TOKYO -- The latest meeting between Japanese Prime Minister Shinzo Abe and U.S. President Donald Trump offers a clue as to how to deal with the so-called Trump risk, a subject of major global interest.
Trump's next targets likely are Germany and China, and they will surely be analyzing the Japanese approach: follow the path of least resistance by making the self-proclaimed deal-maker happy.
Trump once maintained that OPEC nations were ripping off the U.S. via huge trade surpluses and that the country should take back that wealth and use it to rebuild its economy. The same sentiment is now directed at China.
Such mercantilist claims were not something Trump just hastily took on for his presidential campaign. He repeats the idea in his book, "Time to Get Tough: Make America Great Again," the Japanese version of which was recently released.
The book was first published in 2011. A revised version followed in 2015. During that period, the U.S. eliminated its trade deficit with OPEC nations thanks to plunging crude oil prices, but the deficit with China remains huge. As China accounts for half the U.S. trade deficit, Trump is by no means likely to avert his eyes from the country.
Trump attacked Mexico first and then shifted his brunt to Japan. Perhaps he sees them as easier targets, and now that he's gotten his way with them, the president is poised to deal with tougher negotiators. With an agreement with Japan reached, Trump will inevitably take aim at Germany and China.
Peter Navarro, head of the newly created National Trade Council under Trump's White House, has said the euro is an "implicit deutsche mark" that is excessively undervalued. He claims Germany is taking advantage of the weak euro and exploiting European Union members and the U.S.
Citigroup sees Navarro's remarks as a confrontation between U.S. and German mercantilism and positions them as a declaration of currency war by the U.S.
To the Trump administration, Germany has shielded itself from claims of currency manipulation by hiding behind the euro, which it sees as an "undervalued German mark."
Japan surpassed Germany as the second-largest contributor to the U.S. trade deficit in 2016. But the U.S. trade deficit with the eurozone as a whole is more serious, and Germany logged its biggest ever surplus in trade with the U.S. in 2016.
While Germany's excessive adherence to fiscal health has caused a lack of demand in the eurozone, it covers the shortfall with external demand through the undervalued mark, Navarro said. The U.S. is cheated as a result, he added.
Two roads, two precedents
Citigroup envisions two possible scenarios ahead.
In the first, the Trump administration tries to steer the euro higher to counter Germany's persistent mercantilism. The move would cause low inflation in core eurozone countries, such as Germany, and increase the vulnerability of neighboring countries including Italy, according to Citigroup. The scenario is similar to what Japan has experienced since the 1990s.
The other scenario envisions the Germans resorting to fiscal spending, which would enable the eurozone to pull out of low inflation on a rise in the rate of inflation in Germany. One risk is that an economic bubble would occur in Germany and eventually burst, similar to what happened in Japan in the second half of the 1980s.
Which of these predictions is more realistic may be apparent in view of Germany's position as the leader of the eurozone.
Against this backdrop, key elections will be held in Europe: a general election in the Netherlands, a presidential election in France and a general election in Germany. Thus, the eurozone is highly likely to serve as a demon's gate for markets.
The Trump administration positions China as being in the final heat of the race because trade and security are closely linked and because of its sheer size. As that battle is unlikely to be settled soon, Japan will have no choice but to avoid being lumped together with China by the U.S.