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Opinion - World Economy

Only Germany and Japan have room for economic stimulus

Key Points
  • Washington is facing binding constraints for additional monetary and fiscal stimuli. All the U.S. has left are instruments of economic and financial crisis management.
  • Germany and, to a lesser extent, Japan have plenty of scope for large public and public-private partnership investments in growth-enhancing infrastructure projects of transportation, information technology, life sciences and social welfare.
  • The U.S. could help itself, and the rest of the world, by prodding Germany and Japan to contribute to global economic growth and the stability of the Western world order.
German Chancellor Angela Merkel shaking hands with Japan's Prime Minister, Shinzo Abe at the opening day of the G-20 summit on July 7, 2017 in Hamburg, Germany.
Friedemann Vogel | Getty Images

People complaining about dangers of free money should not have to look too far back to find — and understand — the most recent "original sin."

It all started with the U.S. Federal Reserve's excessive credit creation and the culpable failures of its bank supervision. That led to the epochal financial crisis and the Great Recession.

The ensuing rush to prevent a systemic failure of the U.S. economy was an all-out effort to keep the banks afloat with liquidity provisions, technically called banks' borrowed reserves at the Fed, culminating in November 2008 at an astounding $700 billion.

To get an idea of the panic and the magnitude of the crisis, you can compare that astronomical amount with monthly averages of $240 million that banks were borrowing at the Fed in June and July of 2007.

A monetary creation on such a gigantic scale meant that the Fed's balance sheet kept expanding by leaps and bounds. During 2015, the Fed's monetary base exceeded $4 trillion, and the banking system was flooded with $2.7 trillion of excess reserves, the money banks could lend.

Focus on trade and leave the Fed alone

Again, in relatively normal, immediate pre-crisis times, the monetary base was fluctuating around monthly averages of $820 billion, and the banks' excess reserves were roughly stable at about $1.5 billion.

Twelve years on, we are not out of the woods yet. As of Aug. 28, the Fed's monetary base was expanding again toward $3.3 trillion, and the money banks can lend was reported at $1.4 trillion.

That indicates that the Fed's process of "normalizing" credit conditions has been stopped — and reversed — in an apparent move back toward zero interest rates.

And, you guessed it, the election-driven Trump administration is pushing for a monetary and fiscal stimulus. Never mind that such a thought should not even occur to people watching a 7% of GDP public sector budget deficit, and counting, and a public debt well on the way to 110% of GDP.

Japan is another example where a large credit creation has been tried for some time to rev up the economy. The result is quite modest, to put it mildly. Over the last five years, the average annual GDP growth has been 1%, and the inflation rate in July was 0.6%, far below the official target of 2%.

There is hope, however, that Japan's GDP numbers for the first half of this year may be heralding a much-needed structural change. Indeed, that was one of the rare occasions when net exports shaved 0.25% off the economic growth, leaving the increase in domestic demand to drive the economy's annual gain of 1%.

But how sustainable is that? Private consumption, about 60% of the economy, is quite weak, while increases in residential and business investments are unlikely to continue. Housing demand is undermined by declining demography and family formation, and private sector capital outlays cannot grow if exports continue to fall, as was the case in the first two quarters of this year.

Germany and Japan should boost investments

All that means that Japan's monetary policy alone cannot deliver a steady and sustained cyclical upturn. Government investments in infrastructure of information technology, life sciences, social welfare and other sectors catering to an aging society would help. A relatively small 2.5% budget deficit could allow that, and a steadier and stronger growth could contribute to reducing Japan's huge public debt.

The European Union economy is essentially a German story, where the imposition of Berlin's ill-advised fiscal austerity had forced the European Central Bank to rescue the continent's disintegrating economies and financial systems with aggressive monetary easing.

That is still the case, because Germany refuses to support its economy — while peremptorily demanding that France, Italy and Spain, one half of the monetary union's GDP, continue to consolidate their budgets and keep their public debt down.

The way out of this predicament is quite simple and thoroughly feasible: With its budget surplus of 2.3% of GDP, Germany has plenty of space for a meaningful stimulus to its moribund domestic demand. That would allow the rest of the euro area, and the EU, to benefit from rising employment, demand and output, and would also relax budget constraints to growth in other European economies.

But don't hold your breath for that. Germany won't budge. The ECB will have to pick up the pieces with more of its negative interest rates.

And, unforgivably, Washington will continue to look the other way – totally ignoring what German and Japanese refusals to properly stimulate their internal demand are doing to half-a-trillion dollars of U.S. exports, whose stronger growth would be a safe and meaningful shot in the arm to the American economy.

Investment thoughts

The U.S. has no room for — and does not need — additional monetary and fiscal stimuli. All the U.S. has left are instruments of economic and financial crisis management.

But Germany and, to a lesser extent, Japan have plenty of scope for large public and public-private partnership investments in growth-enhancing infrastructure projects of transportation, information technology, life sciences and social welfare.

Strangely, Japan — fearing China's dominance — could be more willing to move than a poorly governed and an increasingly divided Germany.

The U.S. could help itself, and the rest of the world, by prodding Germany and Japan to contribute to global economic growth and the stability of the Western world order.

You can be forgiven for taking all that as the proverbial pie-in-the-sky. Yes, such is the western disarray, and a dangerous lack of allied solidarity under American leadership.

All we have left, then, are the digital money printing presses — for now, as Washington's popular saying goes.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.