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Is Germany a currency manipulator?

What’s at stake: the Financial Times reports that Peter Navarro, head of the US’s National Trade Council, has accused Germany of currency manipulation

Publishing date
06 February 2017
Authors
Silvia Merler

Paul Krugman argues that Navarro is right and wrong at the same time. Germany in effect has an undervalued currency relative to what it would have without the euro, against its neighbors. This is the result of a large real depreciation during the euro’s good years, which has only been partly reversed, because wages are downward sticky, and Germany has refused to support the kind of monetary and fiscal stimulus that would raise overall euro area inflation, which remains stuck at far too low a level. But this does does not necessarily mean that the euro as a whole is undervalued against the dollar. The euro is weak, but there’s no clear relationship between the problems of Germany’s role within the euro and questions about the relationship between the euro and other currencies.

Jeromin Zettelmeyer at PIIE argues that Navarro’s comments are worrisome because of two assertions he made earlier in September 2016, both of which seem to underpin the thinking behind his criticism of Germany. First, that freely floating currencies would eliminate trade imbalances - and by extension, that trade imbalances are a manifestation of “currency manipulation.” Second, that Germany’s euro membership, as a policy choice that keeps Germany’s exchange rate undervalued, is an act of currency manipulation. Both these assertions are incorrect.

On the first point, freely floating currencies are consistent with large, persistent deviations from trade and current account balance. This is because freely floating exchange rates are shaped not only by currency supply and demand associated with trade, but also by currency supply and demand associated with investment flows.

On the second, the Euro’s undervaluation today is largely a consequence of the euro crisis. So the assertion that German euro membership constitutes currency manipulation is baseless for two reasons: Euro membership did not reflect any decision, on behalf of the German government, to steer its exchange rate. Nor is Germany’s competitiveness a structural feature of euro membership. Euro membership merely implies that the real exchange rate takes longer to adjust to shocks than would be the case in a floating system.

Frances Coppola says that Navarro is wrong, but Merkel misses the point. Navarro is not saying that Germany directly influences the Euro’s exchange rate, but that the weakness of the southern European economies in the European Monetary Union holds the Euro at a lower exchange rate than the Deutschmark would have as a freestanding currency. Coppola argues that this argument is fallacious, and by refusing to regard the Eurozone as a single bloc, Navarro wilfully misinterprets the relationship between Germany’s trade balance and the exchange rate of the Euro.

The Euro is indeed undervalued for Germany, but it is also overvalued for other countries in the bloc. If the bloc were to break up, Germany’s restored currency would appreciate, but other restored currencies would depreciate. Overall, the US would gain very little. So - Coppola  concludes - although Navarro appears to deny the reality of the Eurozone, he does not actually want it to break up. Moreover, he is the one who is de facto demanding currency manipulation, as what he wants is for the Euro to be artificially maintained far above its market level to benefit the US at the expense of Germany.

Matthew Klein at the FT argues that the US should blame Germany - rather than Mexico - for “losing” at trade. He argues that American (and British) “profligacy” is the result of the rest of the world’s unwillingness to spend more. From this perspective, any negotiator committed to putting “America first” should focus exclusively on those countries with the largest current account surpluses, since those are the ones putting the most pressure on America’s trade balance. Moreover, negotiators should be pressuring those countries to make policy changes that would increase the purchasing power of their domestic consumers, since that is the most durable and effective way to aid American exporters and reduce the importance of debt. Looking at the world today, those countries do not include Mexico, but rather Germany, China, Japan, Korea, Taiwan, the Netherlands, Switzerland, and Singapore. Among them, American negotiators should focus the bulk of their energy on the euro area and on its recent current account surplus.

Laurence Kotlikoff writes on Forbes that Peter Navarro needs a refresher course in economics. Germany is part of the Eurozone, any intervention in exchange markets is done by the ECB, and while Germany has a big influence on the ECB, it doesn't dictate ECB exchange-rate policy. Moreover, there is no ground to argue currency manipulation by the ECB based on money supply data. The Federal Reserve has been supplying far more Dollars than the ECB has been over the past decade: Fed’s supply of money grew by a factor of 4.3 since 2007, and the comparable factor for the ECB is roughly 3.5. For Japan it’s 1.3. And for China, it’s 2.4. So if any of these regions has spent the last decade trying devalue and, thus, manipulate its currency to make its goods cheap, it’s the US.

Kotlikoff argues that the demand for Dollars relative to Euros has played an even stronger role than has the relative supply of the two currencies. Over the period, the Dollar appreciated 34 percent against the Euro, appreciated 5 percent against the Japanese Yen, and depreciated only 6 percent against the Chinese Yuan. Demand for the Dollar has been strong thanks to the US’ more rapid recovery from the Great Recession, Southern Europe’s near depression-like condition, Japan’s slow growth, China’s slowing growth, the perception that the US is a safe haven and, recently, Brexit.

About the authors

  • Silvia Merler

    Silvia Merler, an Italian citizen, is the Head of ESG and Policy Research at Algebris Investments.

    She joined Bruegel as Affiliate Fellow at Bruegel in August 2013. Her main research interests include international macro and financial economics, central banking and EU institutions and policy making.

    Before joining Bruegel, she worked as Economic Analyst in DG Economic and Financial Affairs of the European Commission (ECFIN). There she focused on macro-financial stability as well as financial assistance and stability mechanisms, in particular on the European Stability Mechanism (ESM), providing supportive analysis for the policy negotiations.

     

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