You probably heard that Germany recorded its third consecutive year of government budget surpluses. This year, it was the highest full year surplus since German reunification – 24 billion euros. A lot of the commentary on Germany’s budget is stressing whether it’s a good thing or a bad thing that Germany has surpluses. Forget all of that. There are actually two other things you need to know.
First, it’s a lot easier to run a budget surplus when you have a massive trade surplus too. When you look at a country like Germany that is an export juggernaut — we’re talking an 8% current account surplus here, That’s 270 billion euros —you have to put in the context of the economy’s other sectors. In a normal economy, net of investment, the private sector will always be in a surplus position. That surplus has to be offset by either the government or the external capital position since the three sectors of economy balance to zero.
Now, say the German private sector saved 250 billion euros last year, net of investment. That means that the combined public and external capital deficit has to be the same amount. And since we know that the current account is in surplus by 270 billion euros, we also know that the Germans are exporting 270 billion of capital. Put differently, the capital account is in deficit by 270 billion euros. By pure accounting identity, you know you’re going to get a 20 billion euro budget surplus. That’s how the math works.
Here’s the second thing about that: the Germans understand the budgetary benefit of trade surpluses and are trying to get everyone in the eurozone to follow this model. When the euro area countries gave up monetary sovereignty to be a part of the euro, budgetary discipline became critically important because of the threat of bond vigilantes questioning a country’s solvency. What the Germans have proved is that this problem is a lot easier to tackle if you have a massive trade surplus. And since the financial crisis, the euro area has gone from a roughly balanced current account to one that is massively in surplus.
Here’s the chart:
So that’s where Europe is headed. First, budgetary discipline will continue to be an anchor principle. Second, getting the budget deficit down or into surplus is a lot easier if you have a trade and current surplus. German Finance Minister Wolfgang Schäuble wants Germany to lead the way on both these scores as a matter of ‘leading by example’. Third, the eurozone is indeed following this example. We can see the numbers; the euro currency area now has a surplus with the rest of the world, where just 6 or seven years ago it had a deficit.
I don’t know how long the EU wants this policy framework to continue. It ism’t clear if this is a ‘ride out the storm’ approach or a permanent policy framework. I believe they want the surpluses to continue indefinitely. But if these surpluses do continue indefinitely, Donald Trump will put Europe in his crosshairs. And we’ll have to see whether he’s all bluster or whether he intends to take action.