How Germany Can Make Peace With Trump on Trade

A wealthy former corporate lawyer and supervisory board chair of BlackRock Inc.’s German asset management unit, Merz should be a good foil for Trump: both speak the language of money. The CDU candidate’s populist rhetoric doesn’t always play well at home, but the future occupant of the White House might view it more positively.

An ardent Atlanticist, Merz must be aghast about his US counterpart’s disdain for the North Atlantic Treaty Organization. But he seems on board with Trump’s insistence that Germany spend more on its military. (While Germany will this year meet its alliance commitment to spend 2% of gross domestic product on defense for the first time in decades, that’s the bare minimum required in view of Russia’s brutal invasion of Ukraine and fraying US security guarantees.)

Trade looks like a much pricklier topic: Surging energy and commodity prices in 2022 only temporarily reduced Germany’s external imbalances, and the country is likely to run a current account surplus in excess of 6% of GDP on average through 2027, according to S&P Global Ratings (albeit that’s well below the peak.)

Amid a paucity of Chinese demand, Europe’s biggest economy has become increasingly reliant on exporting to the US — Germany’s bilateral goods trade surplus with the US amounted to a record €63.3 billion ($67 billion) last year.

Berlin does not control domestic trade policy, which is the responsibility of the European Union. But if Trump makes good on his threat to impose tariffs of up to 20% on imports, Germany would be hit hard; the Bundesbank has warned these threatened levies could deduct 1% from national output. It’s unclear how forcing its ally back into recession benefits the US — it would probably weaken the euro and thus further entrench Germany’s trade surplus.

Trump is obsessed by German automakers exporting more to the US than the other way around, and he wants them to manufacture their products stateside instead.

The reality is they already do. While the Porsches driven by Americans are built in Europe, BMW AG and Mercedes-Benz Group AG have massive US factories. Indeed, the US is by far the largest recipient of German direct investment with the total amounting to almost half a trillion euros.

Capital exports are the flip side of Germany running a big current account surplus; because it doesn’t buy an equivalent amount of stuff from overseas, the country’s excess savings are recycled abroad. Yet the fact that Germany has experienced more than €650 billion of net capital outflows since 2010 is beginning to look like a problem.

Merz views this capital flight as evidence of the country’s shrinking attractiveness as a business location, and I think he has a point.

When Germany last experienced a severe economic crisis two decades ago, Gerhard Schroeder’s center-left coalition passed the so-called Hartz reforms to boost employment and improve Germany’s international competitiveness. However, suppressing wage costs contributed to an increase in the current account surplus.

This time, the focus needs to be on boosting domestic consumption and investment. While Germans have lately enjoyed inflation-busting pay rises, their propensity to save remains very high at around 11% of disposable income.

This thriftiness doubtless reflects a lack of confidence in Germany’s economic prospects, the large baby-boomer generation nearing retirement, as well huge wealth inequality; The rich stash away heaps, while those at the bottom of the income scale barely make ends meet, notwithstanding increases in the minimum wage.

But here’s the rub: When companies and households are reluctant to spend and the government is hellbent on trying to balance the budget, it’s no wonder the economy has stagnated in real terms since 2019.¹

In a recent column, I urged Germany to increase its fiscal firepower by reforming the so-called debt brake to fund much-needed public investment. Now that Merz has a good chance of governing he seems to have become more open to the idea.

But Germany must also find ways for more of its corporate and household savings to be absorbed domestically. Merz is in favor of mobilizing some of the trillions of euros that Germans park in low-yielding bank accounts for infrastructure spending — a promising idea.

A state-funded premium for business investment, as favored by economy minister Robert Habeck, is also worth considering. And in view of a chronic housing shortage, Germany should also cut burdensome regulations to boost residential investment.

Another reason why Germans squirrel away so much money is they know the pay-as-you-go pension system — whereby current retiree incomes are funded by current earners — isn’t sustainable, because the working age population is poised to shrink due to demographics. The next government should therefore reform retirement provision to enable more tax-advantaged savings in equities, which over the longer term should generate a good return.

Incentivizing longer working hours and improving childcare for those who currently work part-time (often women) would raise disposable incomes and help stem labor shortages. So would offering tax advantages to those willing to delay drawing a pension and raising the retirement age (currently set to rise to 67 by 2031) to better reflect increased life expectancy.

Persuading Trump that measures like these will ultimately boost demand for US goods will be a tall order. But Merz stands a better chance than most.

^1. Admittedly, Germany hasn't run balanced budgets for the past few years due to flexibility in the debt brake.

A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.

Bloomberg News provided this article. For more articles like this please visit bloomberg.com.

More Active Management Topics >