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“Our world cannot be understood by looking at people behaving within the system because of emergent phenomena. Our markets display decisions that are not in the ergodic world of a gambler at the roulette table because our environment shifts with every interaction and experience—and particularly during crises, which is where it is most critical we find a way to predict or at least understand. When we come to comprehend these limits, we approach a world filled with the giant unknown unknowns: radical uncertainty.” Richard Bookstaber,  The End of Theory

Angela! Seriously? You want to go your own way?

Not satisfied with her maniacal immigration policy, which threatens the very existence of hard fought western cultural norms across Europe, German Chancellor Angela is now complaining about the US not being a viable partner for Germany or Europe. It’s doubtful she vetted these comments with her German industrialist buddies. Why do I say that? It’s because Germany has piggybacked on the US capital and trade regime (and NATO defense shield) to unprecedented proportion for the last fifty years.

“While China is usually singled out for its policies, other countries have behaved more irresponsibly, most notably rich Germany, whose surpluses, the largest in history, were built primarily on an undervalued currency [relative to the D-mark], after the creation of the euro, and on weak wage growth, after the 2003–05 labor reforms.”
Michael Pettis

Let’s consider some trade realities before jumping to conclusions about the “bad guy” in this US-German relationship. Just because President Trump doesn’t use “political hack speech” to make a point, and in so doing rankles the sensibilities of the oh-so urbane egocentric left here and abroad, it doesn’t automatically mean he is wrong.

The chart below shows the German Trade Surplus Monthly 1960-2017 (Apr). Germany is by a far the most export-dependent major economy in the world. Germany’s current account surplus was a whopping 8.6% of GDP for 2016. (For comparison purposes, China’s current account surplus as a percentage of GDP for the same period was only 1.8%; and Japan’s was 3.7%.)

Now compare the chart above to the one showing the US Monthly Trade Balance over the same 57-year period below. Do you see the mirror image here; or is it just me?

Maybe President Trump needed some visuals. Had he shown the two charts above, to support his blunt commentary, someone in the media may have at least hesitated before going directly on the attack.

China could be the new German partner on trade.

Many excited commentators, who simply do not understand how the global trade regime works, or is structured, have willy-nilly suggested Germany could turn to China as their new partner in reforming a viable global trading regime.

It is nonsense.

China cannot absorb imports anywhere close to the degree of the US (and has a closed capital account, and….). And given their precarious debt position, they cannot afford to run a current account deficit which would be a requirement if they were to replace the US in the global trading regime. It’s just not going to happen anytime soon (20-years maybe?). Here’s why…

According to Professor Michael Pettis, “the following five points summarize in simplified form the sequence of conditions that drive the need for China to retain large surpluses on its trade and current accounts:”

  1. Chinese debt levels are extremely high and growing too rapidly largely because the growth in Chinese investment is greater than the economy’s ability to absorb it productively. To rein in credit growth, Beijing must force a sharp deceleration in investment growth, which, because investment growth is a substantial source of economic activity, means laying off a large number of workers employed in investment-related activity.
  2. But to prevent a potentially destabilizing surge in unemployment, Beijing must also implement policies that increase the growth rate of consumption by enough to absorb these workers.
  3. China’s household consumption rate is among the lowest ever recorded in history because Chinese households retain a share of GDP that is also among the lowest ever recorded in history. Consumption growth is constrained by the growth in household income, and an investment deceleration puts downward pressure on the growth in household income by raising unemployment levels.
  4. The only way for Beijing to speed up household income growth sufficiently is through wealth transfers from local governments to Chinese households equal to at least 1–2 percent of GDP every year, a policy to which there is substantial opposition [opposed to wealth transfer] from those to whom the Chinese press refer as the “vested interests.” This transfer is a five-year to ten-year process at best.
  5. The amount of time Beijing has in which to arrange the transfers depends on China’s debt capacity, the limits to which may be reached in as little as two years, depending on a number of variables, including of course the rate at which debt is growing. It currently takes an increase in debt every year equal to an alarming 40–45 percentage points of GDP to generate Beijing’s targeted GDP growth rate of 6.7 percent. If we assume that China’s current account surplus is 2 percent of GDP, a current account surplus set at zero it would require an increase in debt every year equal to 60– 75 percentage points of GDP to generate Beijing’s targeted GDP growth rate, and an increase in debt every year equal only to 15–20 percentage points of GDP if it were double

Maybe Mrs. Merkel can give fortress Europe a try.

If Mrs. Merkel is true to her outburst and attempts to re-fortify fortress Europe with more trade barriers, she will be making a big mistake. This action would likely force the US into retreat as leader of the global trade framework for sure; which it may be in the process of doing anyway.

Europe simply does not have the capacity to absorb German excess savings; i.e. import capital to then buy German exports. That was already tried, and the periphery countries barely survived.

I am sure Chancellor Merkel understands this fact:

Global trade friction damages current account surplus countries much more than those running a current account deficit.

If the US retreats, Germany’s overdependence on exports assures its economy will be severely damaged relative to its competitors.

[I]f it [the United States] withdraws, the alternative is not a new system centered on China but rather the disappearance of an orderly global trade regime. All around the world, including in the United States, investment decisions are made that determine the direction of vast amounts of capital flows. During periods of excess liquidity or excess global savings (or, to put it differently, of deficient demand), especially when central banks are accumulating vast hoards of reserves, the excess savings have to end up somewhere, and this ultimately means that excess savings flow into the U.S. financial markets, leaving the United States with a capital account surplus and its obverse, a current account deficit.

If the US-led global regime changes, and the US decides it will no longer absorb these excess savings from others (allow them to record trade surpluses) we will all be reading eighteenth-century history for new lessons on global trade relations. It would change the game in every conceivable asset market now traded.

“In this global environment of capital abundance we may have reached an inflection point in which savings abundance continues to characterize the global economy but the willingness and ability of the United States to absorb excess savings is at an end.

Back in 1959 Robert Triffin, an economist, warned the US would run current account deficits as far as the eye could see because the US dollar became the effective substitute for gold within the global trading system. Often this prescient view is known as Triffin’s Dilemma.

If Germany pushes down the path of finding a new partner(s) in the system, it will likely mean Triffin gets Trumped and global market volatility returns in a big way.

Thank you.