Monday, 11 April 2016

Germany's negative-rates trap

Germany's Finance Minister Wolfgang Schaueble has long been critical of ECB monetary policy,. But now, as Reuters says, the gloves are off. In a speech at a prizegiving for an ordoliberal economics foundation last Friday, Dr. Schaeuble effectively demanded that the ECB raise interest rates.

The justification? Very low interest rates hurt Germany's savers, which are the bedrock of its economy.

There is a political dimension to this. Dr. Schaueble's party, the CDU, is losing popularity and desperate for pensioner votes. Dr. Schauble even went so far as to blame ECB monetary policy for the rise of the right-wing eurosceptic AfD:
"I said to Mario very proud: you can attribute 50% of the results of a party that seems to be new and successful in Germany to the design of this [monetary] policy," Mr. Schäuble said.
This is outrageous. Dr. Schaueble is a politician, not a central banker. His attempt to influence the conduct of ECB monetary policy to gain domestic political advantage breaks both the spirit and the letter of Article 130 of the Lisbon Treaty:
When exercising the powers and carrying out the tasks and duties conferred upon them by the Treaties and the Statute of the ESCB and of the ECB, neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body.
The Union institutions, bodies, offices or agencies and the governments of the Member States undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the European Central Bank or of the national central banks in the performance of their tasks.
It seems that Dr. Schaueble no longer respects the Lisbon Treaty. Deutschland für Deutschland, and to hell with the rest. The cracks in the Eurozone are widening.

But leaving aside the political implications, is he right? Are ECB interest rates too low for Germany?

Representatives of German banks, pension funds and life insurers say they are too low. The Sparkassen association has long complained that very low interest rates threaten their meagre profitability, because they are unwilling to pass on zero or negative rates to retail customers. And pension funds and life insurers have promised income to their savers that they cannot deliver. Financial institutions are trapped, and savers are angry.

But in its October 2015 monthly report, the Deutsche Bundesbank cast doubt upon both the worries of financial institutions and the anger of savers. Firstly, financial institutions. It seems that German household saving preference is pretty inelastic to price:
...there is quite some evidence to suggest that real returns are not a major driver of the saving and investment behaviour of households in Germany. In actual fact, this behaviour has probably, in recent decades, been shaped chiefly by developments in (expected) disposable income, changes in the institutional framework (especially the tax and social security system), demographics, wealth levels and households’ preferences and (risk) attitudes. It appears unlikely that the – clearly volatile – real return(s) should be a dominant factor influencing saving and investment behaviour given that the latter has displayed constant patterns over time and been subject to only gradual changes.
So German households save firstly because they are (relatively) wealthy, secondly because they are ageing and thirdly because they are worried about the future. Real returns on savings are much less significant. Financial institutions may have promised savers the moon, but failing to deliver it is not going to stop people saving.

The Deutsche Bundesbank also points out that the returns to savers are not that low:
...the return on households’ financial assets – measured in real terms and taking into consideration all the major financial assets in the portfolio – is not as meagre as the low nominal interest rates on bank deposits would initially suggest. Alongside the currently low rate of inflation, this can be attributed in large part to the fact that households hold not only comparatively low-yielding bank deposits but also financial assets that generate strong returns. The total return since the outbreak of the financial and economic crisis may be down on average compared to pre-crisis levels, but since the early 1990s there have been repeated spells in which the real total portfolio return has been far lower still.
Indeed there have. This chart shows that real returns are currently around 2%, which is historically not bad at all:

This chart does however show that since 2011, the return on currency and deposits has been negative. So people who keep their savings in bank accounts are feeling the squeeze. And it seems that use of bank accounts is growing. This fascinating chart shows the change in German household investment behaviour over time:

Saving in "currency and transferable deposits" (physical cash and demand deposit accounts) has more than doubled since 2001, at the expense of more risky, higher-yielding investments. German households are accepting lower returns on savings in return for lower risk and greater liquidity - a clear sign of risk aversion. They are more concerned about the return OF their money than the returns ON it.

This is typical of an ageing society with a large middle class who cannot easily replace savings lost due to asset price falls. Germany is one of the fastest-ageing societies on the planet, and has one of the lowest dependency ratios, which does not bode well for the support of its elderly in the future.

The real return on a balanced portfolio being about 2% suggests that interest rates in Germany are not excessively low. Savers who are getting lower returns are paying the price of their own risk aversion. Though this doesn't stop them being angry. Understandably, they do not want to pay that price.

As we have already seen with Japan - which is even further along the ageing-society curve - the faster a society ages, the more risk-averse its population becomes and the more it tends to save. German households are unquestionably increasingly risk-averse. But they don't appear to be saving more. The German personal savings ratio has hovered at around 9% of GDP for a long time - and was even higher during the 1980s.

However, German households also have a horror of debt. The ratio of household debt to income has been falling for well over ten years:

This does of course to some extent reflect rising income among German middle-class households. But it also suggests that Germans are largely immune to wealth effects. Even with rising income and today's very low interest rates, they are reducing their household leverage, which is economically equivalent to yet more saving. Borrowing for consumption isn't something they want to do. They want to accumulate wealth.

Overall, the German household sector is a rising net lender. Guess what, so is the German corporate sector. And because both the household and corporate sectors are net lenders (i.e. running surpluses), and the German government is also trying to be a net lender (run a surplus), this adds up to FALLING domestic investment, since is not possible for a sector to be both a net lender and a net borrower. This chart from the IMF shows the widening gap between savings and investment:

(the chart only goes up to 2012, but the situation has not materially changed since then).

Now, saving = investment is an identity, so this gap must be closed somehow. This is the driver of the German current account surplus, currently 8% of GDP and rising. The inverse of the current account is the capital account. Germany's capital account is running a deficit equivalent to 8% of GDP. That means Germany is investing 8% of its GDP abroad, rather than at home. We should correctly view the German current account surplus as an inevitable consequence of an excess of saving over investment by all three domestic sectors - household, corporate and government. It has little do with wonderful German industrial production and everything to do with wonderful German thrift.

This is also where the ECB's low interest rates come from. Although the ECB looks across the whole Eurozone when setting monetary policy, Germany's economy is so dominant that conditions there inevitably have a very large influence. The excess of domestic saving over domestic investment puts downwards pressure on real interest rates in Germany, which inevitably flows through into central bank policy settings. This would still be the case even if Germany were not part of the Eurozone.

However, the other side of this is currency effects. Large and growing capital exports put UPWARDS pressure on the currency. Indeed the Eurozone's own capital deficit, which is itself partly due to Germany's capital deficit, is having exactly that effect: the Euro remains strong despite persistent attempts by the ECB to weaken it. But Germany's capital deficit does not respond to Euro strength, because Germany exports its capital mainly in Euros. So the ECB is fighting a battle on two fronts - externally, where it is trying to prevent the currency rising in response to Eurozone capital exports, and within the Eurozone, where it is forced to respond to the deflationary effects of German capital exports. This is a battle it cannot win.

The truth is that very low interest rates in Germany are not caused by ECB monetary policy. They are the result of a structural excess of saving over investment by German private AND public sectors. The prized "schwarze null" entrenches zero or negative interest rates. So if Schauble wants interest rates to rise, he should look to his own fiscal policy, not to the ECB.

To correct its capital account deficit, Germany needs to run a sizeable fiscal deficit, devoted principally to domestic investment but also to supporting the elderly (to improve household confidence and thus discourage excess saving). So what if this means breaking the Stability and Growth Pact. If Schauble can renounce the Lisbon Treaty over central bank independence, he can renounce the Maastricht Treaty over fiscal debt and deficits too. Bring it on.

Related reading:

A current account surplus is obviously a good thing, isn't it? - Notes On The Next Bust


  1. Is Germany now unable to export its Euro savings to S Europe because of austerity preferences that were caused by previous exports?

  2. This is an excellent article Frances. This is complex stuff and often counter intuitive but you manage to explain it very well.

    What is your idea: are policy makers in Germany (including Schaueble) plain ignorant or do they understand this but publically say something different to please their voters/public?


  3. Does it ever occur to anyone in Germany that instead of endlessly lending cash to foreigners who will not be able to pay the money back, spending and enjoying the cash at home might be a good idea? Lower taxes, increase public spending - which also has the fine byproduct of stimulating the rest of the European economy. Happy days! Can I have Schaueble's job?

  4. Schäuble is a moron and it's an embarassment for the country to have him as Finance Minister. Does he really think that a central bank can wave a magic wand and suddenly deliver 5% ROI for pensioners? These are the dangers of letting an accountant run an economy: they don't understand the numbers, they just know where to put them in the balance sheet.

    1. Accountants are educated to understand the numbers. And, yes, accounting is quit imperfect. But, it is worth learning some thing about.

      But, a centrally run economy is a bad idea; even if run by accountants. As, an economy is actually quite decentralized. Centralized it would be less of an economy.

      "It may not have occurred to you, but double-entry book-keeping is one of the most important discoveries in history."

      " Luca Pacioli, a Franciscan friar who for many years lived with Leonardo da Vinci is known as the Father of Accounting as he wrote the first accounting texts from 1494. Accounting is credited as one of the most significant factors that gave rise to the Italian Renaissance. Better and wiser business decisions were made and as markets grew around the world, wealth was created on a scale never before seen, lifting millions of people out of property [poverty]." -- (what a typo! It has worked that way too in history.)

      Bahi-Khata: The Pre-Pacioli Indian Double-entry System of Bookkeeping, by B. M. LALL NIGAM

  5. Good article. I only take issue with the claim that Germany’s trade surplus is the automatic consequence of the private and corporate savings glut. Germany’s record trade surpluses are to a large part driven by its largely price-inelastic industrial export basket. It is no coincidence that the surplus exploded after 2000 when the reunification effect ended and China and other emerging markets’ industrialization push intensified. Sadly the surpluses have been recycled by the banking system into billions of subprime assets.
    The real issue is that German savers are overexposed to fixed income products which are obviously suffering in the current low-yield environment. They are underexposed to asset classes that do well in such an environment such as equities and residential real estate. Who owns equities and real estate in Germany? A minority, the upper middle-classes and above. So the current market environment combined with suboptimal savings preferences of the majority of households exacerbates the highly unequal wealth distribution. And this is becoming politically toxic in Germany. Schäuble is right to identify this, but the ECB is obviously the wrong scapegoat.

  6. A small note about this very good post

  7. Social credit theory teaches us the problems in the industrial economy go far beyond interest.

    In a word depreciation.
    Firms are forced to "add value" or complexity over time even if it has no real utility.

    Germany is perhaps the best zone of operations for increasing complexity.
    In simple terms they could make a 2cv for £1000 ~ pounds today.
    However the typical cars produced are in the 20,000 pound bracket.
    (If a firm cannot "add value" in this inflationary market then it goes bust even if it's product is simple and effective)

    A 2cv can only depreciate by 1000 if recycling cost balance ( there is not much metal to recycle anyhow)
    A modern car and almost all other finished goods goes to a different level.
    This depreciation of overly complex manufactured items is creating great instability in national economies.
    Germany appears to be a success but when the music stops it will become a basket case like the rest as present consumption is not and indeed cannot service real organic demand given the lack of compensated price to balance the now increasing depreciation seen in "successful growing" economies such as the Irish jurisdiction.

    1. Yet at that point germany might dampen the depreciation thus quickly solving the problem, reducing cost, and price.

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  8. Depreciation...Add complexity over time...

    I think that is also called technological obsolescence and planned obsolescence.

    Warren Buffett does not like to buy technology and automobile companies for that reason. The auto company has huge depreciation of product and plant. This is also risky for the job holder also.

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  9. And, did Mario respond " very proud: you can attribute 100% of the economic and political collapse of the European periphery to your stubborn refusal to reform the Eurozone and support expansionary fiscal policies"?

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  15. Dork of Cork, get your own blog and stop grandstanding on mine.

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  19. How many more years do you think the EU can go before trying some kind of fiscal policy?

  20. Personally I think the German economic characteristics of industrial production and thrift run are intertwined rather than being independent.
    But to me the solution is blindingly obvious: Germany leaves the Eurozone.

  21. The real issue is that German savers are overexposed to fixed income products which are obviously suffering in the current low-yield environment. They are underexposed to asset classes that do well in such an environment such as equities and residential real estate. Who owns equities and real estate in Germany? A minority, the upper middle-classes and above.