacies there is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity. While government has no power to make people more prosperous by interference with business, it certainly does have the power to make them less satisfied by restriction of production.” 

(emphasis added)

We are not surprised that Wolf of all people is rehashing Keynes' 'Santa Claus' fable, but it remains a fable nonetheless.

Wolf then briefly discusses the ECB's policies. He has of course never seen a money printing press he didn't like, but following the mare's nest of fallacies and contradictions he has dished out up to this point, he tries to avoid contradicting himself even further by admitting that more ECB money printing would be bound to lower the exchange rate of the euro – which naturally, would tend to increase Germany's trade surplus even more. To no-one's (at least not ours) particular surprise though, he holds back when it comes to the secret of the 'solution'. What precisely are the 'regulatory failures' that need to be addressed? 

“The most likely way that a more aggressive monetary policy would be effective is by depreciating the euro’s exchange rate. If, for example, the ECB were to undertake large-scale quantitative easing, by buying the bonds of the members in proportion to their shares in the central bank, a falling euro would be the most likely result. But that would exacerbate the tendency of the eurozone, operating under German influence, to force its adjustment on the rest of the world.

As the vulnerable countries shrink their external deficits, while the chief creditor country remains in surplus, the eurozone is generating huge external surpluses: the shift from deficit towards surplus is forecast by the IMF to be 3.3 per cent of eurozone GDP between 2008 and 2015. Given the shortfall demand in the eurozone, the shift might need to be even larger, at least if the vulnerable nations are to have much chance of cutting unemployment. This is a beggar-my-neighbour policy for the world. The US has every right to complain about it, just as others had a right to complain about past US regulatory failures.” 

(emphasis added)

So now not only Germany, but the entire euro-zone is to be condemned for 'creating surpluses'. Mind, for once we agree with a point Wolf makes, namely  that the devaluation of the euro would indeed be an insane policy. However, it must be seen in context: as discussed further above, the ECB's policy is thus far actually far less inflationary than that pursued by other major central banks. The proof is in the pudding: US money supply has increased by 81% since 2008, the euro area's by about 50%. In fact, Wolf doesn't explain why it is possible for the euro area to be such a successful exporter even though the euro's exchange rate has risen sharply, except to go on about imaginary 'demand deficiencies', but if the rest of the world is so eagerly buying euro-zone exports, there is obviously no 'demand deficiency' elsewhere.

Since Wolf neglects to give a satisfactory answer regarding the best way to actually tackle the problems of unemployment and faltering economic growth, allow us to make a few modest proposals:

1. Ignore all advice by Martin Wolf. 2. Make sure you ignore all advice dispensed by Paul Krugman as well. 3. free up and completely deregulate the euro area's labor markets. 4. reduce all still existing tariffs to zero. 5. scratch as many regulations as is humanly possible; if necessary go with a big magnet over the hard drives where they are stored and use the paper they are printed on for producing environmentally friendly recycled paper. 6. cut taxes and then cut them some more. And then cut them again. 7. stop government spending; to do so, shrink the size of government by 90% for a start and consider whether it is really necessary to finance what remains by taxation. It may be doable with voluntary donations. 8. return money to the free market and abolish the central bank system in favor of free banking. 9. open borders to all comers, but give them zero state welfare.See? That's how simple it is. Europe would have full employment and strong economic growth before Martin Wolf could say 'what happened'?

Of course those dastardly Germans may still end up having a trade surplus. Unfortunately they would no longer have any state-run departments that could be consulted about trade issues, since those would have become completely superfluous following the implementation of the above reforms.

Wolf and the US treasury could then go and lodge their complaints with the Austrian salt authority.