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Germany, the Euro, and Currency Manipulation

Summary:
IMF Peter Navarro, the closest thing Trump has to an economic guru, made some waves by accusing Germany of being a currency manipulator and suggesting that both the shadow Deutsche mark and the euro are undervalued. Leaving aside the dubious notion that this is a good target of US economic diplomacy, is he right? Yes and no. Unfortunately, the “no” part is what’s relevant to the US. Yes, Germany in effect has an undervalued currency relative to what it would have without the euro. The figure shows German prices (GDP deflator) relative to Spain (which I take to represent Southern Europe in general) since the euro was created. There was a large real depreciation during the euro’s good years, when Spain had massive capital inflows and an inflationary boom. This has only been

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Germany, the Euro, and Currency Manipulation
IMF

Peter Navarro, the closest thing Trump has to an economic guru, made some waves by accusing Germany of being a currency manipulator and suggesting that both the shadow Deutsche mark and the euro are undervalued. Leaving aside the dubious notion that this is a good target of US economic diplomacy, is he right?

Yes and no. Unfortunately, the “no” part is what’s relevant to the US.

Yes, Germany in effect has an undervalued currency relative to what it would have without the euro. The figure shows German prices (GDP deflator) relative to Spain (which I take to represent Southern Europe in general) since the euro was created. There was a large real depreciation during the euro’s good years, when Spain had massive capital inflows and an inflationary boom. This has only been partly reversed, despite an incredible depression in Spain. Why? Because wages are downward sticky, and Germany has refused to support the kind of monetary and fiscal stimulus that would raise overall euro area inflation, which remains stuck at far too low a level.

So the euro system has kept Germany undervalued, on a sustained basis, against its neighbors.

But does this mean that the euro as a whole is undervalued against the dollar? Probably not. The euro is weak because investors see poor investment opportunities in Europe, to an important extent because of bad demography, and better opportunities in the U.S.. The travails of the euro system may add to poor European perceptions. But there’s no clear relationship between the problems of Germany’s role within the euro and questions of the relationship between the euro and other currencies.

And may I say, what is the purpose of having someone connected to the U.S. government say this? Are we going to pressure the ECB to adopt tighter monetary policy? I sure hope not. Are we egging on a breakup of the euro? It sure sounds like it — but that is not, not, something the US government should be doing. What would we say if Chinese officials seemed to be talking up a US financial crisis? (It would, of course, be OK with Trump if the Russians did it.)

So yes, Navarro has a point about Germany’s role within the euro. And if he were unconnected with the Bannon administration, he would be free to make it. But in the current context, this is grossly irresponsible.

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Paul Krugman
Paul Robin Krugman (born February 28, 1953) is an American economist, Distinguished Professor of Economics at the Graduate Center of the City University of New York, and an op-ed columnist for The New York Times. In 2008, Krugman won the Nobel Memorial Prize in Economic Sciences for his contributions to New Trade Theory and New Economic Geography.