What German savings tell us about the European real economy

For the first couple of years that followed Mr Draghi’s ‘whatever it takes’ speech, made in 2012, there was an important change in behaviour by German savers, that resulted in the German household sector becoming one of the primary providers of capital not only to their domestic risk asset markets but also to the global asset markets, including those within the Euroland periphery. Thus, the German private sector acquired not only a relatively large €75bn of domestic equities over the two years, but also a historically very significant €220bn of foreign assets. By way of context, Germany’s nominal GDP only increased by €100bn over the two years, and the ‘stock’ of savings therefore probably only increased by less than a fifth of that amount, implying that the switch into ‘risk assets’ occurred primarily via a redeployment of existing savings and a change in ‘investment strategy’ rather than by creation of new savings.

The explanation for this redeployment of German savings away from domestic deposits and bank savings bonds in favour of domestic equities (and property) and in particular foreign bonds could have been that the ECB had managed to reduce domestic deposit rates and yields within Germany relative to the population’s rising expectations of inflation, that it in effect compelled households to take more risk in search of higher yields and capital gains, to protect against the risk of rising inflation that might have followed the ECB’s pronouncements. Yet the effect of German savers forsaking bank deposits and domestic savings bonds has had profound and overwhelmingly deflationary consequences for the domestic banking system, with the latter having lost its supply of cheap long term financing – and beyond the banking system, the movement of funds has proved to be deflationary for Germany’s real economy, as evidenced by the lack of cost price inflation that had been widely predicted, but very helpful for financial markets and in particular Euroland equities and the bonds of peripheral economies. Large capital outflows from Germany therefore proved to be overtly inflationary for financial markets even as they have assisted in the creation of large longer term competitiveness and structural imbalances within the Euro’s member states, just as was the case during the period 2004-2007.

The mood has not followed the facts and the German ZEW institute’s latest survey of German inflation expectations reveals that German private sector expectations of inflation peaked in July, fell back slightly in August, and then plummeted in September- such that the perceived‘real yield’ on Bunds, bank savings bonds and even bank savings deposits may have increased significantly with the result that not only have Bunds rallied but Germany has in all probability started to run a balance of payments surplus once again.

When Germany runs a capital -flows-induced balance of payments deficit, this tends to be bad news for Europe’s real economy in the longer term but inflationary for the risk asset markets in the short term. However, when German savers repatriate funds from abroad, this naturally tends to be deflationary for the asset markets from which they remove funds and also potentially for the economies concerned. Thus, if Greece, Portugal, Italy and perhaps even Spain are now again experiencing balance of payments deficits as a result of a loss of German investor fund flows, then we can expect this to be implicitly deflationary for their economies and this should translate into higher real bond yields. This may be starting to occur, with some recent data on Spain’s credit and real economy looking softer in recent weeks and real interest rates have moved higher.

Meanwhile, the Bundesbank’s net position in the ECB’s TARGET2 system has begun to increase once again, pointing to a new German balance of payments surplus.  If this is the case, and if German banks recycle this increased surplus into more bank lending, this should stimulate Germany’s economy and by implication the global economy – so the return of a balance of payments surplus in Germany could be good news for the global economy, even if not good news for the peripheral economies of Europe in the near term. But if German banks choose to ‘sit on’ the surplus, then there’s no bank-led stimulus for Germany but instead a probable deflationary impact on the Periphery that if unchecked could lead back to a 2010/11-style crisis in Euroland. German bank credit data are slow to be released but the signs aren’t helpful, and for now it would seem that stresses within Euroland’s peripheral markets will build. What’s more, repatriation of German savings into Bunds and domestic bank deposits may prove positive for the Euro, despite the risk of weaker economic activity in the periphery, and that won’t help exports.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla