US Trade Deficit with EU Triples in 10 Years

By Jeff Ferry and Steven Byers

The US goods deficit with the European Union (EU) is on track to triple in a decade.

In July, our monthly deficit with the EU topped $20 billion for the first time ever. In the first seven months of this year, our EU deficit came in 9.8 percent worse than in the same period in 2018. At that rate, we will finish out 2019 with a $185 billion deficit with the EU. That means our deficit has tripled in the ten years since 2009. In Table 1 we compare the growth in the US goods deficit over the nine years from 2009 to 2018. The rate of deficit growth of the EU deficit is double the rate with China, Mexico or the entire world.

Part of the explanation for the rise in our German deficit is the increasing value of the dollar. In those nine years, the value of the dollar rose by 18%, while the Chinese currency was close to flat against the dollar. But our deficit with the EU actually rose more rapidly than our deficit with Germany. The reasons for this lay in the causes and the consequences of the euro crisis of 2010 to 2012.

Table 1. US goods trade deficits with various countries/regions.

Source: US Census.

How the euro crisis impacted the US

The euro came into effect on Jan. 1, 1999. It is used today by19 countries, including four of the five largest economies in the EU (Germany, France, Italy, and Spain). The immediate effect of a new European-wide currency was to drive European interest rates down and spark a boom in European economies.

But at the same time, Germany and the Netherlands began to run large trade surpluses. As Figure 1 shows, Germany went from a current account deficit of -$33 billion in 2000 to a huge surplus of $236 billion seven years later. The Netherlands, with GDP about a quarter that of Germany, went from a 2000 current account surplus of $7 billion to $50 billion in 2007.

Figure 1: Surplus Countries Current Account Balances 1990-2018

These surpluses were lent mainly to EU member countries with weaker economies. Those countries would later pay the price for this foreign borrowing. They are often referred to as the “PIIGS”: Portugal, Italy, Ireland, Greece, and Spain. In some of the PIIGS, the incoming capital flows went to the private sector. In others, they went to the public sector (i.e. increased government borrowing to pay for public spending). Either way, they unleashed strong economic booms in all the PIIGS countries between 2002 and 2007. The economic booms increased GDP in all the PIIGS countries, leading them to spend more on imports. Of course, this benefited the production-oriented economies of Germany and the Netherlands, both of which ran their economies to support manufactured exports. But this also benefited the US, which saw its exports to those countries rise.

The problem was the PIIGS’ economic boom was not sustainable. With a fixed currency and lower growth rates in productivity, the PIIGS were become steadily less competitive compared to high-productivity nations like Germany. Equally important, the inflow of capital was invested not in productivity-enhancing investments but instead in real estate booms or government projects that lacked any financial return.

In a 2015 book,The Eurozone Crisis: A Consensus View of the Causes and a Few Possible Solutions, a group of well-known mainstream economists led by Richard Baldwin and Francesco Giavazzi provided a damning analysis of the many policy mistakes made before and during the crisis. In the words of another member of the team, Agnes Benassy-Quere, “capital flows tended to feed non-tradable sectors in the periphery of the Eurozone…the increase in liabilities was not sustainable since it did not correspond to the building up of export capacities.”

In 2010, when the Greek government told the world that its finances were far worse than they had previously reported, the large capital flows suddenly stopped and the PIIGS countries were plunged first into an economic crisis and then into recession and austerity. The austerity eliminated all five countries’ current account deficits. As imports shrank, they became net exporters. This penalized US exporters, who saw their export opportunities shrink in all these countries.

The large capital surpluses in Germany and the Netherlands could no longer go to the PIIGS. Instead they came to the US, making our deficit worse. Figure 2 shows that the PIIGS’ aggregate current account deficit in 2008 totaled $318 billion, a significant sum representing export opportunities for the US among other nations. But by 2018, under the influence of the “sudden stop” of capital flows into the PIIGS, each of the PIIGS nations was now running a surplus or a balance close to zero. The five nations’ total surplus last year came to $96 billion. That is a swing of over $400 billion.

The US suffered from the same unproductive use of the glut of incoming capital as the PIIGS. As numerous studies have documented, investment in productive plant and equipment fell off after 2000, running at about half the level of the 1980s and 1990s period.  Instead of going into investment in industry, the incoming foreign capital boosted the low-cost loans in the subprime mortgage boom and other forms of financial activity.

Figure 2: PIIGS’ Current Account Balances 1990-2018

The Baldwin-Giavazzi writers are scathing in their criticism of the Eurozone crisis. They criticize the boom period, in which easy money from the northern countries not only created financial asset booms and encouraged irresponsible government behavior, but also caused wages to rise, making many of the PIIGS countries even more uncompetitive than they were in 1999. They criticize the hesitant, uncertain behavior of the EU countries in prevaricating and arguing and then finally facing reality and granting bailouts to each of the PIIGS. And they criticize the post-crisis period when not enough was done to help put the PIIGS back on their feet.

They summarize the situation this way: “The key was foreign borrowing…their euro-denominated borrowing was akin to foreign currency debt in traditional sudden stop crises…in what might be called a tragic double-drowning scenario, Ireland’s banking system went down first, and the government of Ireland went down trying to save it.”

That is the internal perspective, the horror-stricken view of European economists of a supranational organization that in their words was guilty of “policy failures,” and “crisis mismanagement” that increased the “fundamental fragility” of the European Monetary Union.

From an external perspective, the verdict is equally damning. Economic and political leaders have known since the 1940s, when the Bretton Woods system of fixed exchange rates was first designed, that a fundamental flaw in such systems is that balance of payments crises (including “sudden stops” as the PIIGS suffered) force the victims to contract their economies. But there is no mechanism to force the surplus countries to reduce their surpluses, ideally by expanding their economies. Germany entered the Eurozone half-heartedly and while it is 100 percent in favor of using it to benefit its export industries, it is adamantly opposed to policies that would lead to the elimination of its current account surplus. (Only last month, German banker Sabine Lautenschlaeger resigned from the European Central Bank in protest at the latest ECB interest rate cuts designed to boost European economic growth.)

Running a surplus is a form of beggar-thy-neighbor policy. The surplus country expands its industry but by restraining its consumption and imports, its trading partners do not share in the growth. The Eurozone crisis extended that policy stance from Germany and the Netherlands to the PIIGS. Even though the PIIGS are today emerging from the crisis of 2010-2012, it has taken years of reduced growth to get to this point. Some, like Ireland, bounced back relatively quickly. Italy has yet to bounce bank and no political party in Italy has put forward a convincing program to relaunch economic growth as long as Italy stays in the Eurozone. 

For the US, the problem in 2019 is that the policy-driven surplus of Germany and the Netherlands now appears to be generalized to the entire EU. China and the Asian tigers already run policy-driven export surpluses. The US is different from countries like Italy or Thailand. A deep deficit does not force the US into a contraction, because international lenders do not stop lending to us. Instead, the popularity of the dollar enables us to finance and run near-permanent deficits. The cost of those deficits is increased imports, job loss in our manufacturing sector, deindustrialization of our industrial base, and growing inequality as the well-paid manufacturing jobs migrate out of the US to the surplus nations, forcing former manufacturing workers into low-paid service sector jobs. Another likely cost is financial booms and crashes as the capital inflows usually find a home in some previously little-noticed section of the asset markets. We saw that in subprime mortgages. We may see it again in another asset market soon.