Shifting Trade Patterns will Reduce Target2 Imbalances
The Target2 imbalances caused much consternation earlier this year as some economists focused on them as either signs that a transfer union was a fact on the ground, or alternatively, as a sign of the pending costs to Germany, which German politicians fail to acknowledge.
Much ink has been spilled trying to decipher the true meaning, but we know that the Target2 imbalances are nothing more or less than a reflection of the intra-euro area current account imbalances. Before the crisis those imbalances were financed largely by the private sector. That was part of the financial integration process whereby creditors would recycle their surpluses by primarily buying bond in the debt countries.
One element of the financial crisis is a break down of this transmission/recycling mechanism. The private sector creditors are no longer as willing to recycle their surpluses. The renewed home bias and the financial disintegration forces the official sector to step into the breach.
Yet the peripheral countries, Greece, Ireland, Portugal, Spain and Italy have reduced their external deficits. Part of this is a function of domestic recessions, which sap the demand for imports, but the decline in unit labors costs (outside of Italy) means competitiveness is being improved. Exports are also rising.
This means that the Target2 imbalances are being reduced, albeit slowly. However, smaller deficits on the periphery does not automatically translate into a smaller surplus for Germany. Indeed, Germany's ability to diversify its trade away from the euro area is one of the under-appreciated stories of 2012.
Germany reported October trade figures earlier today. Although the surplus fell to its lowest level in six months, but still a bit larger than the 15.5 bln euro surplus the Bloomberg consensus called for. There was a surprise on both imports and exports. The real surprise was that exports expanded. The 0.3% increase in exports contrasted with a consensus expectation for a 0.5% decline after a 2.4% decline in September. Imports rose 2.5%, while the market had looked for a 0.3% increase.
Greece reported its Oct trade figures today. Exports were up 13.8% from a year ago and imports, flattered by energy, rose 10.1% from Oct 2011.
The shifting pattern of German exports was is clear in the aggregate data from Q3. Then exports outside of the EU rose 9.9%. Exports to the EU fell 0.9% and exports to the euro area fell 3%.
Broadly speaking, the US and China imbalances have fallen sharply in recent years. Although the euro area as a whole runs a small imbalance, Germany and The Netherlands continue to run significant current account surpluses at roughly 6.3% and 9.5% of GDP respectively. Both countries enjoy competitive unit labor costs and the benefits of a cheap real exchange rates. Exporters in both countries have been able to diversify their exports to the US, China and a few other emerging markets. A reduction of Target2 imbalances can and is taking place, without a significant reduction of Germany or Dutch current account surpluses.