We all know that Euro membership has been of doubtful benefit to periphery countries such as Greece and Portugal. But Germany has been a net beneficiary of the Euro, hasn’t it?
Not according to these charts from Albert Edwards (h/t Edward Harrison).
Decomposition of German current account and chart of German capital investment trend by Albert Edwards pic.twitter.com/OHtqZMOTsP
— Edward Harrison (@edwardnh) December 14, 2013
Note the point on both charts where the trend changed sharply. Yes, it’s 2000 – when the Euro was introduced. Admittedly, Germany’s gross fixed investment was already declining, but after 2000 it fell off a cliff. And the current account decomposition chart shows us why. Note the collapse in borrowing by non-financial corporations from 2000 onwards. That is disappearing domestic private sector investment. In fact in 2009-10 NFCs were net saving. This is distinctly unhelpful in an economy which has seen gross fixed investment falling for the last twenty years.
To start with, it appears that government borrowing replaced private sector net borrowing. But even that declined from 2004 onwards, replaced by income from a growing current account surplus. Good news for German households, apparently. They increased their saving. But contrary to popular belief, their hard-earned savings have not been productively invested in the local economy. They have unproductively blown up sovereign and private debt bubbles in other countries. The German banking system – including the marvellous Sparkassen, whose equivalent some people would like to see in Britain – has not been doing its job.
Admittedly these charts only go as far as 2010. But they do not tell a story of a booming Germany benefiting from the single currency. They tell a story of a country from which productive investment is being drained by a banking system that sees greater returns elsewhere.
If the German banking system were genuinely a private, free-enterprise system, this would be understandable. But it is not. The majority of it is either state-owned or state-controlled, and even the parts of it that are not state-owned benefit from implicit sovereign guarantee. No way is Germany going to allow its bigger banks to fail: to do so would put at risk the prized Sparkassen, Volksbanken and Raffeisenbanken. It would surely be reasonable to expect that a state-backed banking system would principally invest domestically. But clearly, it doesn’t. German domestic businesses can rightly feel that they have been let down by their banks.
But this is not entirely a story of banking. After all, savers expect banks to generate good returns on their savings, and if that can best be done by investing that money outside the country, then can we really blame banks for doing so? This is a story of the ECB’s one-size-fits-all monetary policy and its insane insistence, prior to 2009, that all sovereign debt was of equal quality.
And it is also a story of too-tight fiscal policy. Instead of increasing its own borrowing to compensate for the fall in NFC borrowing, the German government gradually reduced its fiscal deficit – indeed in 2007 and 2008, it was net saving (running a surplus). On the face of it, this looks sensible: after all, we are led to believe that governments should net save during booms. But not, emphatically not, when there is a growing current account surplus. A persistent current account surplus is contractionary over the medium-term, because it by definition means that productive investment is leaving the country. Note how the domestic deficit (private and public sector) exactly parallels the current account surplus: as I’ve noted before, the larger the current account surplus, the greater the capital deficit, and that translates into reduced domestic investment. If Germany were not in a currency union, then the correct course of action would be to raise interest rates to encourage domestic investment. But Germany does not have that option. Its government should therefore have been borrowing to invest even during the boom, which would have had the effect of raising real interest rates. I know it seems counter-intuitive to suggest looser fiscal policy as a counter to too-loose monetary policy, but remember that the problem is lack of investment: if the private sector won’t invest domestically (because real returns are higher elsewhere), then government must. When countries have no control of monetary policy, fiscal policy cannot be counter-cyclical.
So it seems that Germany has suffered from poor investment since the start of the Euro as a direct consequence not only of the ECB’s interest rate policy but also of its own government’s tight fiscal stance. And this story continues. The German government is intent on fiscal consolidation, even as the current account surplus grows ever larger in relation to GDP:
Increasing government investment in Germany would not necessarily mean the current account surplus fell, at least at first. It could be done on a balanced-budget basis, in which case it would mean reduced domestic consumption spending instead (government spending cuts and/or higher taxes, forcing the private sector to cut spending). Given that German GDP is stagnating at present, this is perhaps not the best course of action. Borrowing to finance increased government investment strikes me as a much better approach. This might mean that the German government would face higher borrowing costs – although savvy investors should regard an increase in German government debt for investment as a good thing. But it would stop the bleeding of capital investment from the domestic economy without squashing domestic demand.
The ghosts of Weimar need to be laid to rest. An increase in government borrowing to fund medium-term investment is not going to result in out-of-control inflation. But failure of capital investment due to an out-of-control capital account deficit will in the end impoverish Germany.