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11/09/2010 12:40 PM

A Distorted Global Economy

US to Bully Germany on Trade Surplus at the G-20

By Christian Reiermann

The US thinks it knows who is to blame for its struggling economy: Germany and other countries
with a trade surplus. Washington wants to see new rules that would punish such imbalances, but
Germany says it shouldn't be blamed for having more competitive companies than the US.

There is an ironclad rule in Berlin politics: The greater the concern the more nervous the rhetoric.

Given such a yardstick, members of the German government must be suffering from anxiety attacks
w henever the talk turns to global free trade these days. A case in point is Finance Minister Wolfgang
Schäuble, a member of the center-right Christian Democrats (CDU), w ho refers to the reports on
currency and trade w ars, foreign exchange battles and devaluation contests as "sheet lightning."

Economics Minister Rainer Brüderle, of the pro-business Free Democrats (FDP), believes he has
spotted the "specter of protectionism" dressed in an insidious disguise. "There are many w ays to
dress up protectionism," the politician w arns. Brüderle recently admitted that, in light of the imminent
risk, he feels like a "missionary" for free trade and globalization.

Berlin's political community is not distressed w ithout reason. When the financial crisis erupted three
years ago, the international community initially managed to prevent an imminent global economic
crash by taking joint action to rescue banks and stimulate the economy. These measures w ere
particularly beneficial for the German economy, w hich w ill experience the strongest growth this year
since 1991.

Dramatic Distortions

But new , dramatic distortions are now looming in the post-crisis global economy. The current global
economic order threatens to fall into disarray in several different areas:

In the w ake of the economic and financial crisis, many countries have begun to seal off their
markets against foreign products in order to protect domestic producers.
Tw o of the w orld's largest economic pow ers, China and the United States, seem to be
initiating a race to devalue their respective currencies.
Key emerging economies, most notably Brazil and Indonesia, are imposing restrictions on the
movement of capital, w hich could disrupt the global money cycle.
In desperation over the grim economic situation, the administration of US President Barack
Obama is embarking on a diplomatic offensive intended to pillory countries w ith chronic trade
surpluses. This puts China, Japan and Germany in the line of fire.

Each individual development is cause for concern on its ow n. But together, they constitute a serious
threat to the w orld economy. The German business model, which builds on the success of the
country's export economy, is particularly at risk.

The movement tow ard liberalization shaped w orld trade for decades. Tariffs w ere reduced or
abolished and trade barriers w ere eliminated. This released energy to stimulate growth and
increased prosperity worldw ide. For years, global trade grew at a faster pace than economic output.
It was a clear indicator of the productive effects of the division of labor and the freedom of trade. As
Scottish economist Adam Smith pointed out, everyone benefits w hen each player in the economic
system produces w hat they are best at producing.

Much at Stake for Germany

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But now , for the first time since the end of World War II, free trade could face setbacks on a broad
front, unless the leaders of the major industrialized and emerging economies can agree on joint
solutions to the current problems. The G-20 will meet this w eek in the South Korean capital Seoul to
discuss the condition of the global economy once again. Currency wars and trade imbalances are at
the top of the agenda.

Much is at stake for Germany, which is currently experiencing an unexpected employment and
growth spurt, due in large part to the substantial competitiveness of its companies in global
markets. The German economy is expected to grow by about 3.5 percent this year, perhaps even
more.

This success has sparked resentment, particularly among countries that are having a hard time
pulling themselves out of the crisis, most of all the United States. The government in Washington
sees the success of others as the source of its ow n troubles. Treasury Secretary Timothy Geithner
has long complained that China's and Germany's trade surpluses indicate that these countries
haven't developed enough domestic demand to help w eaker countries.

A few months ago, French Finance Minister Christine Lagarde used similar arguments to target
Germany. Tw o weeks ago, Geithner followed up on his complaints with action when he proposed a
mechanism that w ould require countries w ith trade surpluses to modify their fiscal and economic
policies in w ays that w ould stimulate domestic demand. This w ould enable these countries to import
more, said Geithner. In other w ords, countries w ith a trade surplus should voluntarily give up their
competitive advantages for the benefit of the United States.

A Bombardment of Communiqués

Geithner failed to get his way at a meeting of G-20 finance ministers tw o weeks ago. Now, President
Obama has decided to take matters into his ow n hands, and he is hell-bent on advancing the issue
at this w eek's summit.

The White House and the US Treasury Department have bombarded their partner countries with
memos and draft communiqués explaining their ideas. Washington w ants to see countries w ith a
trade surplus or deficit exceeding 4 percent of GDP subjected to heightened observation or required
to change their policies. The Americans are doggedly sticking to this quantitative benchmark.

The German government is not prepared to bow to the w ill of the battered hegemon. "The proposal
is not acceptable for Germany under any circumstances," German Finance Minister Schäuble said in a
SPIEGEL interview . His ministry's policy is clear: "We reject non-cooperative solutions."

The German government's negotiators, Jens Weidmann, the chancellor's economic advisor, and Jörg
Asmussen, a state secretary in the Finance Ministry, are feverishly trying to organize a concerted
defense against the American proposal. In the dozens of position papers and memos that have
been traveling back and forth among the capitals of the participating countries, Weidmann and
Asmussen make no secret of their rejection of and disagreement w ith the Geithner proposal.

Germany Seeks to Undermine the US

They point out that there are various reasons w hy countries produce surpluses. A country like Saudi
Arabia w ill generate a surplus for a long time, because it exports oil. China manipulates its currency
to create an advantage for its products.

But Germany's export surplus, Weidmann and Asmussen argue, is not the result of the country
having ample natural resources or a deliberate devaluation of its currency. Instead, it is based on
the diligence and ingenuity of its companies and w orkers. For this reason, they say, Germany should
not be pilloried.

In any case, Germany regards the target range of between plus four and minus four percent of GDP
to be completely arbitrary. There is, they say, absolutely no research that would support setting the
threshold at these specific levels.

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There is, how ever, a clear political reason: The United States does not run the risk of falling afoul of
the limits Geithner proposes. Its trade deficit of 3.2 percent is within the permissible framew ork, as is
that of Great Britain (2.2 percent), w hich supports the US proposal. The French are supporting
neither the US-British offensive nor the German defensive position.

The German government plans to constructively undermine the American proposal. Under Berlin's
concept, the new monitoring regime would not only consider trade imbalances, but would also look
at a country's natural resources, international competitiveness and demographic developments.
Under no circumstances does Germany want to allow a target corridor w ith specific threshold
numbers.

Raw Tone

It remains to be seen w hether Germany w ill prevail or w hether the US will ultimately get its way.

In any case, the tone of the debate among governments is becoming increasingly raw. German
government experts fear that the Americans are interested in more than just forcing other countries
to make adjustments. If a country like China is constantly under suspicion, it becomes much easier to
justify retaliatory measures against its flow of goods. Instead of eliminating global imbalances, the
new mechanism could even accelerate the tendency toward new trade barriers.

The flood of protectionist measures since the height of the financial crisis two years ago has already
become surprisingly large. Particularly given the fact that, during their first conference -- in
Washington in the autumn of 2008 -- G-20 members pledged to dispense w ith self-serving,
protectionist policies.

But in a recent report, the European Commission enumerated 332 individual protectionist measures.
In one case, the United States raised import barriers on steel and certain types of sleeping bags. In
another, Canada granted discounts on domestic milk for the production of ice cream.

Almost 2 percent of EU trade was affected by protectionist policies between October 2008 and
October 2009 (more recent data doesn't exist). "These are the w rong signals altogether," says
senior Economics Ministry official Bernd Pfaffenbach, w ho heads the ministry's division of foreign
economic policy. He notes with concern that many protectionist measures remain in force, even
though the acute crisis is over. "This will be a burden on world trade," Pfaffenbach fears.

The Weapons of War

Economists have long agreed that protectionist measures reduce prosperity -- for all parties
involved. Production declines in countries w hose goods are locked out. This means that they can
import less, w hich in turn affects the protectionist country. Its economy and consumers are also
forced to pay inflated prices for domestically produced goods, w hich leads to a loss of affluence.

For Thomas Straubhaar, director of the Hamburg Institute of International Economics (HWWI),
protective tariffs and other trade barriers are the handguns in the global fight for market share.
Their effects are selective, but they can also be deadly w hen they hit their target.

Countries also w age economic w ar with weapons of a bigger caliber. "Those are exchange rate
manipulations and the expansion of the money supply," says Straubhaar.

The Americans' determined approach was in full evidence last Wednesday, when Federal Reserve
Chairman Ben Bernanke announced that the Fed w ould purchase an additional $600 billion (€432
billion) in US Treasury bonds.

The unrestrained firing up of the money printing machines w ill inevitably w eaken the external value
of the dollar and, in turn, force the Chinese to defend their currency. Bernanke's announcement w as
met w ith harsh reactions in Beijing, w here an advisor to the Chinese central bank rebuked the
United States for w hat he called the "unbridled printing of dollars" and said that China must set up a
"fiscal firew all."

'Resemblance to the 1930s'

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The possibility of an economic arms race looms. "The bad thing about it is that everyone can offer
good reasons to defend his actions," says Dennis Snow er, president of the Kiel Institute for the
World Economy in northern Germany. According to Snow er, the Chinese are manipulating their
currency, the yuan, dow nward to prevent their export sector from collapsing. Meanwhile, the
Americans are tapping the Fed for hundreds of billions in the hope that their economy will pick up
momentum. Both approaches accelerate the decline in the value of both currencies.

The clash of the titans w ill provoke substantial distortions in the w orld economy. If the European
Central Bank, in keeping with its mandate to limit inflation in the common currency zone, does not
relax its monetary policy any further, the value of the euro w ill likely rise considerably against the
dollar. The consequences are foreseeable: Goods from the euro zone w ill become more expensive.
This doesn't bode w ell for Germany. "As the w orld's second-largest exporter, Germany w ould be
particularly affected by such turbulence," says Snow er.

Economics Ministry official Pfaffenbach looks to the future w ith a touch of gloom. He sees parallels to
the Great Depression. Protectionism and a scramble to devalue currency are the last things the
w orld needs at the moment, he says. "It bears a fatal resemblance to the 1930s."

Translated from the German by Christopher Sultan

URL:

http://w w w.spiegel.de/international/world/0,1518,727970,00.html

RELATED SPIEGEL ONLINE LINKS:

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Money for Too Long' (11/08/2010)
http://w w w.spiegel.de/international/world/0,1518,727801,00.html
Germany Blasts Bernanke: Results of Fed Stimulus Could Be 'Horrendous'
(11/05/2010)
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