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Tuesday, June 30, 2009


the german conundrum

it seems as though everyone has a good idea as to what has to happen in order to rectify global imbalances that have their headwaters in trade. east asia, germany and japan were supposed to seamlessly transition to high-wage consumer economies; the united states was supposed to learn to double or more the share of its economy dedicated to export; international capital flows would balance, and all would be well. so transparent was the need that legions of observers ridiculed the agents who did otherwise in the 1930s, dismissing protectionism as the folly of idiots who knew less than we do.

but on the way to recovery a strange thing happened: we rediscovered why protectionism ruled the rebalancing of the early 1930s, and it turns out it isn't because all our grandfathers' economists and politicians were morons. tradermark of fund my mutual fund highlights the deep difficulty that germany is having in transitioning into being the new california.

Germany, in the grip of a massive export slump, firmly believes it has no alternative to export-led growth. But there is an alternative -- the country just doesn't have the stomach for the changes it would require.

There are three ways that Germany, the world's fourth-largest economy, could respond.

One is to sit tight and wait until global trade recovers. That's what Chancellor Angela Merkel's government and much of corporate Germany plan to do. In their view, this recession is an almighty cyclical hiccup, but Germany's economy is fundamentally sound.

right, "cyclical hiccup".

A second option is to increase domestic consumption, and labor unions say it's high time. Export competitiveness has come at the expense of consumer spending, they argue, because German companies have browbeaten workers into forgoing pay raises for years.

except that what is happening is that wages are having to normalize across the same borders that capital and production are crossing with ease in the age of globalization. the deflationary pressure on real wages throughout the west is inexorable, and the only way to put an end to the arbitrage is to -- yep -- raise protective barriers such as tariffs and capital controls.

The third option would be to foster entrepreneurship in new sectors, to supplement Germany's traditional strengths in cars and engineering. ... But genuinely diversifying Germany's economy would require an overhaul of the country's universities, banking and capital markets, bureaucracy, taxes and welfare state, labor market and immigration laws, say economists. That's unlikely to happen soon. The nation is tired of reforms, after years of controversial changes to cut budget deficits and long-term unemployment.

everyone always says "innovate" -- but it just isn't that simple, is it?

the german conundrum is also the conundrum of japan, the other high-wage mercantile export powerhouse. but more importantly it highlights the massive structural and cultural adjustments that must be made in the global economy in order to correct the imbalances we've grown so used to. such structural and cultural changes take years to effect and are expensive in frictional costs.

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"it seems as though everyone has a good idea as to what has to happen in order to rectify global imbalances that have their headwaters in trade. east asia, germany and japan were supposed to seamlessly transition to high-wage consumer economies"

I posted this on Credit Writedowns and Gold Versus Paper on China and it could apply to other export based economies too:

"China cares for its interests primarily. If protectionism and mercantilism is in its interests, it will adopt those policies even if it harms other nations. I suppose a key macroeconomic theme (as described here) is the hallowing out of the Western middle class in countries that have an Anglo-Saxon labor market. This is caused by stagnant wages from competing against immigrants, third world labor, and technology. Increasing consumption during the bubble years was not provided by increased earning power, but by the accumulation of debt.

One can make money from globalization by importing goods made in countries with cheap labor to countries where firms still retain significant pricing power. Globalization in the long run seems to undermine the earning power of the Western middle class.

Furthermore, profits from globalization come from intertemporal discount rates that gravitate towards short-term consumption over long-term saving (it is basically the argument presented here) in wealthy current account deficit nations. Given the gravitation towards savings in those nations, it is unlikely that the current form of globalization will be significantly profitable, and this is one reason why I expect interest rates to fall.

So could multinationals rely on China? Of course, there are a lot of workers in China and that would serve to depress domestic wages (and consumption) despite their enormous savings. Chinese protectionism would destroy the thesis that Chinese consumption would help lead the global economy to recovery. I do not think China could replace the Western middle class."

I am an emerging market bear, and I am skeptical of the transition away from export dependency to domestic demand. Even if Chinese domestic demand will drive its growth, I wonder whether the state will allow investors to profit from its economic growth. China has protectionist policies, so it would not allow other nations and investors who operation outside of China to benefit from its growth

BTW, do you count yourself among the contrarian debt deflationists, or are you a "contrarian" inflationista? I think your blog has a deflationist bias towards it.

Regarding other issues, I am interested in your thoughts about the financial crisis and religion. From your previous posts (years ago), it seems that you are a Roman Catholic. Despite being an atheist, I do respect your thoughts as I did like your blog entry about how nihilistic individualism preverted Christianity (religion as entertainment was probably its name).

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