US prosperity is a credit-based prosperity. Greenspan's dilemma is that interest rates must rise to reduce the trade deficit ($617B in 2004) and keep foreign investors ($2B a day) though this could brust the real estate bubble and raise consumer prices.
MR. GREENSPAN AND THE GERMAN WAY
The US as growth machine will soon stutter. Germany needs a general economic-political recovery.
By Herbert Schui
[This article published in: Freitag 20, 5/20/2005 is translated from the German on the World Wide Web,
http://www.freitag.de/2005/20/05200301.php. Herbert Schui is a professor of economic theory at the University of Hamburg.]
The worldwide economic recriminations give us no other choice, chancellor Schmidt explained in the seventies, when the dismantling of the social state began. These recriminations have turned into globalization, a term that makes difficult rational analyses of concentrated international economic relations and suggests threat. Nearby in Eastern Europe, the low wages and taxes endanger our jobs, it is said, and the yellow danger far away threatens with even cheaper labor. Thus production in Germany must be maintained with lower business taxes and patriotic appeals – now dolled up in an anti-capitalist way by Franz Muntefering.
While propaganda formulas of the First World War are not spreading, business leaders and employees defend the location Germany shoulder to shoulder.
Whoever amid so much fate soberly calls attention to inadequate domestic demand, low wages and trifling profit taxes is quickly reproached for being unrealistic and not in keeping with the times. However this seemingly starry-eyed and not modern perspective is as burning as ever and a task of historical importance. Foreign trade surpluses cannot be realized in the long run without “recriminations” to the burden of other nations. Whoever wants to export in the future at a high level must do everything to import more goods and services so international trade- especially foreign trade with the US – will be balanced as much as possible. If this does not happen, the United States must slow down its growth so it imports less and reaches a balanced foreign trade.
The better alternative – increasing imports of Germany and the EU countries – requires a higher growth on this side of the Atlantic that can only be achieved with increased domestic demand. Globalization means more interdependence. German politics must understand this and abandon its “reform”-provincialism.
In 2004 the US deficit in trade with goods and services ran up to $617 billion (5.3 percent of the gross domestic product). China, the EU (European Union) and Japan profit with their deliveries to North America. These exports operate like their own state deficits although the governments do not have to worry about debt service. The all-decisive question is whether the United States will keep up its exorbitant balance of trade deficit – whether it will grow more quickly in the future than Europe and Japan. Only in this way can it fulfill the function of import vacuum cleaner in the future.
For a long time the high growth in the US was owed to the credit-financed demand of the state (a consequence of the Iraq war) and the consumption of private households whose four percent savings rate is much lower than the eleven percent in Germany. The low interest rates of the past years were a crucial prerequisite for this demand-driven growth since people could become indebted on favorable conditions. In the meantime the incentive to take credits disappears because the US Federal Reserve – whether willing or not – must react to the world economic imbalances with higher interest rates.
From a technical standpoint, financing the balance of trade deficit is not a problem for the US because the dollar is always accepted by its suppliers as currency. The question whether the dollars earned in export are used to buy US bonds flowing back to the US is also not crucial. The extent to which the acquisition of these securities – the dollar demand – keeps up with the inflated money supply is important and how the price of the dollar, the exchange rate, develops. If the demand is too weak, the foreign value of the US currency will fall. This will damage the status of the dollar as an international reserve currency and as an international means of payment and also the American commercial banks that earn their money with dollar credits.
The inflation question comes into play. In February 2005 prices in the US increased one percent compared to the previous month. The interest increase of the US Federal Reserve in March was justified because of this “inflation pressure.” The Federal Reserve made clear that it would raise the interests again in “appropriate” steps. Higher interests improve the profitability of US securities that are now increasingly sought by private investors. The danger that only the Asian central banks, above all the Chinese and Japanese, will stabilize the dollar by purchasing American bonds to prevent the upgrading of their own currencies and the loss of sales chances in the US will thereby be averted.
US interest policy shows that the United States does not expect to reach a lower deficit in its balance of trade through devaluation and raising the prices of imported goods. The other option is equalizing the trade balance through lower economic growth and reduced domestic demand. The recent fall of the consumer confidence index calculated by the University of Michigan could be a first sign. Less trust and higher interests will lower the readiness to accept credits. In the US, a prime interest rate of three to four percent is still regarded as economically neutral. This is in no way certain. The US Federal Reserve has announced further interest increases for reasons of price stability. In addition Alan Greenspan has urged cutting the state deficit in half that would considerably reduce domestic demand. This orientation will gain significance when Greenspan is replaced in 2006 by Ben Bernanke as the new Federal Reserve chief.
Domestic demand is under pressure. Deliveries to the EU – amounting to a quarter of US exports – will probably decline. This happens when growth in Europe diminishes and the market for US exports narrows. The first signs cannot be ignored. The Ifo-economic barometer for Germany has declined since February from 95.4 to 94.0 points; industrial production fell 1.4 percent in January 2005 compared to January 2004 and incoming orders around 1.7 percent in the same time period.
The growth predictions for Germany were corrected downwards from 1.6 to 0.7 percent. In France the aggregate index for the business climate has also fallen. Italy reached its lowest state since the summer of 2003. This growth weakness will intensify if the European central bank raises interests in the coming six months – against the admonitions of the International Monetary Fund.
There are many indications that the demand for US products in the US and abroad is slackening and economic growth in the US is declining. Differences in growth do not usually lead to equalized trade balances. The currency of the deflation country will be devalued but the deficit will not recede despite the rising prices of imports and the lower prices of exports. An equalized trade balance can only be attained through less growth. If for this reason the balance of trade surplus of the EU falls, this will have new repercussions on European economic growth.
The International Monetary Fund’s warning should be heeded. If the demand in the US and China should collapse, “Germany will be among the main ones who suffer.” Thus a recession can only be avoided if growth in the EU and especially in Germany becomes stronger. However this can only occur through more domestic demand. The incomes of those private households that spend nearly everything they receive must rise. Wage increases are the command of the hour and more taxes on profits to raise tax revenues and possibilities for spending. The European central bank should support this growth program with low interest rates.
Although these priorities can hardly be ignored, Germany policy marches in the opposite direction. Business taxes will be reduced even more. Lower wages and reduced social spending of businesses are demanded more stubbornly than ever. However globalization is not possible in the long run with one-sided advantages. Whoever focuses only on his world market position and neglects his own domestic market acts irresponsibly in every regard. Responsible German policy in the current situation would mean increasing imports through more growth – as a result of more domestic demand. In this way the fatal reaction of US growth to the balance of trade deficit can be prevented or at least controlled.
The concentration of international economic relations – globalization – forces us to consider all these repercussions that must inevitably appear with high balance of trade surpluses but must be kept within limits by a skilful policy. Whoever only relies on the reaction of free and open markets risks chaotic and abrupt adjustment processes. Taking responsibility would be more intelligent. Therefore Germany needs an economic-political general recovery that opens up growth perspectives for the domestic market.
The US as growth machine will soon stutter. Germany needs a general economic-political recovery.
By Herbert Schui
[This article published in: Freitag 20, 5/20/2005 is translated from the German on the World Wide Web,
http://www.freitag.de/2005/20/05200301.php. Herbert Schui is a professor of economic theory at the University of Hamburg.] The worldwide economic recriminations give us no other choice, chancellor Schmidt explained in the seventies, when the dismantling of the social state began. These recriminations have turned into globalization, a term that makes difficult rational analyses of concentrated international economic relations and suggests threat. Nearby in Eastern Europe, the low wages and taxes endanger our jobs, it is said, and the yellow danger far away threatens with even cheaper labor. Thus production in Germany must be maintained with lower business taxes and patriotic appeals – now dolled up in an anti-capitalist way by Franz Muntefering.
While propaganda formulas of the First World War are not spreading, business leaders and employees defend the location Germany shoulder to shoulder.
Whoever amid so much fate soberly calls attention to inadequate domestic demand, low wages and trifling profit taxes is quickly reproached for being unrealistic and not in keeping with the times. However this seemingly starry-eyed and not modern perspective is as burning as ever and a task of historical importance. Foreign trade surpluses cannot be realized in the long run without “recriminations” to the burden of other nations. Whoever wants to export in the future at a high level must do everything to import more goods and services so international trade- especially foreign trade with the US – will be balanced as much as possible. If this does not happen, the United States must slow down its growth so it imports less and reaches a balanced foreign trade.
The better alternative – increasing imports of Germany and the EU countries – requires a higher growth on this side of the Atlantic that can only be achieved with increased domestic demand. Globalization means more interdependence. German politics must understand this and abandon its “reform”-provincialism.
In 2004 the US deficit in trade with goods and services ran up to $617 billion (5.3 percent of the gross domestic product). China, the EU (European Union) and Japan profit with their deliveries to North America. These exports operate like their own state deficits although the governments do not have to worry about debt service. The all-decisive question is whether the United States will keep up its exorbitant balance of trade deficit – whether it will grow more quickly in the future than Europe and Japan. Only in this way can it fulfill the function of import vacuum cleaner in the future.
For a long time the high growth in the US was owed to the credit-financed demand of the state (a consequence of the Iraq war) and the consumption of private households whose four percent savings rate is much lower than the eleven percent in Germany. The low interest rates of the past years were a crucial prerequisite for this demand-driven growth since people could become indebted on favorable conditions. In the meantime the incentive to take credits disappears because the US Federal Reserve – whether willing or not – must react to the world economic imbalances with higher interest rates.
From a technical standpoint, financing the balance of trade deficit is not a problem for the US because the dollar is always accepted by its suppliers as currency. The question whether the dollars earned in export are used to buy US bonds flowing back to the US is also not crucial. The extent to which the acquisition of these securities – the dollar demand – keeps up with the inflated money supply is important and how the price of the dollar, the exchange rate, develops. If the demand is too weak, the foreign value of the US currency will fall. This will damage the status of the dollar as an international reserve currency and as an international means of payment and also the American commercial banks that earn their money with dollar credits.
The inflation question comes into play. In February 2005 prices in the US increased one percent compared to the previous month. The interest increase of the US Federal Reserve in March was justified because of this “inflation pressure.” The Federal Reserve made clear that it would raise the interests again in “appropriate” steps. Higher interests improve the profitability of US securities that are now increasingly sought by private investors. The danger that only the Asian central banks, above all the Chinese and Japanese, will stabilize the dollar by purchasing American bonds to prevent the upgrading of their own currencies and the loss of sales chances in the US will thereby be averted.
US interest policy shows that the United States does not expect to reach a lower deficit in its balance of trade through devaluation and raising the prices of imported goods. The other option is equalizing the trade balance through lower economic growth and reduced domestic demand. The recent fall of the consumer confidence index calculated by the University of Michigan could be a first sign. Less trust and higher interests will lower the readiness to accept credits. In the US, a prime interest rate of three to four percent is still regarded as economically neutral. This is in no way certain. The US Federal Reserve has announced further interest increases for reasons of price stability. In addition Alan Greenspan has urged cutting the state deficit in half that would considerably reduce domestic demand. This orientation will gain significance when Greenspan is replaced in 2006 by Ben Bernanke as the new Federal Reserve chief.
Domestic demand is under pressure. Deliveries to the EU – amounting to a quarter of US exports – will probably decline. This happens when growth in Europe diminishes and the market for US exports narrows. The first signs cannot be ignored. The Ifo-economic barometer for Germany has declined since February from 95.4 to 94.0 points; industrial production fell 1.4 percent in January 2005 compared to January 2004 and incoming orders around 1.7 percent in the same time period.
The growth predictions for Germany were corrected downwards from 1.6 to 0.7 percent. In France the aggregate index for the business climate has also fallen. Italy reached its lowest state since the summer of 2003. This growth weakness will intensify if the European central bank raises interests in the coming six months – against the admonitions of the International Monetary Fund.
There are many indications that the demand for US products in the US and abroad is slackening and economic growth in the US is declining. Differences in growth do not usually lead to equalized trade balances. The currency of the deflation country will be devalued but the deficit will not recede despite the rising prices of imports and the lower prices of exports. An equalized trade balance can only be attained through less growth. If for this reason the balance of trade surplus of the EU falls, this will have new repercussions on European economic growth.
The International Monetary Fund’s warning should be heeded. If the demand in the US and China should collapse, “Germany will be among the main ones who suffer.” Thus a recession can only be avoided if growth in the EU and especially in Germany becomes stronger. However this can only occur through more domestic demand. The incomes of those private households that spend nearly everything they receive must rise. Wage increases are the command of the hour and more taxes on profits to raise tax revenues and possibilities for spending. The European central bank should support this growth program with low interest rates.
Although these priorities can hardly be ignored, Germany policy marches in the opposite direction. Business taxes will be reduced even more. Lower wages and reduced social spending of businesses are demanded more stubbornly than ever. However globalization is not possible in the long run with one-sided advantages. Whoever focuses only on his world market position and neglects his own domestic market acts irresponsibly in every regard. Responsible German policy in the current situation would mean increasing imports through more growth – as a result of more domestic demand. In this way the fatal reaction of US growth to the balance of trade deficit can be prevented or at least controlled.
The concentration of international economic relations – globalization – forces us to consider all these repercussions that must inevitably appear with high balance of trade surpluses but must be kept within limits by a skilful policy. Whoever only relies on the reaction of free and open markets risks chaotic and abrupt adjustment processes. Taking responsibility would be more intelligent. Therefore Germany needs an economic-political general recovery that opens up growth perspectives for the domestic market.
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