Chermany?

Martin Wolf introduces this name, a combination of China and Germany (as opposed to “Chimerica”, a name invented by Niall Ferguson and Moritz Schularick), to discuss the economic policies of the two countries in his opinion piece, “China and Germany unite to impose global deflation.” (See http://www.ft.com/cms/s/0/cd01f69e-3134-11df-8e6f-00144feabdc0.html.)
Wolf’s approach is not inconsistent with that of Paul Krugman, whose recent work was discussed in my Monday post “Why Should China Change?” (See http://seekingalpha.com/article/193689-why-should-china-change.) The only difference is that Wolf includes Germany in the discussion.

The basic premise is that China and Germany, “although very different from each other,” are pursuing economic policies that are very similar. Both have huge trade surpluses and massive surpluses of saving over investment. “Both believe that their customers should keep buying, but stop irresponsible borrowing.”

The Germans have “picked” on the European Union; the Chinese have “picked” on the United States.

In Wolf’s assessment, “the surplus countries are most unlikely to win.” The real loser, however, will be the world.

The problem with this analysis seems to be that all of the writers engaged in this discussion accept “the war” as only an economic war. A more correct assessment of the situation might lead one to conclude that what is going on is more political than just economic. What is going on is the shifting battle for relative national position in the world pecking order. The time is especially propitious for changing the political landscape as some countries are experiencing massive shifts in their economic strengths. And, the list is not just limited to China and Germany.

In the European frame of reference, the initial focus was on Greece, but economic problems abound for Spain, Portugal, Italy, and France. And, don’t forget the difficulties being faced by Ireland and England.

Economically, Germany is substantially better off than these countries and does not want to be made weak by giving these other countries a “free ride” to recovery. Why should Germany have to suffer economically because of the undisciplined budget policies of these other nations?

China, on the other hand, is smelling weakness, and, as a consequence, is seeing this as a way to improve its relative position of influence in the world. But, it is also pursuing this path in many different ways, establishing diplomatic relations with nations around the world, especially those that are wealthy in natural resources, buying companies all over the world, and gaining influence in the scientific and technological community. China’s influence is growing everywhere.

Others are on the move as well recognizing that the time is right for them to exert themselves in the world.

The argument that is being raised by Wolf and Krugman is that the behavior of the Chinese and the Germans is detrimental to the economic recovery of the other western nations. Continuing along the path they are now following will prevent the United States and France and Spain and the UK and others from getting back on their feet and this will result in a collapse of world trade and, hence, the economic well-being of everyone.

But, that is solely the economic analysis. It does not include the political aspects of the situation.

There are very few times in world history when the position of the nations of the world can be substantially altered. The period from the 1910s through the 1940s was such a period. As we know, the United States moved into a position of dominance during that time, both economically and militarily.

At the present time, some countries are sensing another massive shift in world power. And the potential big players are China, India, Brazil, and Russia. Germany and Japan would like to be there. And, there are others: Canada, Iran, and Argentina.

Nations who have a longer-term time horizon and see the world in decades, like China and India, are not going to let this opportunity pass. They also do not see that the issue of change will be resolved in the next ten to twenty years. In the short run we, individuals, may all be dead, but the nations will live on.

And, this is precisely the problem. Over the past fifty to sixty years, the countries that are now experiencing the most problems focused on the short run and, as a consequence, created an economic environment built upon a lack of saving, debt creation and inflation.

It says a lot when some of the leading intellectuals of this philosophy, “Keynesians” like Oliver Blanchard, propose that the solution to the current difficulties is to create higher targets for inflation. (See “The Lure of Inflation’s Siren Song” by David Reilly: http://online.wsj.com/article/SB20001424052748703734504575125943325490212.html#mod=todays_us_money_and_investing. Included in this piece is the quote, “Inflation can achieve what no congress can, fast reductions in fiscal deficits," Christian Broda, head of international research at Barclays Capital.) My response to this is “Doesn’t Anyone Understand Inflation?” (which can be found at http://seekingalpha.com/article/188351-doesn-t-anyone-understand-inflation).

Now, we have Wolf and Krugman arguing that those that are in the stronger position economically should “bail out” those that acted imprudently in the past. And, here is where the concept of moral hazard comes into play. If the countries having problems right now do get “bailed out” by those that are economically stronger, why should they, once they have recovered from their economic difficulties, act in a disciplined manner in the future? As with other institutions that have been “bailed out”, there is little incentive to for them to act prudently going forward.

The “Keynesians” have had their day. We are living with their legacy. We cannot expect the Chinese or the Germans to give them another chance. We cannot expect the Chinese or the Germans to place the future that they see within their grasp in jeopardy in order to rescue those that have willingly become addicted to more and more debt in their lives.

The ethos of the 1950s and the 1960s may have dominated the last fifty years, but it is my guess that the 21st century will be determined by what takes place in the 2010s and 2020s. The complete lack of fiscal discipline in the United States over the last eight years or so may have accelerated this transition in ways that we do not yet understand. One of the problems in dealing with such changes going forward, however, will be a failure to recognize that certain changes have already occurred.