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The US and German Relationship

Summary

US and German relations may be strained, but this is not unprecedented.

It has been fanned by Trump and Merkel’s rhetoric.

A European sphere of influence seems to have been the force pushing in that direction.

 

US President Trump reserves his most scornful indignation for the traditional media and US allies, while seemingly praising authoritarian leaders abroad. Given the Administration’s domestic challenges, no wonder a cabinet official spoke wistfully about the lack of protests in Saudi Arabia.

The latest target for Trump’s wrath seems to be Germany, where he and German Chancellor Merkel are trading barbs. There is both less and more than meets the eye.

Germany is in Trump’s cross hairs on two counts. The first is that Germany, like most European NATO members, has not fulfilled their agreed upon obligation of spending 2% of GDP on defense. Second, Germany runs a large external surplus that contravenes EU rules and is a significant imbalance which has also drawn the IMF’s ire.

The US President misunderstands about NATO obligations. The US military might is not a mercenary force, or at least it has not been traditionally. The US-sponsored NATO not because Europe agreed to pay, or because the US was altruistic. Rather, the US learned in the Great War (WWI and WWII) that the US cannot enjoy peace and prosperity if Europe doesn’t. Preventing the spread of the Soviet Union and avoiding a return to the Great Depression were the two main priorities of US foreign policy at the end WWII.

The money that was to be earmarked for the defense was not about payments to the US.  In that very real sense, Germany and other NATO members do not owe the US money.  It was about building capacity and capabilities.  Nor must defense mean strictly military resources.  Germany argues that part of the defense spending is earmarked for dealing with past wars, like the cost of refugees.    If Germany’s military spending and spending on refugees were combined, then it would be near its 2% obligation.

Moreover, if there is another ground war in Europe, wouldn’t Germany and European countries be paying well more than their 2%? In some ways, the US pays with dollars, what Europe would pay with lives. Europe has skin in the game in the way that the US doesn’t. The US troops permanent stationed in Germany are more of a tripwire than a forward defense.

Trump also misunderstands German trade. On the highest level, Trump and National Economic Council Director Cohn do not appear to appreciate that the EU negotiates trade policy. Germany, and to use Cohn’s example, Belgium are bound by the same trade treaties. The EU, which the US traditionally has been a strong advocate for, is a customs union.

Germany is the biggest, and arguably, the most competitive economy in Europe. However, it does not dictate European policy, and the interests of other members shape EU policies, including trade policy. In some ways, it is similar to the US experience. It is the largest economy and even has a veto at the IMF, but the multilateral institutions do not simply do the US bidding.  In fact, the US has been critical of many of those institutions it helped create. Trump has proposed cutting various funds for the United Nations for example, and has declared that if a WTO ruling is not to its liking, it may not abide by it.

Trump has repeatedly complained about the German auto industry.  German brands have around a 7% market share of the US auto market.  Many of those cars are made in the United States. Volkswagen, which has less than a 2% market share, builds vehicles at a Tennessee plant that employs 2k workers directly. That plant, by the way, was a greenfield investment.

German car companies do dominate the luxury car market.  BMW and Mercedes have factories in the US South, which we have suggested is a larger competitor to Detroit than Tokyo and Munich. More than 50% of the SUV’s BMW produces at its South Carolina factory are exported. US brands (GM and Ford) do not compete so much with German at the high end, but rather make their business the mass-market SUVs and pick-up trucks.

The source of Germany’s large trade surplus, like the US large trade deficit, is a function of domestic policy. The external imbalance can be understood as the difference between a nation’s savings and investment. Germany’s surplus means that it saves more and the US deficit means it saves less. Many call on Germany to boost its investment and offset some of the austerity in the periphery with more stimulative domestic policies.

Some blame the labor reforms under the Social Democrat Chancellor Schroeder that have kept German wages down. Even now with full employment, wage growth is not accelerating. However, the current head of the SPD and Merkel’s challenger in the September election, Schulz, who has been critical of the labor reforms, is faltering in the polls. Indeed with a strong push by the CDU and the FDP, a grand coalition with SPD may not be needed for what would be Merkel’s fourth term.

Merkel is in campaign mode, and sensing a popular undercurrent, has not shied away from poking back at Trump.  And this serves to egg on the US President. This has spurred a bunch of navel gazing and chin wagging as if this is the first time the US and German leaders disagreed. Kohl did not want to put Reagan’s tactical nuclear weapons in Germany. Schroeder was critical of Bush’s war in Iraq. There were often asymmetrical threat perceptions.  Brandt’s Ostpoltik ruffled feathers in Washington.

On the other hand, the rise of a new generation of German leaders, for whom the burden and guilt of WWII have eased, and experience of the Great Financial Crisis, have made possible, if not necessary, the projection of German leadership. A stronger more capable Europe is necessary regardless of who is occupying the White House. The crisis and Brexit are changing Europe. The UK obstructed some efforts of greater European integration, like the establishment of a European Army.

Early in the 20th century, the US, a revisionist power of the day, offered an alternative to the traditional basis of international relations, spheres of influence. Wars were often fought as one side to increase their sphere of influence at the expense of another. Instead of fixed spheres of interest, the US proposed variable shares, and the variability was a function of one’s economic prowess. This was first used to defend the territorial integrity of China, which was being carved up into concessions (spheres of influence) by the European powers and Japan. (I explore these issues in depth in my new book Political Economy of Tomorrow).

The “America First” that Trump harkens back to was a rejection of this as embodied in Wilson’s 14 Points after WWI. The Open Door is embodied in the post-WWII multilateral institutions. To the extent that Trump rejects the Open Door, he signals a return to spheres of influence. Trump reportedly briefly toyed with the idea of formally recognizing Russia’s hold on Crimea. His trade priority is the continental market and abandoned a more comprehensive deal (TPP) that would have also modernized NAFTA.

A populist and protectionist in the Washington spurs a reaction aboard. Next week’s election in Mexico’s largest state may see the left-populist party win, setting up a national victory next year. Several countries want to proceed with TPP without the US. China’s One Belt-One Road is the international infrastructure initiative of our day, and it fits well into a Sino-sphere of influence.

The UK is abandoning the centuries-old strategy of balance-of-power politics in Europe. The US’s pivot to Asia under Obama also made room for continental leadership. Since the UK chose to leave the EU (52% to 48%) last year (in what was offered as a non-binding referendum), EU sentiment has generally risen in Europe. In some ways, both the UK and the US are threats to the body politic in Europe, and the response has been circling the wagons. As great leaders have often found, nothing unites disparate peoples like a common adversary. Merkel has found that running against Trump in Germany plays well.

Full story here
Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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