Today, the IMF released a refreshing report analyzing the world's external imbalances and offering advice as to how those imbalances might best be cured. The timing of this report could not be more propitious. It comes on the very eve of European Commission President Jean-Claude Junker's visit to the United States in a last-ditch effort to avert a US-European trade war.
The main finding of the IMF's report is that, at around 3 ¼ percent of GDP, the global external imbalance is excessive by between 40 and 50 percent. It identifies Germany and China - and to a lesser extent Korea, the Netherlands, Singapore, and Sweden - as those countries with persistently large external surpluses. At the same time, it identifies the United States and the United Kingdom as those countries with excessively large external deficits.
The main merit of the IMF's report is that it reminds us that a country's external imbalance is arithmetically the result of an imbalance between its saving and investment rates. Those countries with excessively large external surpluses, like Germany, are those which are saving too much in relation to how much they invest. Conversely, those countries with excessively large deficits, like the United States, are those countries which are saving too little in relation to how much they invest.
Flowing from its identification of the underlying causes of the global external imbalances, the IMF advocates a cooperative solution to reducing those imbalances. The external surplus countries should take measures that discourage saving and that increase investment. Conversely, the external deficit countries should move in the opposite direction by taking measures to increase saving and reduce investment.
It is against this background that the IMF correctly takes to task the present US administration for engaging in a highly expansive budget policy at this late stage in the US economic cycle. By increasing its budget deficit, the US is all too likely to reduce the US saving rate. That in turn will result in a further increase in its external deficit as occurred with the twin deficit problem in the 1980s.
Similarly, the IMF is correct to take the German government to task for not using the fiscal space that it has to move toward a more expansive budget policy. By moving to a more expansive fiscal policy, Germany would help reduce that country's excessive savings rate. That in turn would help reduce Germany's outsized external surplus that presently amounts to a staggering 8 percent of its GDP.
Sadly, both the US and German governments are on entirely different wave lengths from the IMF on the external imbalance issue. The Trump administration has managed to convince itself that, never mind what practically every economist might say, what matters for the external imbalance is not the savings-investment imbalance but rather whether trade is fair or not. For its part, the German government is convinced that pursuit of budget balance under all circumstances has served Germany well and that a large current account surplus should be seen as a sign of virtue and not something to be corrected.
With the governments of two major countries having diametrically opposite views on the external balance issue, and with the IMF seemingly unable to broker a compromise between those two countries, one cannot help feeling that the US and Germany might be sleepwalking toward a highly damaging trade war between those two countries.