Trade Optics that the US will Like

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China and Germany have been subject to criticism over their trade practices, albeit for different reasons. Both reported smaller than expected trade surpluses today.  The optics are good, but will not stand in the way of a tougher US stance.  The risk is that trade frictions increase in the coming months.  The US is still weighing action on steel and aluminum on national security grounds, which gives it potential for broad application.  The intellectual property right concerns are more directly focused on China.  

News that China’s trade surplus was more than halved from $54.7 bln in December to $20.3 bln in January needs to be taken with a grain of salt.  The main driver of the drop was the reported surge in imports of near 37% year-over-year.   It was likely skewed by the Lunar New Year, which last year was in the tail end of January and the celebration spilled over into February.

It is not uncommon for the Chinese trade balance to deteriorate in January and February.  For the past 15 years, including this year, the Chinese trade surplus fell in 10 of Januaries.  Of the past 14 Februaries, China’s trade surplus fell in 12 years.

A 12-month moving average of China’s trade surplus peaked in in late 2015 near $49.5 bln.  It stood at $35.2 bln at the end of last year and $42. 5 bln at the end of 2016.  The Lunar New Year celebration begins a week from now.  Last February, China surprised by reported a $11 bln trade deficit.  That was the first monthly deficit since February 2014 when a $22.6 bln deficit was reported.

The takeaway is that China’s trade surplus may be falling, but the January trade report exaggerated the decline, and February may also be distorted.  The trade tensions with the US and EU are likely to intensify regardless of the high frequency data points.

Germany’s December trade surplus was smaller than expected.  The surplus fell to 18.2 bln euros from 23.7 bln.    The change owed more to a rise in imports (1.4% month-over-month) than a fall in exports (+0.4%).  What this means is that for the first time since 2009, Germany reported a reduction in its annual trade surplus.  The reduction was small (245 bln euros vs. 249 bln), but the direction is important.

Economists and policymakers often worry about global imbalances.  The US deficit and the China and Japan’s surpluses have fallen, but the German surplus remains stubbornly high.  The broadest measures, the current account surplus peaked at 8.4% of GDP in 2015 and was a little below 8% last year.   The sustained magnitude violates agreements with in the EU, and the EC, ECB, IMF, and US have been critical of Germany.  One of the concerns is that the large, sustained surpluses in Germany foster protectionism elsewhere.

While China’s trade surplus is likely to recover when the seasonal distortions are lifted, there may be more reason to be optimistic about Germany.  If the Social Democrats ratify the agreement struck with the CDU/CSU, there is reason to expect Germany have a less tight fiscal policy and maybe boost domestic investment.   Still, we ought not to exaggerate this point.  Many observers may place too much weight on the Social Democrats being center-left and may under appreciate that they too accept the ordo-liberalism that defines Germany’s political economy.

Stronger wage growth, reflected by I.G.Metall’s recent agreement, and similar demands are being made by other unions.  These dynamics have little to do with the configuration of the next government, and may be more important in shaping the economic outcomes.  A boost in German imports while maintaining robust exports is a potential non-zero-sum outcome.

Lastly, there is some risk that the US external balance deteriorates further.  Some see the implications of the recent tax changes as maintaining incentives to offshore production.  Others see the fiscal stimulus on top of an economy already growing above trend as likely to boost imports.   The US has experienced a significant improvement in its energy trade balance, but that means that the non-oil balance is deteriorating even before the tax cuts.

There are two broad explanatory models of foreign exchange.  One emphasizes the policy mix and interest rate differentials.  The other puts more weight in external imbalances.  With the interest rate differentials and policy mix struggling to make sense of the recent price action, the external imbalance arguments have returned to the fore.    We expect the repatriation of overseas earnings to show up in the US investment income component of the current account.  The impact may be short-lived, but the optics will likely show a reduced shortfall.