Posted by: Dirk | June 9, 2011

Does Germany have to have net exports to bail-out the periphery?

So claimed Hans-Werner Sinn in an opinion piece at CNN in February:

Many politicians today criticize Germany for its large current account surplus, and insist that it be reduced. Germany, goes the argument, profited the most from the euro and should now stand by the troubled countries and give them more loans. Those who so argue show they haven’t understood a thing. They blithely overlook the fact that both demands stand in contradiction to each other, because a country’s current account surplus is by definition the same as its capital exports. It is impossible to reduce the current account surplus and lend more capital to other countries at the same time. They also ignore the effects wrought by the euro throughout Europe.

There is nothing wrong with the claim that ‘ a country’s current account surplus is by definition the same as its capital exports’ from the balance of payments perspective. However, whether ‘ [i]t is impossible to reduce the current account surplus and lend more capital to other countries at the same time.’ is open to discussion. In pre-euro times, I would agree with Sinn’s statement, but in a currency union national balance of payments statistics work in a different way. Let me explain what I think to be the right approach.

Inside a currency area, a loan from the government to a local institution which is in financial trouble is always a possibility. For instance, Washington bailed out mostly Texan banks in the savings and loan crisis in the early 1990s. Did this transaction enter into the balance of payments? The balance of payments records transaction between domestic and foreign agents (households, firms, governments, etc.). Were foreigners part of these transactions? No, they weren’t. So, the bail-out had nothing to do with net exports or net capital exports.

Germany is a member of the euro area. Now what would happen to the German balance of payments if the German government lends to the Greek government? This is, after all, an investment and will be booked in the capital account – twice, since this is double entry book-keeping. So, on one side there will be a reduction in holdings of ‘foreign’ debt (euros) and on the other side there will be an increase in holdings of foreign debt. From a balance sheet perspective, Germany’s government will have to raise some euros (through higher taxes or debt, no foreign involvement needed) and transfers them to Greece in return for government bonds. So, I cannot see how this affects the current account. Will Germany export more?

So, I think that the argument that Greece can only be bailed out if Germany increases net exports is bogus. Think of it that way: the German government can lend euros on the European market at about 3% and then lend to Greece at more than 3%. I cannot see how the current account is a necessary part of the story. Sure, if Germany bails out Greek bond holders that then use the proceeds to buy Porsches, German exports will rise. However, they might as well buy Ferraris. By the way: from the euro area balance of payments, nothing would have led to entries. These are all transaction between domestic players and therefore do not affect the balance of payments. Just as a transfer of capital from Washington to Texas would not affect the US balance of payments.

N.B.: I treat euros as foreign debt since they are claims against the euro area. I might as well declare them to be claims against the German Bundesbank, it wouldn’t change the argument. Greece would get euros (claims against the Bundesbank), Germany gets Greek bonds denominated in euros (claims against the Greek government).

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