This research note is provided by Fathom Consulting. All of the charts below and many many more, covering a range of topics and countries on both the macroeconomy and financial markets are available in the Chartbook to Datastream users at www.datastream.com. Alternatively you can access Fathom’s Chartbook at www.fathom-consulting.com/TR.
Germany’s savings, Europe’s problem
It has become an established view that the German current account surplus and the euro area crisis are intimately connected. It is not just Fathom’s view, the IMF, the OECD and even the EU seem to agree. But by the same token most, though not Fathom, would also now argue that the Euro Crisis is behind us. And yet, Germany’s current account surplus is just as big as it ever was. So, were we and everyone else wrong to link the crisis to Germany’s endemic over-saving?
Globally, investment has to equal savings; on a national basis that does not necessarily have to be true. If a country has excess savings, these savings will go abroad to finance investment in other countries, appearing as a capital account deficit, which is the mirror image of the current account. Thus, the current account can be defined as the balance between national savings and national investment. Put differently, in surplus countries national savings exceed national investment which is why they accumulate net foreign assets making them a net lender to the rest of the world. Hence, Germany needs to run a current account deficit in order that at least some of the money it lent abroad will be repaid.
Current account and TARGET2 balance are more balanced
Here there is some good news. While Germany’s overall current account surplus has barely budged, its surplus with the rest of the euro area has narrowed. As indeed has its surplus within the TARGET2 since late-2012. But beneath the headlines, the news is less rosy.
With respect to the decrease of the German current account balance with the Periphery, the decrease in the German trade balance – the main determinant of the current account balance – is almost entirely attributable to a drop in exports rather than a rise in imports. In other words, due to internal evaluation, encouraged by Germany, Periphery imports from Germany have collapsed. Record unemployment rates and social protests have already led to calls for procrastination of reforms in Periphery countries, suggesting that further surges in the current account balance driven by increases in net trade are limited.
In contrast to the German economist Hans-Werner Sinn, we think current account imbalances contribute only to a limited extent to the TARGET2 imbalances. Instead, TARGET2 imbalances have decreased because savers in the Periphery reversed some of their transfers of deposits to Germany. However, imbalances persist nonetheless – the TARGET2 balances are far away from being balanced.
Despite an increasing current account balance of Periphery countries with the rest of the world – all Periphery countries had a current account surplus in 2013 – and a decreasing current account balance of Germany with the Periphery countries, the euro area crisis is by no means over. An adjustment through the exchange rate is not possible and the potential for internal revaluation is limited. This means that for a meaningful recovery, a rebalancing within the euro area must take the form of an increase in the current account balance of Periphery countries, driven by a rise in German imports. That is, for a sustainable recovery from the euro area crisis, the current account balance of Germany with the periphery has to substantially decrease further, reducing the overall current account balance of Germany, ceteris paribus.
Who is responsible for the German current account surplus?
Whereas German national investment, as measured by gross capital formation, is broadly in line with that of other advanced economies, the German gross national saving rate was five percentage points above even that of Japan. This suggests that there is considerable scope for Germany to reduce savings, or equally, increase consumption.
Gross savings and gross fixed capital formation can be decomposed by sector, namely households, corporates and government. Calculating the respective differences between saving and investment then gives the contributions from each sector to the German current account.
Through the last decade, households have been by far the main contributor to the German account surplus. While compared to 2009 and 2010, the private sector contribution decreased it has been roughly constant since 2011 – although at a relatively high level. In contrast, in 2012 and 2013, the German government became a current account contributor – since the beginning of the 1990s this was only the case twice. That is, in addition to the private sector the public sector has become a net contributor to the current account surplus in Germany, further increasing the imbalances in the euro area.
The increasing contribution of the corporate sector to the German current account surplus over the past three years is mainly due to reduced investment as measured by the gross capital formation as a share of GDP. Additionally, German Defined Benefit pension schemes were overfunded in 2012 by 18%. This suggests that there is scope for German corporates to increase investment, contributing to a reduction of the current account balance.
The German government is likely to stay a current account contributor as it is limited in its ability to increase investments and/ or decrease savings due to the Schuldenbremse (debt brake), which requires the federal government to cut its structural deficit to 0.35% of GDP by 2016; the 16 Länder (states) must eliminate theirs entirely by 2020. Thus, it is down to the private sector to decrease the current account balance by reducing savings and/or increasing investment.
However, households have to play the leading role. While the gross capital formation of German households as a share of GDP is relatively high compared to that of other advanced economies, so is the saving rate of German households. German households have saved more than twice as much as UK and Japanese households when measured as per cent of GDP.
The different treatment of pensions in ESA 2010 is expected to decrease the saving rate of German households slightly while potentially increasing the household saving rate of other countries, lessening the differences between them. However, the comprehensive German welfare system and the high reliance on public pensions suggests a limited precautionary saving motive, inferring that the German household saving rate should lie below that of, for instance, UK and US households. The modified treatment of pensions under ESA 2010 is unlikely to achieve that.
Furthermore, the historically close relationship between the yield on ten-year German government bonds and the saving rate of German households broke down around 2000; the saving rate of German households reversed its downward trend against a backdrop of continuing falling yields on ten-year German government bonds. That is, the difference between the saving ratio and the return on German Bunds has actually been steadily rising since 2000.
Scope for German households to reduce their saving rate is suggested by a few things: the high level of the saving rate of German households despite plummeting returns on savings with real interest rates close to zero and a limited precautionary savings motive due to both a comprehensive welfare system and a high reliance on public pensions.
Since 2011, there have been no signs of a reversion of the current account surplus – by none of the three sectors. A rebalancing towards domestic demand of the German economy and a sustainable recovery of the euro area crisis is by no means around the corner. Therefore, our conclusion is the same as it was in August 2011 – Germany has to significantly run down its current account surplus in order to substantially contribute to a recovery from the financial crisis – the worst thing that the German taxpayer can do in these circumstances is batten down the hatches and save more.
Ultimately, the German government might need to implement direct incentives such as raising the rate of tax applied to income from savings or reduce the rate of VAT, to encourage the required shift. It’s time for Germany to lead the way out of austerity and crisis.
Receive stories like this to your inbox as they are published. Subscribe here and follow us @Alpha_Now on Twitter. If you are looking to access Thomson Reuters data or analytics, register for a free trial.