President Donald Trump’s recent decisions have a left a void in the U.S.’s global leadership. He decided to reduce the country’s global trade ties by withdrawing from the Trans-Pacific Partnership, insisted that North Atlantic Treaty Organization allies pay their “rightful share” of 2 percent of gross domestic product for their defense, and announced that the U.S. would exit the Paris climate control accord.
Global integration—through closer trade, currency and policy-making ties—and U.S. leadership have served financial markets and investors well since the end of World War II. Channeling American aid to war-devastated Europe between 1948 and 1951 through the Marshall Plan was a major factor in the recovery of the region, and helped make the continent a major destination for U.S. investment and exports. European and Japanese exports to the U.S.—then, and now, the largest economy in the world—helped revive those countries and provided a basis for their equity markets to grow.
Which country is best equipped to take on the global role that the U.S. used to play, and how can investors take advantage of the changing situation? As the largest European economy, and a leading member of the euro zone, which has a regional population bigger than the U.S., Germany is getting global attention. Chancellor Angela Merkel has recently taken steps that appear to consolidate her and nation’s positions on the global front.
Responding to Trump’s criticism of Germany’s large trade surplus with the U.S., and for not contributing sufficiently to NATO’s finances, Merkel said at a recent campaign rally that Germany could no longer rely on the U.S., and that Europe would have to take its future into its own hands. Recent moves suggest that she is taking on the global mantle being relinquished by the U.S.
When it comes to climate change, Peter Altmaier, Merkel’s chief of staff, called the U.S. withdrawal from the Paris Accord a “major setback.” He indicated that Germany and the European Union would work with large emerging markets such as China and India in reach a new global climate agreement.
Merkel moved on the financial front as well. She was in Latin America this month in preparation for hosting a meeting of G-20 leaders in Hamburg in July. After conversations with President Enrique Peña Nieto of Mexico, the chancellor expressed interest in updating the EU’s free trade agreement with Mexico that has been in effect since 2000. She indicated that German companies would closely follow negotiations to reset rules for the North American Free Trade Agreement because of their interest in investing in Mexico.
Providing another contrast with Trump on trade, Merkel said at a press conference in Buenos Aires that she would seek a trade agreement involving Mercosur, the South American free trade region, and the EU. Such an accord would strengthen ties between Europe and the Southern Cone countries, especially the large economies of Brazil and Argentina, prompting additional European investments in the region.
While these steps are positive, Germany needs to do more to assume the mantle of global leadership. At issue is Germany’s huge surplus in the current account of the balance of payments (billions of dollars, solid white line in the chart below), larger than even that of China, the other country criticized for its surpluses (yellow dotted line).
The solution would be on two major fronts. First, the government should encourage employers to accelerate wage increases that were suppressed as part of the structural reforms initiated in 2003. Last year’s 2.9 percent increase in wages and salaries (chart below) can be increased significantly, allowing German workers to better enjoy their economy’s health and, just as important, increase imports and lower the current account surplus.
Second, the euro zone is still an imperfect currency union with no fiscal transfers across countries or common bonds. As a large creditor, Germany is probably the only European country that could loosen fiscal purse strings and structure a program—its version of the Marshall plan—that Italy or Greece could follow to revive growth as they stabilize their economies. This would be a better solution than German officials’ emphasis on Greece, for example, following austerity measures that do little to revive growth or financial markets.
If Germany does implement such measures after elections in September, it could be a once-in-a-lifetime opportunity for investors. The benefits are likely to come in three related fronts. First, expect a medium-term strengthening of the euro, boosting returns for non-euro based investors. Second, there would be less sovereign risk for investors in Italy, Mexico or Argentina if the countries’ economic policies are better coordinated with those of Europe’s giant economy. And third, watch for a significant decline in European bond yields, lowering the cost of capital for new investment projects.
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