Euro Crisis Leading to Trade Tension

Ashby Monk

With the Euro in free fall and stock markets crashing, it’s a good time to start thinking about what the European situation will mean for the global economy. Thankfully, Michael Pettis has already done all the heavy lifting. Indeed, he has a remarkable post on his blog that outlines the global implications stemming from the Euro crisis. It’s not pretty:

“Expect trade tensions to get nastier than ever by the end of this year or the beginning of the next.”

Why you ask? It’s complicated. Nonetheless, I encourage you to take the time to read and understand Pettis’ logic below; it’s very compelling:

“1. I assume that for the foreseeable future the major trade deficit countries in Europe are going to find it very difficult to attract net new financing. At best they will be able, through official help, to refinance part of their existing liabilities.

2. If these countries cannot attract net new capital inflows, their currency account deficits, currently equal to two-thirds that of the US, must automatically contract.

3. If European trade deficits contract, there must be one or both of two automatic consequences. Either the trade surpluses of Germany and other European surplus countries – larger than that of China and just a little larger in sum than the European deficits – must contract by the same amount, or Europe’s overall surplus must expand by the same amount.

4. We will probably get a combination of the two, but a much weaker euro – combined with credit contraction, rising unemployment, and German reluctance to reverse policies that constrain domestic consumption – will mean that a very large share of the adjustment will be forced abroad via an expanding European current account surplus.

5. If Europe’s current account surplus grows, there must be one or both of two automatic consequences. Either the current account surplus of surplus countries like China and Japan must contract by the same amount, or the current account deficits of deficit countries like the US must grow by that amount, or some combination of the two.

6. If the Chinas and Japans of the world lower interest rates, slow credit contraction, and otherwise try to maintain their exports – let alone try to grow them – most of the adjustment burden will be shifted onto countries that do not intervene in trade directly. The most obvious are current account deficit countries like the US.

7. The only way for this not to happen is for the deficit countries to intervene in trade themselves. Since the US cannot use interest rates, wage policies or currency intervention to interfere in trade, it must use tariffs.”

If things play out according to this scenario – and it’s hard to see how they won’t – tensions surrounding trade will undoubtedly increase. This could, in turn, have implications for SWFs’ investment strategies. Moreover, while many seem to think that the Greek crisis and the Euro depreciation have taken the heat off of China for a RMB revaluation, the Pettis’ scenario actually strengthens the argument for RMB adjustment. But will that happen? Probably not. I leave you with Pettis’ depressing conclusion:

“I don’t really see how the numbers are going to work. Europe, China and Japan are all implicitly demanding that the US trade deficit rise to help them through their domestic employment problems. The US has its own domestic employment problems and is determined to bring the trade deficit down. Both sides cannot win and there doesn’t seem to be much serious attempt at global coordination.”

1 Response to “Euro Crisis Leading to Trade Tension”


  1. 1 Rien Huizer May 22, 2010 at 9:38 am

    Apart from the US and thanks to the Greek crisis, all countries now have either a tradition, a need or a powerful constituency (industry) that biases policy towards positive net exports. And all these countries behave as if they -individually- can treat trade like a zero sum game. Leave it to others to carry the burden of maintaining an open trading system.

    So there is not much that can be dome. Usually it takes a generation to overcome the effects of this type of problem, if it is allowed to fester further. Perhaps in our age that may be cut in half, so count on the current crisis to be over already by around 2023, when the world will have added over a billion of (net) new people.

    But MIchael fails to mention the bright side: the REERs are a lot better than they were a few months ago, even including China’s. So perthaps we could move to a world of exchange rates negotiated between governments, rather than by “investors”


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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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