U.S. President Donald Trump wants to stimulate the American economy, but he has shown no interest in existing trade deals or in the basic rules of economics. It is a dangerous cocktail for German industry.
Senior executives in Germany have been keeping close tabs on the stream of visitors heading for an audience with Trump, full of concern and nervous about what the future might hold. They have refrained from speaking about Trump publicly, but internally, it’s the only thing they are talking about.
There is significant fear that they too might become Trump targets. Nobody knows what rules are still valid in this new political era, one in which billions in value can be destroyed by a single tweet. An era in which it is no longer clear who is a friend and who is an enemy.
It is an era that began on Donald Trump’s first day in the White House, when he turned away from what has been the global economy’s most important motor for decades: free trade and globalization no longer have any place in America’s new populism.
Trump immediately backed out of the Trans-Pacific Partnership (TPP) and is intent on renegotiating other such free trade deals, these “horrible deals,” which he sees as the source of America’s downfall. “This wave of globalization has wiped out totally, totally, our middle class,” he said while on the campaign trail.
On the same Monday, he received dozens of America’s most important executives, representatives of the country’s leading economic sectors. Trump called it a “listening session,” but he didn’t appear to be the one interested in listening. Rather, it was the business leaders who were to receive the new rules of this new era. “America first,” is the only relevant philosophy, and those who go along will be rewarded by way of massive tax cuts and investments.
Attack on the German Model
Trump’s first week was a power play, full of attempts at intimidation and threats. It was a week that raised new, fundamental questions: Can Trump really suspend the fundamental rules of economics, which force multinational corporations to maximize profits and minimize costs? Can globalization be reversed through a few tweets? And most importantly, is the U.S. president risking a global trade war so that he can impose his domestic agenda? For the moment, the answers to these questions appear to be: Yes.
The consequences of this radical political shift are not limited to the United States. When the world’s largest and most influential economy makes changes, the shockwaves can be felt everywhere. A new economic world order is coming into being. And it is an attack on the German model.
In his campaign speeches and tirades against globalization, Trump primarily identified China and Mexico as his enemies, but Germany, a nation of exports, is likely to be third on that list. No other large economy is more reliant on the free exchange of goods and services, on border-free trade and barrier-free exports, than the German economy.
It is becoming apparent that Trump’s presidency represents a break in the trans-Atlantic relationship, the kinds of which hasn’t been seen since World War II. With a U.S. president who openly threatens a German carmaker with punitive tariffs of 35 percent, one who warns that the Germans were “very unfair to the U.S.,” it could even mark a shift from friendship to animosity. In corporate headquarters and in Angela Merkel’s Chancellery, executives and government officials are considering how best to stand up to this challenge. Is it better to remain composed and unperturbed, relying on rationality, on the strength of decades of ties and on the rules of the global economy? Or would it be better to prepare countermeasures, search for new allies in, for example, Asia or perhaps even to take advantage of the vacuum that is being created?
Either way, with the world looking more fragile than it has in quite some time, there is a lot at stake. The consequences of an economic crisis or even a trade war would likely be disastrous for Germany, particularly with elections approaching in autumn. Right-wing populists, who would love to see Trumpism imported to Germany, would be certain to take advantage of any economic downturn by posing as the champions of the victims of globalization.
Much will depend on the economic recipes that Trump ultimately mixes together and the effects they will have — whether the U.S. economy will begin to wobble or whether it will actually become stronger, at least for a time.
Tax cuts and additional government spending would usher in a period of sustained economic growth. That, at least, is what the new president is promising, and the stock markets seem inclined to believe him. Optimists believe that good times are on their way and that if the American economy does well, Trump’s threats will quickly fade.
A Clear Signal
However, most economists believe that anti-globalization policies can only end in a global trade war that would kill corporate innovation and plunge the entire world economy into a recession. The pessimists are concerned. The worse the American economy fares, the more radical will be the measures taken by President Trump.
In the first week of his presidency, Trump began putting together his team, charged with transforming his course campaign rhetoric into clear plans for financial and tax policy and for the Fed, for industry and for trade.
To do so, he has not surrounded himself with the country’s best economists as his predecessor did. That too is a clear signal. Instead, Trump is relying almost exclusively on “businessmen:” men who have made billions, or at least millions, on the free market. They are not all committed to the same ideological course. On the contrary. Some are in favor of protectionism while others are considered to be adherents of globalization. Some want an enormous state-sponsored infrastructure program while others want to see radical spending cuts. Some want to unleash the markets while others are in favor of state regulation of key industries. Some are arch-conservatives while others are liberal.
It is — intentionally — unclear who will emerge victorious. The president has divided the influence of his advisers across several power centers. In the end, only one person will decide how to proceed, likely on an ad hoc basis, largely dependent on his mood. Unpredictability is one of the tenants of Trumpism. Contradictions and conflicts are intentionally fostered.
Basically, though, Trump’s team, regardless of ideological proclivities, can be divided into two camps. On the one side is a random collection of speculators and crisis profiteers, provocateurs and extremists. The chair of the Council of Economic Advisors will likely be a television host. On questions of monetary policy, he relies on an arch-conservative lobbyist who wants to reintroduce the gold standard. An oil industry billionaire advises him on energy policy.
On the other side, Wall Street is celebrating its political resurrection. Steven Mnuchin is to become Secretary of the Treasury, a man who was long a partner and board member at Goldman Sachs. Head of the National Economic Council is Gary Cohn, who was chief operating officer at Goldman Sachs until a short time ago. His chief political strategist Stephen Bannon was once a Goldman Sachs executive.
During the campaign, Trump constantly attacked Hillary Clinton for her close ties to the financial industry. And many of his followers see Wall Street as the core of the conspiracy against American citizens and as the driving force behind the hated establishment.
Such crass contradictions show how deeply dissatisfied Americans are with the slow economic growth that characterized the Obama years. They long for an economic boom and for the growth rates seen in decades past — and are willing to accept any means necessary.
An Historic High
Stock markets and consumers seem unconcerned that many of the key elements of Trump’s economic plan don’t fit together, or even cancel each other out. On Wednesday, the Dow Jones climbed to an historic high. Consumer confidence is higher than it has been since before the Sept. 11, 2001, terrorist attacks.
Their enthusiasm is driven by expectations of trillions of dollars in tax cuts, particularly for corporations. The cuts are supposed to encourage both companies and individuals to invest and consume, with the hope that the resulting economic growth will produce sufficient tax revenues to pay for the cuts.
Larry Kudlow, designated head of the Council of Economic Advisors, promises that the tax cuts will “really put a booster rocket underneath this economy” and produce growth rates of up to 5 percent. Growth, he says, solves all problems, including the budget deficit.
Such concepts are not new. Ronald Reagan made “supply side economics” popular in the early 1980s. But they didn’t work quite as planned.
To be sure, the massive tax cuts produced economic growth rates of over 3 percent. But at the same time, the U.S. developed sovereign debt higher than anywhere else in the world along with an enormous budget deficit. Later, one of the architects of Reaganomics, a domestic policy advisor to the president in the 1980s, wrote a book pillorying the supply side approach, saying that the strategy had been a “failure.” Reagan’s successor, George H. W. Bush, even referred to Reagan’s policies as “voodoo economics.” Bush felt impelled to significantly increase taxes.
As such, economists are extremely concerned, regardless of their political affiliations, that Trumponomics could end just as disastrously as Reaganomics in the long term — with enormous budget deficits, an even more rapidly shrinking middle class and a deeply wounded economy. Perhaps even with a stock market crash.
Nikolaus von Bomhard, chairman of the board at the reinsurance giant Munich Re, believes the recent stock market upturn to be excessive. He finds it particularly regrettable that “a part of the price movements will prove expensive, coming at the cost of engagement against climate change and its consequences.” He says that if Trump expands infrastructure investments and reduces taxes while pursuing protectionism at the same time, it will drive sovereign debt and inflation in addition to the desired economic growth. “There will be huge disappointment,” says Edmund Phelps, a Nobel laureate for economics and director of the Center on Capitalism and Society at Columbia University. He warns that a “deep recession,” could result.
The worse the U.S. economy, the more likely Trump will be to target his putative enemies from abroad. His policies are likely to become more aggressive, including punitive measures against foreign “dumping” and attacks on all those companies who build their new factories in Mexico instead of Milwaukee.
Peter Navarro, a professor at the University of California in Irvine, is responsible for developing these policies. He is head of the newly created National Trade Council.
Part 2: German Automakers at Risk
Most economics experts believe such anti-free trade plans are naïve at the least and perhaps even dangerous. “State trade barriers would inflict significant damage on the economy,” says Phelps. The immediate consequences, he says, would be felt by those who Trump promised to help: people who have been left behind by globalization. They are particularly dependent on low prices. But if tariffs were to make imported goods more expensive, their quality of life would suffer immediately.
His first victim was the conglomerate United Technologies, which was planning to move a few hundred jobs from Indiana to Mexico. Trump went after the company on Twitter. Now, the company intends to keep some of the jobs in the U.S. Several other companies, including Ford, General Motors and a half-dozen others, have also said they were planning to modify plans to move elements of their production to Mexico after their stock prices came under pressure following public attacks from Trump.
“It sounds like the economics of fascist times,” says Nobel laureate Phelps. “The leader should be in charge of the economy and tells the companies what they ought to be doing.”
He says that the greatest danger is to corporate innovation. “If an innovator contemplates the idea for a new product or company but has to worry that he will become the target of punitive action or threat from the government leader, then he will think twice about making the investment and effort,” Phelps says.
One of the industries that Trump recently targeted is pharmaceuticals. In demanding lower drug prices, he triggered significant uncertainty among drug companies and biotech firms. What if the government sets prices in the future? Is it perhaps better to freeze investments for the time being?
Trump isn’t slowed by such concerns. Rather, he is intent on pushing through his new economic order both in the United States and globally. And he was quick to identify German companies as his next target.
He threatened BMW, for example, with a punitive tariff of 35 percent if the German automaker were to build a new factory in Mexico. In a recent Twitter post, Trump wrote: “Car companies and others, if they want to do business in our country, have to start making things here again. WIN!”
In his attack on the German automobile industry, the U.S. president singled out a company that actually could be seen as an example of the perfect foreign investor in the United States. BMW has been building automobiles for more than 20 years in Spartanburg, South Carolina. In 2016, over 411,000 SUVs were assembled there, many more than BMW actually sells in the U.S. Together with its suppliers, BMW employs around 70,000 people in America, and plans on hiring even more.
BMW is contributing to the reduction of the U.S. trade deficit. Seventy percent of the vehicles that BMW produces in the U.S. are exported. In fact, with exports valued at almost $10 billion, the Bavarian company is the largest car exporter in the U.S. “We refer to the U.S. as our ‘second home,'” says BMW CEO Harald Krüger.
Thus far, the U.S. president’s threat hasn’t had much of an effect at company headquarters in Munich. BMW has continued construction on its factory in Mexico, with completion scheduled for 2019. The carmaker could easily export the 3-Series sedans that will be produced there to countries other than the U.S.
Other German automobile companies, however, are more vulnerable to import tariffs imposed on vehicles produced in Mexico, such as Daimler and Volkswagen. Daimler, of course, has long been building cars and trucks in the U.S. and the company is currently expanding its American presence by moving production of its Sprinter van from Düsseldorf to South Carolina. But more than one-third of all trucks that Daimler sells in the U.S. are produced in Mexico. A 35 percent tariff would make this part of the company’s business unprofitable.
‘Reliant on Free Trade’
The consequences would be similarly drastic for VW. One of the company’s most important factories is located in Puebla, Mexico, where the Golf, Jetta, Beetle and, soon, the Tiguan are assembled. Over 60 percent of all the cars that Volkswagen sells in the United States are manufactured here. The company is also currently building a factory in San José Chiapa, where its Audi subsidiary plans to assemble the Q5 SUV — largely for export to the U.S.
At the groundbreaking ceremony, Audi CEO Rupert Stadler was still exclaiming, “Viva México, viva Audi.” Now Stadler doesn’t want to comment on the U.S. president’s attack on the company’s business model. He isn’t alone either — executives at Daimler and BMW are also holding back.
“The fact is and remains that the global automobile industry remains reliant on free trade,” says BMW CEO Krüger. “I believe that integration in world trade, overall, provides a major advantage for all concerned,” says Daimler CEO Dieter Zetsche. No one wants to provoke Trump. The modus operandi at the moment seems to be to duck away from the threats coming out of the White House. Behind the scenes, the companies are seeking to establish contact with the president’s confidants and to use those channels to try to ensure that the facts about German manufacturers’ activities in the U.S. ultimately reach Trump’s ears.
Some German companies that are already extremely active in the American market could even stand to profit from Trumponomics, especially when it comes to possible mass infrastructure investments. They could also benefit from weakened environmental protection regulations.
“Our expectation of our companies is that they will not duck away politically or even praise the supposed advantages of an authoritarian economic policy,” says Michael Vassiliadis, head of the German union for employees in the mining, chemical and energy industries (IG Bergau). “Those who have spent years calling for more cosmopolitanism, flexibility and globalization can’t now simply accept American protectionism in silence.”
German executives will have to abandon their reserve anyway considering how Trump’s policies represent a frontal attack on the German export model. The German economy is heavily dependent on foreign trade, with around one-fourth of all jobs in Germany pegged to overseas business. And many companies have been focused on the global market for over a century.
The German economy has always fared best when the global market was open and flows of goods remained unhindered. Few other industrial economies profited as much as Germany from the opening of markets in the Eastern Hemisphere, especially China’s. But Donald Trump’s presidency could mark the end of this trend — at least temporarily.
Recently, Germany registered a record surplus in global foreign trade, exporting 260 billion euros more than it imported — an amount equal to 8 percent of gross domestic product. Trade in goods with the United States in particular flourished, with some 54 billion euros of the total export surplus originating from America. This massive imbalance has been a source of irritation with the Americans since long before Trump became president. But how can an imbalance on that scale be corrected?
Germany’s industry, with the strength of its exports and its successful products, can’t really be blamed, but one could be critical of the German government’s economic policies, which have kept domestic demand notoriously weak. Consumers and companies spend too little money domestically. Carl Christian von Weizsäcker, an economist with the Max Planck Institute for Research on Collective Goods in Bonn, has come up with an idea he believes would strengthen imports without weakening exports.
Weizsäcker’s proposal envisions a kind of braking mechanism for the current accounts balance. Parliament would sink the value-added (sales and services) tax, fueling consumers in Germany to spend more, buying import goods and thus aiding the economies of the countries delivering the goods and services. “The current accounts balance brake would be a strong weapon to use against newly growing protectionism that represents a threat to Germany’s prosperity.” Of course, the German government would have to adopt that model — a move that isn’t very likely.
The End of Globalization?
The more likely scenario is that it will grow increasingly difficult for the German export industry to maintain its dominance and that the surplus will melt away on its own in the coming years. Globalization is losing momentum and the balance is shifting in the world economy. The hegemony of the West — e.g. America and Europe — over the Asia-Pacific region is waning in terms of influence and importance as the global world becomes multipolar and more complex.
“Our view is that globalization has now come to an end and is slowly being replaced by a world where very distinct poles are forming — economically, socially, ethically and politically,” economists at Credit Suisse recently wrote in a report on the world’s changing state.
This means that the global economic order, as it has been known until now, is history. “It is crumbling at the moment,” says economics professor Thomas Straubhaar of the University of Hamburg. He says the international division of labor is undergoing a reordering and that Germany must still find its place in that new order.
Against that backdrop, virtually the entire political class in Berlin is monitoring developments in Washington with deep concern. Inside the German Economics Ministry, the computer systems have been churning nonstop since Trump’s election. With the use of stochastic general equilibrium models, officials there have been seeking to determine the possible effects Trump’s brash announcements and his first official acts as president will have on the German economy.
What they have determined is this: If the world’s most powerful man isolates the U.S. domestic market, German economic growth, depending on the scope of Trump’s trade barriers, could shrink by up to three-quarters of a point. Experts within the ministry are horrified at the possibility that Trump could withdraw from NAFTA, the free trade agreement with neighboring Mexico and Canada that was negotiated over two decades ago. If Trump were to revoke the treaty, there would be a six-month transition period before tariffs would be applied as set out in the deal agreed to during Uruguay round of talks at the World Trade Organization.
Officials in Berlin are still hoping that the new government in Washington won’t go that far. They’re betting that a move to pull out of NAFTA would lead to outcry from U.S. companies whose factories in the American South maintain extremely tight relations with their Mexican suppliers. “Members of Congress from North Carolina or Alabama will make clear to Trump the consequences that would have,” say Economics Ministry sources.
If Trump does make good on his words, though, then the export industry must prepare for a drastic slump.
Berlin Explores Alternatives
In order to prevent the situation from deteriorating that dramatically, the government in Berlin is already exploring alternatives to trans-Atlantic trade. German politicians focusing on trade issues followed with interest the reactions triggered by Trump’s decision to halt talks on TPP, which would have created a giant Asian free trade zone with the U.S.
Australia and New Zealand have announced that they intend to forge ahead without the U.S. and possibly even establish the economic zone with China instead. Berlin is also laying plans to ensure that German companies might profit to the greatest extent possible from such a deal. A string of trade deals with countries across the Pacific boom region is envisioned, providing access to German companies.
A little under six years ago, the EU reached an initial trade deal with South Korea. Since then, German exports to the country have risen by around 50 percent. But improved ties with China would hold even greater promise. A new Berlin-Beijing alliance could — in part, at least — supplant the old trans-Atlantic order.
The importance of the Chinese economy has been growing for years now among its neighbors. With Trump’s election, China is now likely to attract countries that had previously been anchored in the trans-Atlantic alliance. Europe isn’t just closer to China when it comes to issues like climate change, the Middle East or the Iran nuclear program. It may soon become closer on trade policy too.
Chinese President Xi Jinping has already begun positioning himself as a defender of free trade. “We should adhere to multilateralism,” Xi said recently in Davos, choosing a term that Trump uses primarily as an invective. He extolled a “global network of free trade agreements” and warned against “forming exclusive groups that are fragmented in nature.”
This year, the Regional Comprehensive Economic Partnership (RCEP) is to be signed, an economic area encompassing over 3 billion people and which is also open to Western countries. And Germany seems willing to cast its gaze eastwards. “Europe should quickly begin working on a new Asian strategy,” said Germany’s new foreign minister, Sigmar Gabriel, at the beginning of the week. “We should now take advantage of the space that America is freeing up.” China, he said, “isn’t yet ready to be an equal partner for investors,” he said, referring to limitations imposed by China on German companies in the country. But his critical comments also contained a promise: If you improve access to your markets, we can make a deal.
For the moment, there are frequent disagreements between Beijing and Brussels, centered on cheap Chinese steel and on the country’s imposition of an electric vehicle quota. But following President Xi Jinping’s passionate speech at the World Economic Forum in Davos advocating free trade and the market economy, European economic representatives believe the climate could soon improve. “We will take him by his word,” said a source in the German government. On Wednesday, the German chancellor spoke with Chinese Prime Minister Li Keqiang on the phone, with Merkel suggesting that the two countries take joint action to confront the “elements of uncertainty” in the global economy: “China and Germany should send signals of stability to the global markets and safeguard the international system together via the liberalization of trade and investment.”
It is exactly these sorts of developments that have for months been the subject of warnings from opponents of Trump’s anti-free trade policies. Withdrawing from TPP, argues Michael Froman, the U.S. trade representative under Obama, would “basically hand the keys to China and say we’re withdrawing from our leadership position.” This, he noted, “is geostrategically damaging.”
China policy isn’t the only core element of Trumponomics that could end badly for the Americans. With his aggressive approach, Trump often also ignores broader economic implications. His economic stimulus plan to generate growth through tax cuts won’t just provide a boost to the stock markets. It will also drive up interest rates and, as a consequence, the strength of the dollar. That makes the U.S. more attractive for foreign exporters while at the same time making American exports more expensive and thus less attractive overseas.
Ultimately, the economy could even overheat. The American economy is already almost at capacity and if growth spikes, monetary policy would have to be normalized. “If that doesn’t take place, we could be faced with a boom-bust scenario of the kind we have seen in developing economies where a period of strong growth is followed by a violent slump,” warns Philipp Hildebrand, vice chairman of the world’s largest investment management company BlackRock. One trigger for such a scenario, he says, would be if the Federal Reserve failed to react timely enough to strong growth and raised interest rates abruptly to counter inflation.
The Fed is concerned that Trump might try to pressure it to keep interest rates low and the dollar weak. There is even a possibility that Trump could start a currency war. Some at the Fed believe that Trump could seek to exert pressure on other central banks around the world should the interest rate difference between the U.S. and Europe or Japan become too large and the dollar too strong. “In such a situation, he could issue a demand that the European Central Bank raise its interest rates,” says one Federal Reserve official.
A New Dynamic
The decisive question will be how cohesive and self-confident Europe might react to such pressure coming from Washington. And not just when it comes to interest rates.
European Commissioner for Trade Cecilia Malmström, for her part, has proven combative in recent days: “Trump or no Trump, we have a long list of countries willing to deal with the EU,” she said in a speech on Tuesday.
Currently, the EU is involved in free trade talks with around 60 countries, with CETA, the controversial deal with Canada, the furthest along. Then in March, Japanese Prime Minister Shinzo Abe is coming to Brussels. The EU has been negotiating with Japan, the third largest economy in the world, since 2013 over a far-reaching market liberalization package. Now, Malmström hopes, the deal could soon be finalized.
Negotiations for a treaty with Vietnam have been completed; in South America, the EU is presenting itself as an alternative to the U.S.; and in February, a delegation from the European Parliament’s International Trade Committee is heading for Mexico, Trump’s favorite target. Europe has offered Mexico a new, comprehensive trade pact. “An entirely new dynamic in the negotiations can suddenly be felt,” says Bernd Lange, head of the International Trade Committee in Brussels.
As such, Germany doesn’t have to come up with a completely new business model, says Hamburg-based economist Peter Straubhaar. But there is one particularly important consequence of Trump’s vision of an isolated America: “Even more than before, we are dependent on a prosperous Europe. The internal market is more important than ever before.”
By Dietmar Hawranek, Martin Hesse, Alexander Jung, Christoph Pauly, Michael Sauga, Thomas Schulz, Gerald Traufetter and Bernhard Zand