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Bernanke’s misguided fix for Germany

Published in Business Spectator (Melbourne), 9 April 2015

Since March 30, former Federal Reserve chairman Ben Bernanke has been blogging on economic policy for the Brookings Institution, where he is a Distinguished Fellow in Residence. His first posts dealt with questions such as why interest rates were so low, the thesis of a ‘secular stagnation’ and the global savings glut. It was all very interesting but somehow lacking a bit of punch.

But then, on day five of his blog, Bernanke finally singled out a real villain for the world economy: A country that allegedly posed a great danger to its neighbours and whose policies jeopardised chances of a global economic recovery.

Bernanke was not writing about debt-ridden Japan or Greece, nor was he discussing reform-shy Brazil or Italy. Instead, Bernanke made Germany the target of his criticism. “Germany’s trade surplus is a problem,” his headline claims.

Bernanke’s blog post is rehashing some old complaints about Germany’s competitive strength, which resurface every now and then.

Five years ago, then US treasury secretary Tim Geithner openly scolded Germany for its large trade surpluses (Europe’s most dangerous man, 11 November 2010). In 2013, the US Treasury formally rebuked Germany’s for its export successes (Don’t put Germany on the economic axis of evil, 7 November 2013). Late last year, the French government also presented some rather bizarre ideas on how to reduce Germany’s competitiveness (France’s indecent proposal is an affront to policymaking, 23 October 2014).

To be fair to Bernanke, of course he has a point. Germany is indeed benefiting from an exchange rate that is too low for its economy. He is right when he writes: “The comparatively weak euro is an underappreciated benefit to Germany of its participation in the currency union. If Germany were still using the deutschemark, presumably the DM would be much stronger than the euro is today, reducing the cost advantage of German exports substantially.”

Bernanke also correctly explains why Germany’s large trade surplus does not correct itself. “Systems of fixed exchange rates, like the euro union or the gold standard, have historically suffered from the fact that countries with balance of payments deficits come under severe pressure to adjust, while countries with surpluses face no corresponding pressure.”

However, in the remainder of his blog post, Bernanke does not draw the appropriate conclusions from his own analysis. If Germany’s exchange rate is out of kilter, and if its balance of payments surplus appears persistent because the country is part of a fixed exchange rate system, then does that not suggest that Germany should just not be part of the eurozone?

Bernanke describes problems in his post that are all triggered by the very fact that Germany no longer has its own currency. None of the imbalances he mentions would have any remote chance of persisting if Germany returned to the Deutsche mark. On the contrary, the moment Germany exited the eurozone, its new currency would appreciate, its relative competitiveness would decline and its trade surplus melt. Problem solved.

Unfortunately, Bernanke does not even mention the thought of a German euro exit once. Instead, he seems to accept Germany’s euro membership as a given and proceeds from there. This then leads him to propose ‘solutions’ which might help to reduce the German trade surplus, but would all come at the price of causing further trouble down the line.

So what are Bernanke’s suggestions? He presents three proposals:

  • Increased investment in public infrastructure.
  • Raising the wages of German workers.
  • Increasing domestic private spending.

Though the three suggestions make some superficial sense, they are nevertheless all wrong.

Bernanke is once again right when he explains that Germany’s public infrastructure could do with some investment. It is true that since 2003, the German government’s net capital formation has been negative in every single year. In other words, Germany is living off the substance of its infrastructure. It is also true that Germany can currently borrow at exceptionally low interest rates.

None of this, however, means that the Germans should now go on an infrastructure spending binge, least of all to help correct the trade surplus. It is quite wise to steer the federal budget to surplus because Germany will need a fiscal buffer to deal with its ageing population. Going further into debt in the face of rapidly rising retirement costs would be grossly irresponsible.

Bernanke’s second suggestion is even worse. Yes, indeed “German workers deserve a substantial raise,” as he writes. Such a raise would come automatically if the exchange rate was able to adjust. Absent such exchange rate appreciation, there is unfortunately little that can be done to mandate a nationwide wage increase. Or does Bernanke seriously suggest that government should legislate for higher wages?

Let us be clear. There was a policy mistake (the introduction of a fixed exchange rate system for disparate countries aka the eurozone) and in response to this first grave mistake Bernanke now wants to make the next one: to interfere with the price mechanism in the labour market. Bernanke is an ex-central banker but this idea sounds more like that of a central planner.

Which leads us to his final idea: to increase domestic spending. There he suggests “increased tax incentives for private domestic investment; the removal of barriers to new housing construction; reforms in the retail and services sectors; and a review of financial regulations that may bias German banks to invest abroad rather than at home.”

With all due respect, none of this makes any sense at all. First of all, there are no barriers to new housing construction as current 20-year highs in house building demonstrate. What country is he talking about? It certainly cannot be Germany. Second, which financial regulations does Bernanke have in mind that bias German banks against investing in Germany?

It rather seems that German companies prefer to invest abroad for a number of reasons, none of which have anything to do with German financial regulations. Third, how on earth would reforms in retail reduce the trade surplus? And which reforms does Bernanke have in mind? There is not a hint in Bernanke’s article about what retail reform might do to the trade surplus, and I cannot think of any such mechanism either.

The problem with Bernanke’s blog post is that he correctly analyses a problem (Germany’s persistent trade surplus) but then fails to come up with any sensible solutions. That is because he does not acknowledge its single most important cause: Germany’s membership of the eurozone.

Critics of Germany’s unhealthy competitiveness should have the courage to take their criticism to its only logical conclusion: to demand of Germany to leave the euro. For everyone’s sake.

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