Canada’s private sector deficit, Germany’s current account surplus and Germany’s outreach to a Turkey in crisis

The daily is a bit late today because I had some engagements this morning. Things will be back to normal tomorrow. But expect a late newsletter on Thursday as well.

1. Canada’s private sector echoing 1990s America

Goldman has a good note out on Canada that the National Post is covering. It’s worth highlighting because it goes to how we think about the macroeconomy. Here’s what the Financial Post has cross-posted from Bloomberg:

One under-appreciated indicator is flashing red for some developed markets, Goldman Sachs analysts say.

The private-sector financial balance — an economy’s total income minus the spending of all households and businesses — has proven more powerful in predicting crises than the current-account balance, Goldman analysts led by Jan Hatzius, the bank’s global head of economics, wrote in an Aug. 23 research note.

“The good news is that the biggest DM economies — the U.S., the Euro area, and Japan — are all running healthy private sector surpluses,” they wrote. “The not-so-good news is that some of the smaller DM economies — especially Canada and the U.K. — are running sizable deficits and appear vulnerable to higher interest rates and weaker asset markets.”

The finding is another warning sign for the global economy at a time of sporadic turbulence arising from monetary tightening, U.S.-China trade battles, and stress in some emerging markets.

A private-sector deficit means households and firms can’t finance their current spending with current income and rely on net borrowing or asset sales, the Goldman analysts wrote. That makes growth and financial stability more vulnerable in an environment of rising rates or market declines, they said.

Hatzius is a good economist. Most people fearmonger government budget and current account deficits as harbingers of doom. But it’s private sector deficits that are truly unsustainable.

For example, in the 1990s, the Clinton Administration was praised for cutting the US government budget deficit and generating a surplus. And Democrats always talk about this when comparing their fiscal rectitude to the last two Republican presidents.

The problem with this view is that it is incomplete. You need to look at the private and external sectors too. Hatzius has been saying this for years. And in the US case, the more relevant thing to focus on was the private sector, because it was running up a deficit as the public sector ran surpluses.

Essentially, households and businesses were collectively spending more than they took in. And the private sector can’t print money. So the only logical ways for that unsustainable path to correct is either through a reduction in private sector spending or through an increase in net transfers from the public sector.

We know what eventually happened. The private sector retrenched and recession took hold. Goldman is essentially warning that conditions in Canada (and the UK) are likely to end the same way unless the government increases deficit spending. And given the huge house price bubble in Canada, that’s a bad thing.

2. But what about the current account? Germany, for example?

There was an article in the FT yesterday criticizing Germany for having a current account surplus. Here are some salient points on the framing of the issue from that piece:

Germany’s current account surplus, the balance of trade between exports and imports, is set to hit almost $300bn, or 7.8 per cent of gross domestic product, the world’s largest. This has drawn criticism from the Trump administration and international organisations such as the IMF.

They point to the increasing global imbalances between countries with deficits and surpluses, and the risks that high levels of overseas assets pose for the stability of financial markets.

Germany’s response is to insist on the benefits of free trade for all, the demand for high-quality German products and the needs of an ageing society.

Fair enough. But macro imbalances are dangerous. We saw that when the intra-EU deficit nations hit the skids in the European sovereign debt crisis. We also saw that with Germany’s suffering immediately after the financial crisis. It’s economic growth dropped more than any other G-7 country because its growth was dependent on external demand.

There is an asymmetry in all creditor-debtor relationships though. As Keynes put it once – adjustment is “compulsory for the debtor and voluntary for the creditor”. And so, most of the framing of these relationships put the creditor in a ‘virtuous’ position and the debtor in the ‘spendthrift’ position. I think Stephen Roach’s piece in Project Syndicate yesterday is a good example of this framing. That’s where the Germans are coming from too.

But a “large current account surplus makes you strong in good times, but weak in bad”. We saw that after the financial crisis in Germany already. That is a recipe for radicalizing the electorate in surplus countries.

But what also happened then is that German banks ran into trouble. And when they did, the banks – through their surrogates in the Troika of the EU, ECB and the IMF – forced debtors like Greece to pay up. The Greek ‘bailout’ was a disaster for Greece. But it was very helpful for creditor banks. That is a recipe for radicalizing the electorate in deficit countries.

So you don’t have to frame the current account positions as ‘good’ or ‘bad’ to realize that recessions bring adjustments that carry political and socioeconomic consequences. When current account imbalances are large, the recessionary adjustments are equally large. And the result is a massive political and socioeconomic consequence. I think we need to watch the politics of the EU in the next downturn. It will be explosive.

3. I told you the speculation about Turkey’s allegiances was overdone

Remember when I wrote about people speculating Turkey would join China and Russia twelve days ago? I said “my odds are on Turkey’s remaining allied to the West, only using ‘the Russia card’ as a ploy to extract concessions in bilateral negotiations.” I still feel that way.

The latest is that Germany is examining options for helping Turkey out of its economic crisis. The Wall Street Journal had reported earlier that the German government was thinking about supplying Turkey with some emergency financial aid But, as with Greece and the rest of the periphery,  German government officials are now saying there will be no direct financial assistance.

Now, Germany’s statistics office showed the country recorded a budget surplus of €48.1bn in the first six months of this year. That’s 2.9% of GDP.  A lot of that goes back to the current account surplus, which is running above 7% of GDP. But the point is that the Germans are in a position to give financial assistance. They just don’t want to do so. And that’s because they are concerned about their future government budgetary position given the demographic challenges that await.

Germany wants Turkey to turn to the International Monetary Fund for any financial rescue, two other government officials said. But because President Recep Tayyip Erdogan has ruled out approaching the IMF and U.S. support for any aid is uncertain, European governments might have to consider stepping in as a last resort, though it would be tied to conditions, they said.

The Finance Ministry in Berlin declined to comment. Merkel’s chancellery didn’t respond to a request for comment.

This is according to Bloomberg. I don’t see it yet. I think Turkey will avoid the IMF like the plague. And so, the situation there will deteriorate. Will Erdogan use the Russia card at that point? Maybe. But I think it would just be a bluff. Erdogan and Merkel plan to meet on September 28th in Berlin. I expect the crisis in Turkey to have come to a head by then. So we will have some answers soon.