by Bill O’Grady
At the NATO meetings late last month, the German media reported that President Trump had called the Germans “bad” for running trade surpluses with the U.S. The president threatened trade restrictions, focusing on German automobiles. Needless to say, this comment caused a minor international incident.
Although such incidents come and go, it did generate a more serious question…are German policies causing problems for the world? In this report, we will review the saving identity we introduced in last month’s series on trade and discuss how Germany has built a policy designed to create saving. We will move the discussion to the Eurozone and show the impact that German policy has had on the single currency. From there, we will try to address the question posed in the title of this report. We will conclude, as always, with market ramifications.
The Saving Identity
In the month of May, we published a four-part report on trade that is now combined into a single report. In that report, we introduced the saving identity.
(M – X) = (I – S) + (G – Tx)
The saving identity states that private sector domestic saving (I – S) plus public sector saving (G – Tx) is equal to foreign saving. If a country is running a positive domestic savings balance, either by investing less than it saves or by running a fiscal surplus, it will run a trade surplus (X>M). In public discussion, trade appears to be all about jobs, relative prices, trade barriers, etc. However, regardless of how nations interfere with trade, the saving identity will always be true. As we noted in the aforementioned report, tariffs, exchange rate manipulation and administration barriers will, in the final analysis, be explained through the saving identity.
In the process of economic development, nations must build productive capacity through investment. Both public and private investment are necessary for success. Public investment in infrastructure, roads, bridges, canals, etc., are critical to supporting private investment. In capitalist societies, a legal framework to adjudicate contract disputes and support the enforcement of agreements is also necessary and mostly provided by the public sector. Private investment usually occurs along with public investment. But, all investment requires funding, which comes from saving. That saving can come from both domestic and foreign sources.
 Imports (M), exports (X), investment (I), saving (S), government consumption (G) and taxes (Tx).