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President Trump’s economic war against Germany and the euro

Giancarlo Elia Valori

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[yt_dropcap type=”square” font=”” size=”14″ color=”#000″ background=”#fff” ] J [/yt_dropcap]ust a week after his official installation at the White House, Donald J. Trump lashed out at China, accused of manipulating its currency to “win the globalization game”, but also at Germany which, as the President of the new National Trade Council, Peter Navarro, said “is exploiting both its neighbours and the United States with the euro”.

The accusation is not new. In the early 1970s the United States accused the old European Monetary System (EMS) of keeping the currencies adhering to it artificially high.

Inter alia, the EMS – with fixed exchange rates but with predefined fluctuations within it – was the European response to the US-prompted end of the 1944 Bretton Woods agreement.

Nevertheless, it was also Europe’s reaction to the planned weakness of the dollar during Jimmy Carter’s Presidency, when precisely the dollar area sent huge capital flows into Germany, which had a “high” Mark, thus pressing it against the French Franc and hence destabilizing the entire European internal monetary exchange system.

Furthermore, in the early 1980s, the British Labour Prime Minister, Denis Healey, got convinced that the EMS was a real German “racket”, considering that the German Finance Minister had told him that his country planned to have a comparative advantage precisely by limiting the depreciation of the other European currencies.

This happened because Germany had lower labour cost-driven inflation rates and, hence, a currency with fixed rates would have anyway ensured export-driven surpluses only to Germany.

However also the G20 long negotiations have never led to any result: currently, in absolute terms, the German export-led surplus is much larger than China’s, namely 8.6% of the German GDP.

In fact, according to IMF estimates, the surplus is equal to 271 billion US dollars, a huge sum capable of changing all global trade flows.

Finally Chancellor Angela Merkel replied to Trump (and to Navarro) by recalling that the European Central Bank is the institution issuing the euro, but it is not lender of last resort. Nevertheless, she has not contradicted the US President about the fact that the Euro is really undervalued.

Furthermore, when we look at the currencies undervalued as against the US Dollar, we realize that the most undervalued currency is the Turkish Lira, followed by the Mexican Peso, the Polish Zloty, the Hungarian Forint, the South Korean Won and, finally, our own Euro.

Finally, when we look at the number and size of transactions denominated in euros, the European currency is already the second most traded currency in the world.

Hence, probably the undervaluation of the Euro against the US Dollar originates more from the expansionist policy of the European central Bank than from Germany’s actions for its exports and monetary parities.

Certainly Germany gains in having a currency that is much weaker than it would be if it were only a German currency but, on the other hand, with a Euro artfully devalued, the “weakest” Eurozone countries succeed in having lower interest rates than they could obtain with their old or new national currencies.

Moreover, it is worth recalling that Germany exports profitably both in countries where the currency is stronger than the Euro and in regions where the currency is even more depreciated as against the US Dollar, such as Japan.

According to last year’s data, the United States have a trade deficit with Germany equal to 60 billion US dollars.

Germany exports mainly cars, which account for 22% of their total exports to the United States.

It also exports – in decreasing order – machine tools, in direct competition with Italy, electronics, pharmaceuticals, medical technologies, plastics, aircraft and avionics, oil, iron and steel, as well as organic chemicals. All German exports are worth 35% of its GDP.

Why, however, is the Euro depreciated because of Germany?

Firstly, since 2000 the German cost of labour has grown by 20-30% less than in the Eurozone’s German competitors.

Hence German products were ipso facto 20% more competitive than those of the others, without any exchange rate manipulation.

If Germany still had had the Mark, it would have automatically appreciated by 20%.

The appreciation of this hypothetical Mark would have changed demand, by reducing exports and increasing imports by the same percentage.

In that case, the ideal would have been a floating exchange rate – and this should also be the case for a re-modulated Euro compared to the current situation.

A fluctuation prefiguring the creation of a new monetary “basket” with the major currencies, with exchange rates floating within a certain range, but much more realistic than the current ones.

A further cause of the current account surplus in Germany is the intrinsic strength of its exports – hence Germany does not suffer the competition of low-tech economies, such as Italy’s.

Another reason for the excessive German surplus is the low domestic demand, with the relative increase in private savings.

An additional cause of the surplus is the fact that savings have long been higher than investment.

In 2015, German savings amounted to 25% of the Gross Domestic Product (GDP), while investment was worth only 16% of the GDP.

Obviously, another decisive reason for the accumulation of such a large German surplus was the fall in oil prices.

Therefore, the vast German surplus and the Euro undervaluation foster its exports, but block the exports of the other Eurozone countries.

In fact, according to our calculations, if Germany stimulated its domestic demand, thus allowing its inflation to increase, this would be enough for the final stimulus of global demand and, above all, it would make the Eurozone economies under crisis get out of their predicament.

Hence the real problem of too high a Euro is not so much for the United States, which can devalue as against the Euro whenever they want and anyway have still their own autonomous monetary policy, but rather for the single currency countries in the Mediterranean, which are experiencing a downturn caused by too low domestic demand.

Could we also do as Germany? No, we could not.

It is not possible for anyone in the Eurozone to create an 8% surplus, such as Germany, and not all countries could benefit from a devalued exchange rate of the European currency.

As many politicians say, restructuring the production system to increase productivity means – in a nutshell – years of deflation and high unemployment, which create a negative multiplier effect.

We cannot afford so – the social and economic conditions have already reached the breaking point.

Hence, let us put our minds at rest, the ”two-speed Europe” will last generations and it would be better if this could also be reflected in the single currency.

Or better in a series of two-three currencies deriving from the Euro with pre-fixed exchange rates floating within a range.

Furthermore, Germany will certainly replace China as the “bad” currency manipulator and there will be increasing competition between it and the rest of Europe.

Therefore, the German export surplus actually leads to an unfair competitive advantage over the Eurozone countries and, in other respects, over the North American exports.

This is the sense of the struggle against the Euro waged by President Trump and his future Ambassador to the EU, Ted Malloch, who has stated that the Euro may “collapse” over the next eighteen months.

The Euro is certainly undervalued.

According to a study carried out by Deutsche Bank, the Euro is allegedly the most undervalued currency in the world, according to the criteria of the Fundamental Equilibrium Exchange Rates (FEER).

And the Euro is undervalued even if we look at its external value and the mass of transactions of the individual countries currently adopting it.

Hence, not only can Germany be accused of managing an improper comparative advantage over the dollar and the other major currencies but, according to the FEER data, the accusation holds true even for Italy and for the other single currency European countries.

With a view to solving the issue, some analysts – especially North Americans – think it should be Germany to leave the Euro.

On the one hand, Germany cannot revalue its currency (which is also a political problem – suffice to think of German savers) without the Euro appreciating also for the Eurozone weak economies, such Italy and Spain.

The World Bank believes that the German trade surplus is at least 5% too high and, hence, the German exchange rate is largely undervalued by at least 15%.

In fact, the differential between the German Euro and the Euro of the Eurozone weakest countries is 20%.

This means that, in terms of Purchasing Power Parity (PPP), the Italian or Greek Euro is worth 20% less than the German one.

The issue could be solved with an equivalent 20% Euro revaluation, combined with an expansionary fiscal policy.

However, this cannot be done as long as Germany is within the Euro. This means that Germany cannot revalue the exchange rate without doing the same in the other 17 countries that adopt the European single currency.

This would mean definitively destroying the Italian, Greek, Portuguese and Spanish economies.

Therefore, if Germany came out of the Euro, its new currency would appreciate as against the non-German Euro and the other countries would have a devalued currency, which could help them in exports.

There are two ways in which the German trade surplus creates deflation – and hence crisis – in the rest of the Eurozone.

Obviously the first is by pushing up the value of the European currency.

A strong euro weakens the demand for European exports, especially for the most price-sensitive goods of the Eurozone Mediterranean economies.

Moreover, the high value of the European currency reduces the price of imported goods, thus negatively reinforcing the price fall – another deflationary mechanism.

And the German inflation which, as everyone knows, is lower than in the other Eurozone countries, further weakens the peripheral economies.

Hence a landscape marked by low domestic demand and national markets’ production crisis.

However, in Navarro’s and in Trump’s minds, there is the implicit belief that trade imbalances can be solved in a context of free-floating currencies.

It is not always so and, however, fluctuations apply only when there are structural changes in trade systems – in principle all players envisage and operate, for sufficient time, with fixed or maybe slightly floating rates.

Therefore, reading between the lines, what both Trump and Navarro really tell us is that the very Euro membership is an act of monetary manipulation.

Hence, what is done?

The unity of the European economy is broken, with unpredictable effects and further global chaos, while the United States acquire exports that were previously denominated in euros.

Or the United States could impose quotas or specific tariffs for Germany, which is illegal in WTO terms but, above all, would expose the United States to a series of reprisals and retaliation by Germany and probably also by the rest of the Eurozone.

There is no way out: therefore, again reading between the lines, probably Trump is telling to the Eurozone weak economies that they should leave the single currency, which is only in Germany’s interest, and create new post-Euro currencies, which will be somehow pegged to the US Dollar.

Or Trump and Navarro could define a new relationship between Euro, Dollar, Yuan, Ruble, Yen and some other primary currencies on the markets and impose a predetermined fluctuation between them, but obviously the Euro would enter this new “Bretton Woods” by being valued in line with the markets and not being overvalued as today.

Europe, however, shall put back in line and tackle all trade and political issues with Trump’s America, which will make no concession to anyone and, most importantly, does no longer want to favour Europe militarily, strategically, financially and commercially.

In particular, Donald J. Trump has in mind the big game with Russia and China. He is scarcely interested in a continent, such as Europe, which is not capable of defending itself on its own and shows severe signs of structural crisis.

Advisory Board Co-chair Honoris Causa Professor Giancarlo Elia Valori is an eminent Italian economist and businessman. He holds prestigious academic distinctions and national orders. Mr Valori has lectured on international affairs and economics at the world’s leading universities such as Peking University, the Hebrew University of Jerusalem and the Yeshiva University in New York. He currently chairs "La Centrale Finanziaria Generale Spa", he is also the honorary president of Huawei Italy, economic adviser to the Chinese giant HNA Group and member of the Ayan-Holding Board. In 1992 he was appointed Officier de la Légion d'Honneur de la République Francaise, with this motivation: "A man who can see across borders to understand the world” and in 2002 he received the title of "Honorable" of the Académie des Sciences de l'Institut de France

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Transitioning from least developed country status: Are countries better off?

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The Least Developed Countries (LDCs) are an internationally defined group of highly vulnerable and structurally constrained economies with extreme levels of poverty. Since the category was created in 1971, on the basis of selected vulnerability indicators, only five countries have graduated and the number of LDCs has doubled.  One would intuitively have thought that graduation from LDC status would be something that all LDCs would want to achieve since it seems to suggest that transitioning countries are likely to benefit from increased economic growth, improved human development and reduced susceptibility to natural disasters and trade shocks.

However, when countries graduate they lose international support measures (ISMs) provided by the international community. There is no established institutional mechanism for the phasing out of LDC country-specific benefits. As a result, entities such as the World Bank and the International Monetary Fund may not always be able to support a country’s smooth transition process.

Currently, 14 out of 53 members of the Commonwealth are classified as LDCs and the number is likely to reduce as Bangladesh, Solomon Islands and Vanuatu transition from LDC status by 2021. The three criteria used to assess LDC transition are: Economic Vulnerability Index (EVI), Human Assets Index (HAI) and Gross National Income per capita (GNI).  Many of the forthcoming LDC graduates will transition based only on their GNI.  This GNI level is normally set at US $ 1,230 but if the GNI reaches twice this level at US $ 2,460 a country can graduate.

So what’s the issue?  A recent Commonwealth – Trade Hot Topic publication confirms that most countries graduate only on the basis of their GNI, some of which have not attained significant improvements in human development (HAI) and even more of which fall below the graduation threshold for economic development due to persistent vulnerabilities (EVI).  This latter aspect raises the question as to whether transitioning countries will, actually, be better off after they graduate.

Given the loss of ISMs and the persistent economic vulnerabilities of many LDCs, it is no surprise that some countries are actually seeking to delay graduation, Kiribati and Tuvalu being two such Commonwealth countries despite easily surpassing twice the GNI threshold for graduation.

How is it possible that a country can achieve economic growth but not have appreciable improvements in resilience to economic vulnerability?  Based on a statistical analysis discussed in the Trade Hot Topic paper, a regression model, based on all forty-seven LDCs, was produced.  The model revealed that there was no statistically significant relationship between economic vulnerability and gross national income per capita.  The analysis was repeated just for Commonwealth countries and similar results were obtained.

Most importantly, analysis revealed that there was a positive relationship between GNI and EVI. In other words, increases in wealth (using GNI as a proxy) is likely to result in an increase in economic vulnerability.  This latter result is counterintuitive since one would expect more wealth to result in less economic vulnerability.

So what’s the take away?

The statistical results do not necessarily imply that improving the factors affecting economic vulnerability cannot result in improvements to economic prosperity.  It does suggest, however, that either insufficient efforts have gone into effecting such improvements or that there are natural limits to the extent to which such improvements can be effected.

One thing is clear, the multilateral lending agencies should revisit the removal of measures supporting climate change or other vulnerabilities for LDCs on graduation, since the empirical evidence suggests that countries could fall back into LDC status or stagnate and be unable to achieve sustainable development. Whilst transitioning from LDC status should be desirable, it should not be an end in itself. Rather than to transition and remain extremely vulnerable, countries should be resistant to such change or continue to receive more targeted support until vulnerabilities are reduced to more acceptable levels.

What are your thoughts?

Commonwealth

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U.S. policy and the Turkish Economic Crisis: Lessons for Pakistan

M Waqas Jan

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Over the last week, the Turkish Lira has been dominating headlines the world over as the currency continues to plunge against the US dollar. Currently at the dead center of a series of verbal ripostes between Presidents Donald Trump and Recep Tayyip Erdogan, the rapidly depreciating Lira has taken center stage amidst deteriorating US-Turkey relations that are wreaking havoc across international financial markets. Considering Pakistan’s current economic predicament, the events unfolding in Turkey offer important lessons to the dangers of unsustainable and unrealistic economic policies, within a dramatically changing international scenario. This holds particular importance for Pak-US relations within the context of the impending IMF bailout.

In his most recent statements, Mr. Erdogan has attributed his economy’s dire state of affairs as an ‘Economic War’ being waged against it by the United States. President Trump too has made it evident that the latest rounds of US sanctions that have been placed on Turkey are directly linked to its dissatisfaction with Ankara for detaining American Pastor Andrew Brunson. Mr Bruson along with dozens of others has been charged with terrorism and espionage for his purported links to the 2016 attempted coup against President Erdogan and his government.  There is thus a modicum of truth to Mr. Erdogan’s claims that the US sanctions are in fact, being used as leverage against the weakening Lira and the Turkish economy as part of a broader US policy.

However, to say that the latest US sanctions alone are the sole cause of Turkey’s economic woes is a gross understatement. The Lira has for some time remained the worst performing currency in the world; losing half of its value in a year, and dropping by another 20% in just the last week. Just to put the scale of this loss in to perspective, the embattled currency was trading at about 2 Liras to the dollar in mid-2014. The day before yesterday, it was trading at about 7 Liras to the dollar.

While the Pakistani Rupee has also depreciated quite considerably over the last few months, its recent drop (-17% against the dollar over the past 12 months) pales in comparison to the sustained and exponential downfall of the Lira. Yet, both the Turkish and Pakistani economies are at a point where they are experiencing an alarming dearth of foreign exchange reserves that have in turn dramatically increased their international debt obligations.

The ongoing financial crises in both Turkey and Pakistan are similar to the extent that both countries have pursued unsustainable economic policies for the last few years. These have been centered on increased borrowing on the back of overvalued currencies. While this approach had allowed both governments to finance a series of government investments in various projects, the long term implications of this accumulating debt has now caught up with them dramatically. As a result, both countries may soon desperately require IMF assistance; assistance, that in recent times, has become even more overtly conditional on meeting certain US foreign policy requirements.

In the case of Pakistan, these objectives may coincide with recent US pressures to ‘do more’ regarding the Haqqani network; or a deeper examination of the scale and viability of the China- Pakistan Economic Corridor. With regards to the latter, US Secretary of State Mike Pompeo has clearly stated that American Dollars, in the form of IMF funds, to Pakistan should not be used to bailout Chinese investors. The rationale being that a cash-strapped Pakistan is more likely to adversely affect Chinese interests as opposed to US interests in the region at the present. The politics behind the ongoing US-China trade war add even further relevance to this argument.

In the case of Turkey however, which is a major NATO ally, an important emerging market, and a deeply integrated part of the European financial system, there is a lot more at stake in terms of US interests. Turkey’s main lenders comprise largely of Spanish, French and Italian banks whose exposure to the Lira has caused a drastic knock on effect on the Euro. The ensuing uncertainty and volatility that has arisen is likely to prove detrimental to the US’s allies in the EU as well as in key emerging markets across South America, Africa and Asia. This marks the latest example of the US’s departure from maintaining and ensuring the health of the global financial system, as a leading economic power.

Yet, what’s even more unsettling is the fact that while the US is wholly cognizant of these wide-ranging impacts, it remains unfazed in pursuing its unilateral objectives. This is perhaps most evident in the diminishing sanctity of the NATO alliance as a direct outcome of these actions.  After the US, Turkey is the second biggest contributor of troops within the NATO framework. As relations between both members continue to deteriorate, Turkey has been more inclined to gravitate towards expanding Russian influence. In effect, contributing to the very anti-thesis of the NATO alliance. The recent dialogues between Presidents Erdogan and Putin, in the wake of US sanctions point markedly towards this dramatic shift.

Based on the above, it has become increasingly evident that US actions have come to stand in direct contrast to the Post-Cold War status quo, which it had itself help set up and maintain over the last three decades. It is rather, the US’s unilateral interests that have now taken increasing precedence over its commitments and leadership of major multilateral frameworks such as the NATO, and the Bretton Woods institutions. This approach while allowing greater flexibility to the US has however come at the cost of ceding space to a fast rising China and an increasingly assertive Russia. The acceleration of both Pak-China and Russo-Turkish cooperation present poignant examples of these developments.

However, while it remains unclear as to how much international influence US policy-makers are willing to cede to the likes of China and Russia over the long-term, their actions have made it clear that US policy and the pursuit of its unilateral objectives would no longer be made hostage to the Geo-Politics of key regions. These include key states at the cross-roads of the world’s potential flash-points such as Turkey and Pakistan.

Therefore, both Turkey and Pakistan would be well advised to factor in these reasons behind the US’s disinterest in their economic and financial predicaments. Especially since both Russia and China are still quite a way from being able to completely supplant the US’s financial and military influence across the world; perhaps a greater modicum of self-sufficiency and sustainability is in order to weather through these shifting dynamics.

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Social Mobility and Stronger Private Sector Role are Keys to Growth in the Arab World

MD Staff

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In spite of unprecedented improvements in technological readiness, the Arab World continues to struggle to innovate and create broad-based opportunities for its youth. Government-led investment alone will not suffice to channel the energies of society toward more private sector initiative, better education and ultimately more productive jobs and increased social mobility. The Arab World Competitiveness Report 2018 published by the World Economic Forum and the World Bank Group outlines recommendations for the Arab countries to prepare for a new economic context.

The gap between the competitiveness of the Gulf Cooperation Council (GCC) and of the other economies of the region, especially the ones affected by conflict and violence, has further increased over the last decade. However, similarities exist as the drop in oil prices of the past few years has forced even the most affluent countries in the region to question their existing social and economic models. Across the entire region, education is currently not rewarded with better opportunities to the point where the more educated the Arab youth is, the more likely they are to remain unemployed. Financial resources, while available through banks, are rarely distributed out of a small circle of large and established companies; and a complex legal system limits access to resources locked in place and distorts private initiative.

At the same time, a number of countries in the region are trying out new solutions to previously existing barriers to competitiveness.

  • In ten years, Morocco has nearly halved its average import tariff from 18.9 to 10.5 percent, facilitated trade and investment and benefited from sustained growth.
  • The United Arab Emirates has increased equity investment in technology firms from 100 million to 1.7 billion USD in just two years.
  • Bahrain is piloting a new flexi-permit for foreign workers to go beyond the usual sponsorship system that has segmented and created inefficiencies in the labour market of most GCC countries.
  • Saudi Arabia has committed to significant changes to its economy and society as part of its Vision 2030 reform plan, and Algeria has tripled internet access among its population in just five years.

“We hope that the 2018 Arab World Competitiveness Report will stimulate discussions resulting in government reforms that could unlock the entrepreneurial potential of the region and its youth,” said Philippe Le Houérou, IFC’s CEO. “We must accelerate progress toward an innovation-driven economic model that creates productive jobs and widespread opportunities.”

“The world is adapting to unprecedented technological changes, shifts in income distribution and the need for more sustainable pathways to economic growth, “added Mirek Dusek, Deputy Head of Geopolitical and Regional Affairs at the World Economic Forum. “Diversification and entrepreneurship are important in generating opportunities for the Arab youth and preparing their countries for the Fourth Industrial Revolution.”

With a few exceptions, such as Jordan, Tunisia and Lebanon, most Arab countries have much less diversified economies than countries in other regions with a similar level of income. For all of them, the way toward less oil-dependent economies is through robust macroeconomic policies that facilitate investment and trade, promotion of exports, improvements in education and initiatives to increase innovation and technological adoption among firms.

Entrepreneurship and broad-based private sector initiative must be a key ingredient to any diversification recipe.

The Arab Competitiveness Report 2018 also features country profiles, available here: Algeria, Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia, Tunisia, United Arab Emirates.

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