Merkel deserves a dressing down, not the red carpet

By Jeremy Warner

Much kowtowing and genuflecting will greet the arrival in Britain today of the German chancellor, Angela Merkel. In some respects, she deserves the applause. Both in her own country, and on the world stage, Ms Merkel is one of the very few European leaders who still commands genuine respect.

Yet it is her supposed ability to deliver favours, rather than her many admirable qualities, that explains much of the faux deference the British government displays towards this de facto, if somewhat reluctant, European monarch. If there is anyone who can engineer the new relationship with the European Union that David Cameron demands, it is the German chancellor.

And it is for her own country's sake, rather than as a favour to Britain, that she needs to deliver; for in truth, the benefit to Germany of British participation in the European Union is substantially greater than any economic positives the UK derives from it.

Given this service, it ought indeed be Ms Merkel who is beholden to us, not the other way around. This is not just because of cultural affinity, shared values and past accommodations, or even our usefulness as an ally on trade and business issues against Europe's many less market-friendly voices.

More importantly, it is because Germany enjoys a whacking great trade surplus with Britain. The UK has long been far and away Germany's largest European export market. Since the onset of the eurozone crisis, German reliance on British export markets has become bigger still. Amid the general wreckage of the European economy, it sometimes seems that Britain is indeed the only decent source of demand left. Since the crisis began, our current account deficit with the rest of Europe has virtually doubled, to a breathtaking and record £102.3bn in 2013.

Recent data point to an even wider deficit last year. Were it not for this trade imbalance with Europe, Britain might be a surplus economy, such is our balance of payments position with other Anglo Saxon economies. More than a third of this deficit is accounted for by Germany, which dwarfs the next largest surplus economy, China, and as a consequence is fast becoming Britain's biggest creditor.

Some of the reasons for this success are obvious enough. Germany makes some of the most desirable cars, vacuum cleaners, washing machines and other consumer goods in the world. It also makes some of the best machine tools, construction materials and so on.

Yet there is a less benign reason too - it is also because of mercantilist policy in Germany, which prioritises exports over domestic demand, and because of extraordinarily accommodative demand management in Britain. Neither policy is ultimately sustainable. Britain cannot for ever keep supporting European demand through credit fuelled monetary and fiscal stimulus. Nor can Germany indefinitely keep clocking up charges against its main export markets. Eventually debtors will find a way of defaulting, or otherwise escaping their obligations. In the meantime, Britain grows, providing Germany with abundant export markets, even as Europe languishes.

At approximately 5pc of GDP for both the budget and the current account deficits, Britain already has one of the biggest twin deficit problems in Europe. The Government continues to borrow to spend at heroic levels. The UK is also one of the few economies in Europe that is seeing decent levels of private sector money and credit creation, sucking in imports from abroad.

If the European Central Bank ever gets around to quantitative easing, it will primarily be to provide stimulus for the demand-starved economies of the eurozone, where price inflation has now almost certainly gone negative. This may, however, already be a hopeless endeavour. Yet one thing it most certainly will do is further depress the euro, providing another boost to the German export machine. The euro is already far too low for a big surplus economy such as Germany. QE threatens to make matters worse still.

That Germany cannot seem to recognise the lessons of its success in British export markets, and apply them to the wider context of Europe's economic crisis, is one of the deeper mysteries of the whole wretched mess.

It doesn't matter how competitive your exported goods happen to be, they will not be successful unless there is sufficient demand for them. Just ask the Greeks, who no longer buy Porsches, Mercedes or Miele washing machines on anything like the scale they used to.

Austerity policies have had such a damaging impact on demand in many eurozone countries that previously yawning current account deficits have shrunk to virtually nothing, or even gone positive. Unfortunately, within the eurozone itself, imbalances in trade have if anything got even worse since the crisis began. Germany has increased its surpluses even as demand has plummeted. If even in the depression-like conditions that exist in Spain, the country still cannot run a current account balance with Germany, it indicates a basically insolvable problem at the heart of monetary union.

Germany this week reported that its inflation rate had fallen to 0.1pc. Its five-year bonds yield virtually nothing, and some inflation linked bonds have been negative on and off since the crisis began. In other words, Germany is not expected to show any inflation any time soon. The internal devaluation needed in other countries to regain competitiveness with Germany has thus become more challenging still; for some countries, prices will need to keep deflating for years to come. It's a hopeless situation, as Alexis Tsipras, the otherwise profoundly unsound leader of Greece's radical left Syriza party, has evidently recognised. Something has to give.

German export success is being bought at the cost of economic calamity throughout much of the rest of the eurozone. As one of the main architects of this catastrophe, Ms Merkel should be held to account, not lauded.

It's not entirely her fault; Germans didn't deliberately set out to create such a destructive economic model. Indeed, they are to be applauded for their success as exporters. It is the absence of adjustment mechanisms that is the problem.

By dint of geography, Britain regrettably finds itself drawn into the same dynamic. We have become the consumers of last resort. So please, Ms Merkel, Germany owes Britain a good deal more than a few negotiating scraps. There is no one else who can cure Europe of its sickness.

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