German GDP jumped as twin surpluses, deflation don't hurt at all
Without much ado, the German economy is behaving in the way that may serve as a role model for everyone else. Half a year ago, we would be bombarded by stories about the bad shape of the Germany economy when its GDP growth happened to be negative in a quarter.
However, the situation looks different these days even though none of the media publish any errata. In the fourth quarter, Germany's GDP added 0.7% (quarter-on-quarter, not annualized) which contributed to the 1.6% annual growth in 2014.
Germany's unemployment rate at 4.9% is among the lowest in Europe and lower than in the U.S.
The country announced $247 trade surplus in 2014. I guess that the weak euro could have helped this result. But anyway, you should compare this result with the $505 billion trade deficit of the U.S. in 2014 (which is still better than in many previous years, partly thanks to the fracking revolution). Also, Germany probably continued with its black zero small budget surpluses.
The fourth quarter jump in the GDP (0.7%) looks particularly good because that's exactly in the time when deflation starts to become obvious. Just in January 2015, Germany announced preliminary deflation of 0.5% month-on-month. There is a whole school – perhaps numerically dominant school – of economists who try to present deflation, even a small one, as a bogeyman. Needless to say, all of these people are cranks.
Deflation may be an accompanying sign (i.e. a consequence) of stagnating or dropping GDP. But it is not a cause of the dropping GDP. During a Klaus' birthday party last June, I had a dialogue about these matters with Ms Eva Zamrazilová, an ex-member of the Czech National Bank board. We completely agreed (and of course that lots of other people who use their brains agree as well) about the underlying dynamics.
The idea that "deflation causes bad things" is based on the assumption that if we know that the prices of XY will be lower in one year, consumers delay the purchase or consumption (because they're waiting for prices that are lower, i.e. better for the buyers), and that's why the GDP should decrease now. Does it make sense? When does it make sense?
If you think about making a very long-term investment, e.g. buying a palace, you may be affected by such things. 1% of the price of the palace is a lot (and the relative drop of the price per year may be larger) so it may make sense for you to delay the purchase. You may sometimes even determine that you will save money if you rent it for a year and buy it later.
A 1985 Czecho-Slovak hit, German edition, still sounds great to me.
Should policymakers care if the sales of palaces are delayed? I don't think so. The palace has already been built. When one owner sells it to another one, the economy doesn't really produce anything. It doesn't increase the employment. It doesn't allow the other people to have richer dinners. That was the case for palaces that already exist. What about houses that are being constructed now? Well, gradually dropping prices may convince the construction companies to speed up the work because the sooner they sell it, the better.
Dropping prices may also lead them to reduce the construction activity. But this activity is ultimately determined by the demand, anyway. If people suddenly have slightly more money, they don't buy houses. For these reasons, we shouldn't discuss these long-term purchases at all.
Instead, we should ask what deflation does to the normal products that are being consumed and that are actually included in the baskets by which inflation or deflation is defined. What will you do if you "know" that the prices of food or electronics or cars exhibit a decreasing trend and they will probably drop by 1% in a year? Will you delay the consumption?
You won't postpone the purchase of the eggs because you could die of hunger during the year. The eggs that you buy now are not exactly the same eggs as those that you buy in 2016. They behave as different products and they are used differently which is why the comparison of their prices can't have important consequences. The 2015 eggs are used to feed you in 2015 and the 2016 eggs are used to feed you in 2016. If you like to eat 2015 eggs in 2016, you may feel sick. And if you eat 2016 eggs in 2015, you may make billions for your time machine. My point is that one never "speculates" about the dropping price of food by making reserves because most of food isn't a long-lasting commodity and even if you talk about food that doesn't get spoiled for many years, people just usually don't create reserves for many years (even though I just poured some fennel and thyme from the 1980s into my soup three hours ago LOL!).
Exactly because food isn't a long-term investment, people are not comparing prices of food in one year and the following years, and that's why decreasing prices won't reduce the consumption now.
The situation is analogous for electronics and similar products. You buy a tablet in early 2015 because you want to use it already in 2015. At least, you want to use it in a near future. The asymptotic behavior of the prices in the future is therefore irrelevant. You surely know that the tablet will be more or less worthless in 10 years, don't you? And it will only gain the value as an antique in 100 years or so. Moreover, if you talked about the prices of fixed electronic products, you would have to agree that there is a huge deflation in one way or another. The memory and other parameters of tablets etc. are being doubled every 2-3 years. The old tablets become cheaper very quickly. Fixed models see their price decrease by dozens of percent per year. The reduced deflation rate for these products may exceed –10%. It really doesn't matter whether the overall inflation rate is +1% or –1%.
If you think about particular people buying particular classes of products, you will see that the idea that "deflation postpones consumption and therefore reduces GDP" simply doesn't work.
Instead, one mechanism with the opposite result does work. If one sees that (food...) prices seem to be going down, it makes him or her more self-confident that next year, he or she will be able to afford at least the same as now. This improves the sentiment, for a very rational reason. Even with fixed nominal salaries, deflation may be seen to gradually do life easier for the consumer, and that makes him or her buy things more enthusiastically.
If prices go down, the number of things one can buy for a fixed salary goes up, of course, but this isn't the whole story. If things seem to be getting easier, one also tends not to pile up savings and instead, one may be inclined to borrow.
So moderate deflation comparable to 1% or perhaps even several percent would be just fine. Central banks such as ECB are often trying to target inflation – the ECB goal is 2% – but I think that it should only be followed as long as there are conventional tools to achieve that goal. If the inflation is too fast, ECB may and should hike the interest rates. And if the inflation is too low and the rates are high, ECB should lower them. But if the interest rates are already near zero and the inflation rate seems to be slightly negative, it's most sensible for ECB to simply do nothing. If we ignore other bad circumstances that have nothing to do with deflation itself, the situation involving this deflation and zero interest rates is just perfectly OK. Negative "central" interest rates are possible but they bring more disadvantages than advantages, I think.
Now, Germany is also running a (tiny) budget surplus and (large) trade surplus. It's an export-oriented economy which "explains" the trade surplus. But it's not a true "explanation". I think that in the normal state of affairs, the market should pretty much adjust all currency exchange rates so that the trade surpluses and deficits of all countries – more precisely, all territories using one currency or another – disappear.
But Germany belongs to the Eurozone and the Eurozone as a whole doesn't reproduce the impressive German trade surpluses. The non-German part of the Eurozone runs trade deficits but Germany's lead is still enough for the whole Eurozone to show trade surpluses, although smaller than Germany's. OK, where is the difference between Germany and others coming from?
I don't think it's right to say that the reason is that the other nations are less skillful, in the sense of being able to achieve a smaller GDP per capita than Germany. Whatever your GDP per capita is, you may have a balanced trade balance (and balanced budget). You must simply adjust all your spending and salaries to your (or your nation's) abilities.
Non-German Eurozone members don't run deficits because they are less skillful than the Germans, even though they mostly are. The actual reasons behind the deficits is that they are less disciplined than Germany. They just don't care about the deficits!
So the disharmony within the Eurozone isn't an unavoidable consequence of the nations' different abilities. Different abilities don't prevent several countries from sharing a currency (as long as they may live with the fact that the average income will be different in different parts of the currency union); for example, Slovakia is doing very well in the Eurozone (although the GDP per capita is several times smaller than in Germany). Instead, what causes the disharmony and imbalance within the Eurozone is the different degree of discipline of the different nations.
The Southern nations are less good engineers than Germans but that wouldn't be a problem for the shared currency. The problem is that the North thinks it's a problem to be in (budget or trade) deficit and a big problem to go bankrupt while the South is not so sure. Someone will bail us out again if we hysterically and self-confidently scream, won't he? And if they won't save us, we still have our ouzo. (The last two sentences only apply to Greece right now; I don't want to create the impression that this meme is applicable to Spain, Portugal, Italy, Ireland, or even France.)
Rammstein: We're all living in Amerika, Amerika ist wunderbar.
This also says something about the solution: I think that there is nothing wrong about a shared currency for everyone, including nations with weaker skills or even poorer discipline. The real problem – that might grow out of control – are only the fiscal transfers. But if the Eurozone imposed the (existing!) rules that fiscal transfers won't happen, and if it simply allowed unsuccessful governments, much like unsuccessful companies, to go bankrupt (which would happen more frequently in the irresponsible nations), things could work just fine. Clearer rules what happens after a default should be written down explicitly – all these important things were avoided because it was preposterously suggested that "such bad things can't occur in the rosy Europe". Alternatively, the Eurozone (or the EU) may allow both deficits and significant fiscal transfers but a necessary condition for those not to get out of control is that the same demos and politicians will have to decide about all the budgets that may be helped in this way. I don't think that the nations will accept that Germans or others would make important decisions about their national budgets (although I guess that most of the Czechs would okay it!).
Also, Germany is running (small) budget surpluses. By doing so, it proves that it's in no way impossible to record GDP growth even though these principles – such as a nearly balanced budget – are being respected. The likes of Krugman who scream that budget deficits are great and perhaps necessary for the economic growth are unhinged crackpots. Their screaming is plain wrong for theoretical reasons – and it's also experimentally provably wrong. These people are really soulmates of the irresponsible Greek governments of the recent 4 decades. They are not showing that they know anything sensible about economics that Germany doesn't know. They are only showing their own irresponsibility and decadence. And it's not just Paul Krugman. Various Obama aides are shouting (this annoyingly pushy woman, Caroline Atkinson has previously called on the world to waste trillions for nonsensical struggle against CO2 and there are surely other reasons for her to be among the top 9 U.S. folks targeted by Russian sanctions) that Germany should run deficits and waste money in various stupid ways. Why? What do they want to achieve? Why they think that it's a good thing? Why?
Can't you just shut up, bitch?
These people are the cause of the mess we are experiencing in Greece these days – and which other countries have experienced in the past and will experience in the future. Why would someone want to copy these mistakes? If I ask you whether the Greek or German macroeconomic management of the economy is preferred, which one will you pick?
The global financial collapse due to the excessive debt and increasingly likely debt crises is in no way inevitable. One may prevent it by simply adopting the German and not Greek logic in much of the world. One may prevent it if billions of people realize that Paul Krugman is an unhinged crank while Luboš Motl is an economics guru. ;-)
Who is the Mr Wichtig here, that is the question.
Fair currency exchange rates: trade balance a better measure than current account
One bonus technicality. I've expressed the same idea in the past but only yesterday, I became very certain about it and could formulate it in a clear way – thanks to a discussion at patria.cz.
The discussion was under an article saying that in 2014, Czechia recorded a current account surplus for the first time. For years, perhaps from the beginning, we would have trade surpluses. But many Czech companies are owned by foreign owners who extract lots of dividends from the Czech daughter companies and these outgoing dividends (which are cash leaving the country, much like in the case when we are buying something) are included with a minus sign to the current account. That's why in the previous years, Czechia would have current account deficits even though it ran trade surpluses.
Now, let's formulate the question rather sharply: if a central bank wants to "repair" some mistakes of the market and determine the "right" currency exchange rate so that we're in a sustainable equilibrium, should it try to set the trade balance to zero, or the current account to zero?
Note that if there are trade deficits (or current account deficits), it's a reason for the currency (CZK – Czech crown – in this case) to weaken because a weaker currency encourages exporters and discourages importers. OK, so which of them is right, trade balance or the current account?
My answer is "trade balance" and for a simple reason. If you weaken your local currency, it doesn't necessarily help to improve the current account (make it less negative or more positive). In fact, it does the opposite to the "dividend flow" part of the current account. The Czech companies that export lots of products may make higher profits thanks to the weaker crown and that leads to higher profits and therefore higher dividends. This, in turn, makes the current account worse. And on the contrary, a weaker crown makes it (a bit) harder for Czech owners of foreign companies. It also makes it more difficult for Czechs to buy foreign companies and perhaps create (new) incoming dividends in the future.
So the weakening of the local currency only "stabilizes" the trade balance but it does the opposite to the rest of the current account! That's why this policy of "weakening the local currency while there is a current account deficit" could actually destabilize the exchange rate – make it decay out of control – if the dividend flows etc. were more important for the current account than the trade balance. And it could happen. The dividends (i.e. profit) are smaller than the exports but they are not necessarily smaller than the difference of exports and imports.
For all these reasons, I think that the healthy currency exchange rate is one for which the trade deficit or surplus is zero, not one for which the current account is balanced. At this moment, the Czech crown is undervalued by both criteria (it's kept undervalued by completely counterproductive promised new interventions by the Czech National Bank) but I think that the careful analysis implies that it has been comparably undervalued for many years.
This determines my views about the "fair" currency exchange rates everywhere in the world. For example, the U.S. dollar is overpriced, as we see from the (still) very large trade deficit. But we know why the dollar is overpriced: it's a reserve currency. With a certain small twist to the logic, we may argue that the currency exchange rates are still determined by setting a "generalized trade balance" to zero.
What is the "generalized trade balance" that is zero in the U.S.? Well, the U.S. produces and exports some things such as iPhones (well, all the hard work is done in Asia but let's ignore that) but it runs a deficit. But what is not included in the exports are the U.S. dollar banknotes and treasuries themselves. The Chinese and many others still use and pile up these papers as their preferred way to store wealth. If you reclassify (an appropriate part of) the (newly printed) U.S. dollar cash and U.S. treasuries as "products that are being exported by the U.S. much like iPhones", you may conclude that the "generalized trade balance" of the United States is zero, too.
An exercise for you: what is the part of the newly printed cash and treasuries that leave the U.S. and that you must reclassify as "exports" if you want to balanced the generalized trade balance? ;-)
Of course, I agree with those who say that the global financial system is asymmetric and unnecessarily non-uniform, which is bound to lead to inefficiencies, thanks to the ability to effectively consider these easily printed pieces of paper as "exports". I do think that the decoupling of the dominant currency from a territory would make the global economy more sensible.