Germany the currency manipulator?

Today gives us an opportunity to look again at the German economy. As we do so we see yet another situation where conventional analysis and media reporting is flawed. So often we read that Germany has in some way been defeated in its efforts to direct the policies of the ECB ( European Central Bank). The evidence for that are the regular bursts of rhetoric from the German Bundesbank against the policies of negative interest-rates and a balance sheet of the order of 4.5 trillion Euros. However this to my mind ignores a much larger victory Germany gained when it joined the Euro because it has achieved for itself a much lower and therefore more competitive exchange rate. It did so in a way which has avoided the barrage of “currency manipulator” allegations that have been fired at others because it was a type of stealth effort.

Also the impact of this move has been heightened by the credit crunch era. We find evidence for this if we look at Switzerland and the Swiss Franc which of the currencies we have is the most similar. How is it doing? Well let me hand you over to the Swiss National Bank. From Reuters yesterday.

The Swiss National Bank’s (SNB) policy of negative interest rates is not ideal but is nevertheless necessary in order to weaken Switzerland’s “significantly overvalued” currency, Chairman Thomas Jordan said on Thursday…………Jordan said negative interest rates, along with the central bank’s willingness to intervene in the currency were absolutely necessary in order to protect exporters from a stronger Swiss franc, which is a safe-haven currency in times of market stress.

So if the Swiss Franc is a safe haven currency what would a German Deutschmark be if it existed? I think we can be sure that its value would have soared in recent times which leads me back to the competitive advantage point. There is also an irony as we note that on Switzerland’s road Germany would have had negative interest-rates anyway and maybe more negative than now. Ouch! We find ourselves in some strange places these days. Also would it now be a hedge fund manager as it tried to find somewhere to put its currency reserves? This week raised a wry smile as Apple passed the US $150 mark as I thought that the Swiss National Bank would be one of those most pleased via its holdings. I guess if you have 695.9 billion Swiss Francs they burn a hole in your pocket or something like that.

The trade surplus

The opening paragraph of Tuesday’s trade figures hammer home a consequence of this.

Germany exported goods to the value of 118.2 billion euros and imported goods to the value of 92.9 billion euros in March 2017. These are the highest monthly figures ever reported for both exports and imports. Based on provisional data, the Federal Statistical Office (Destatis) also reports that German exports increased by 10.8% and imports by 14.7% in March 2017 year on year.

So if you are looking for evidence of a lower currency leading to trade advantages it is hard to miss the persistent surpluses of Germany.

The foreign trade balance showed a surplus of 25.4 billion euros in March 2017. In March 2016, the surplus amounted to 25.8 billion euros. In calendar and seasonally adjusted terms, the foreign trade balance recorded a surplus of 19.6 billion euros in March 2017.

Indeed the statistics agency has an in focus highlight which rams this home.

According to Eurostat data, Germany had the highest export surplus among EU countries (257 billion euros) in 2016, as was the case in the previous years. Germany exported goods totalling 1,210 billion euros while the value of imports was 953 billion euros. Compared with the previous year, the export surplus rose by roughly 3% – in 2015, it had been 248 billion euros.

Interestingly we see that the idea of the Euro area having a large trade  surplus is true but that the vast majority of it is Germany as it was 257 billion out of 272 billion Euros in 2016.

Bond yields

The other gain for Germany from a combination of ECB policy and the credit crunch era is the extraordinary low level of interest it has to pay to issue new debt. Indeed this has frequently been negative in recent times meaning that Germany has been paid to issue its debt.  Some of that is still true as for example the yield on its five-year benchmark bond is -0.31% as I type this.

Even if it were to borrow for ten years then Germany would only have to pay 0.41% which I cannot say often enough is extraordinarily low. So it has clearly benefited from the 368 billion Euros of purchases of German debt by the ECB as we mull if there was a country which needed them less?

The catch is that it is mostly the German government that has benefited as it looks to run a fiscal surplus. As to the ordinary German well as I pointed out earlier this week first-time buyers will be much less keen as the easy monetary policy of recent years has led to something of a house price boom in Germany.

GDP and economic output

This morning’s official GDP data had a familiar drumbeat to it.

In addition, the development of foreign trade was more dynamic and contributed to growth as exports increased more than imports, according to provisional results.

The quarterly number was good and this impression was reinforced by the breakdown of the numbers.

. In the first quarter of 2017, the gross domestic product (GDP) rose 0.6% on the fourth quarter of 2016 after adjustment for price, seasonal and calendar variations……. Capital formation increased substantially. Due to the mild weather, fixed capital formation especially in construction, but also in machinery and equipment was markedly up compared with the fourth quarter of 2016.

Is the weather allowed to be a positive influence? Only in Germany perhaps as elsewhere its role invariably is to take the blame. There is an undercut to this though as we mull the individual experience and note that economic growth over the past year was 1.7%.

The economic performance in the first quarter of 2017 was achieved by 43.7 million persons in employment, which was an increase of 638,000 or 1.5% on a year earlier.

So whilst the employment rise is welcome we see that it very nearly matches the level of economic growth. Also if we look back to the data we are left wondering if the construction investment boom is related to the house price boom and the UK economic model is being copied to some extent.


The economic outlook remains bright for Germany if the Markit business or PMI surveys are any guide.

IHS Markit expects German economic growth to strengthen to 0.7% qr/qr in the first quarter, and the April PMI provides an early signal that expansion will remain strong in the second quarter.

So something along the lines of more of the same is expected although of course that was only one month of this quarter. If we look at the overall situation let us use a type of Good Germany: Bad Germany type of analysis that mimics Italy.

The good sees that the reforms of the past have enabled Germany to expand its economy post credit crunch such that GDP  reached 110. 02 last year compared to 101.66 in 2008. It has a substantial trade surplus and these days has an internationally rare fiscal surplus.

The trouble is that some of the latter points are also part of Bad Germany as we see how its adoption of the Euro has helped feed its trade surplus via a more competitive exchange rate. Also there is the issue that one of the problems pre credit crunch was world imbalances and the German trade surplus was one of them. Within the Euro area some will wonder if it would be helped by less fiscal austerity. Then we get to the issue of comparing the rise in employment with GDP growth, is Germany like the rest of us struggling for productivity growth with its implications for wages? Also as I pointed out earlier this week the rise in house prices will make first-time buyers wonder if they are indeed better off?

Negative interest-rates and QE have created a house price boom in Germany

A feature of these times is that is called easy monetary policy and this is particularly true in the Euro area. There the European Central Bank has a deposit rate of -0.4% and is undertaking asset or bond purchases of 60 billion Euros a month as well. This means that as of last week over 1.8 trillion Euros of bonds have been bought including some 216 billion Euros of covered bonds which support banks and then mortgage lending. Last week we discovered that some countries “have been more equal than others” in terms of where this 1.8 trillion Euros has ended up. From the ECB.

Excess liquidity has been persistently concentrated within a group of banks located in a limited number of higher-rated countries, i.e. around 80-90 % of excess liquidity is being held in Germany, France, the Netherlands, Finland and Luxembourg (see Chart 1) and even their country shares have been fairly stable across time.

It is fascinating that a country geographically as small as Luxembourg merits a mention. But Reuters updates us on the two main beneficiaries.

The study shows that 60 percent of the money spent by the ECB and national central banks on buying bonds ends up in Germany, where sellers, mainly UK banks, have their accounts. France accounts for a further 20 percent.

Okay and the consequence of this is?

But the fact that the money keeps accumulating in the bloc’s richest countries rather than flowing where it is needed the most risks undoing some of the ECB’s efforts and shows the European Union’s objective to create a banking union is still far from reached.

This makes me wonder about asset prices in the main beneficiary Germany as after all these QE ( Quantitative Easing) policies are claimed to have “wealth effects”.

House Prices in Germany

Let us step into the TARDIS of Dr.Who and go back to February of 2014 when the Financial Times reported this.

House prices in Germany’s biggest cities are overvalued as much as 25 per cent, the Bundesbank warned on Monday, adding to fears that international investment has helped to fuel a property bubble in the eurozone’s largest economy. The German central bank said that residential real estate prices in 125 cities rose by 6.25 per cent on average last year. In October, it reported that property prices in the biggest German cities were 20 per cent overvalued, suggesting the problem is getting worse.

If we move forwards to March 2016 then this from Bloomberg is eye-catching.

German house prices went nowhere for years. Recently they’ve grown faster than the UK.

So what had they done?

House prices have increased 5.6 percent a year over the past five years, according to UBS, which is double the average annual rate of increase since 1970.

As we see in so many other places the rises were concentrated in the major urban areas.

Prices are rising particularly fast in urban areas, where young people increasingly want to live. A gauge of advertised apartment prices in seven major cities including Frankfurt and Berlin rose 14.5 percent in 2015, the most since 2000, according to Empirica, a research institute.

As to “wealth effects” there was something else which is somewhat familiar to say the least.

So far the biggest beneficiaries have been Germany’s listed residential landlords. Cheap debt has enabled them to snap up housing portfolios and smaller rivals, thereby achieving cost savings through scale

What about now?

The Bundesbank calculates its own house price index which covers 127 cities and it rose by 8.3% in 2016 following 7.6% in 2015 and 5.7% in 2014. So according to its own index then prices must be very overvalued now if they were already overvalued back in 2014. Putting it another way the index which was set at 100 in 2011 was at 141.4 at the end of 2016. So quite a rise especially for a nation which has little experience of this as for example the period from 2004 to 2007 which saw such booms in the UK,Spain and Ireland saw no change in house prices in Germany.

In January my old employer Deutsche Bank looked forwards and told us this.

In 2017, we therefore expect rents and property prices in the major German cities, and across the country as a whole, to rise substantially once again…….Munich remains the most dynamic German city when it comes to property, with its fast-rising population and historically low vacancy rate likely to lead to further price increases for many years to come.

There is an element of cheerleading here which of course is a moral hazard issue for banks reporting on property prices which will not be shared by first time buyers in Germany. Those in Berlin will have particular food for thought.

Property prices in Berlin are now twice as high as they were in 2005 and have reached the level of some of the major cities in western Germany.

As of the latest news Europace have constructed an hedonic (quality adjusted) index which rose by 7.6% in the year to March.

What about rents?

These have risen but not by much if the official data is any guide. The rent section of the official Euro area CPI measure rose at an annual rate of 1.6% in March. Although Frankfurt seems to be something of an exception as Bloomberg reports.

The monthly cost of a mid-range two-bedroom apartment in Germany’s financial capital rose 20 percent in 2017 from a year earlier, while the cost of an equivalent living space in London fell by 8 percent, according to a Deutsche Bank study.

Frankfurt rent rises will of course be particularly painful for Deutsche Bank employees.


There is a fair bit to consider here but what is unarguable is that the easy monetary policy of the ECB has been associated with house price rises. These are noticeable in international terms but are particularly noticeable in a country which escaped any pre credit crunch boom. Also if we use the Bundesbank data above house prices rose by 41.4% in the period 2011-16 whereas real wages only rose by 6.6% ( Destatis) which is quite a gap! I think we know how first- time buyers must feel and yes there is a fair number as whilst Germany has fewer owner occupiers in proportionate terms than the UK they still comprise 51.9% of the housing market.

It is hard to avoid the thought that this house price boom is what central bankers would call a “wealth effect” from their policies, especially if we note that the liquidity seems to have mostly headed to Germany. Of course some of that will be the equivalent of a company name plate on the door but some will be genuine. Meanwhile as we note wealth transfers and inflation there is of course the near record high bond prices and the highs in the Dax 30 equity index seen last week.




Would the Bundesbank of Germany raise interest-rates if it could?

At the heart of the Euro area economy is Germany but as we have discussed before it has something of an irregular heartbeat in the way it affects its Euro area partners. For example as I pointed out on the 9th of January it is a deflationary influence on them via its balance of payments surplus.

In November 2016, Germany exported goods to the value of 63.2 billion euros to the Member States of the European Union (EU), while it imported goods to the value of 56.9 billion euros from those countries.

One does not wish to be critical of it for its relative economic success but there are clear side-effects as well as benefits from it. One is the trade position above another is that fact that its membership of the Euro makes its exchange-rate higher.. For all the talk and indeed promises of economic convergence the fact is that many Euro area countries have economies with little in common with Germany. For example later this year Italy seems likely to move into economic growth territory for its membership of the Euro which is very different to the German situation. Let us investigate the German economy.


On Wednesday this was released by the Federal Statistics Office.

The inflation rate in Germany as measured by the consumer price index is expected to be 2.2% in February 2017. Such a high rate of inflation was last measured in August 2012. Based on the results available so far, the Federal Statistical Office (Destatis) also reports that the consumer prices are expected to increase by 0.6% on January 2017.

The Euro area standard measure was also 2.2% although it rose by 0.7% on the month. We have a complete switch on the disinflationary period just passed which showed low and at times falling inflation for goods prices as they rose by 3.2%. These were led by energy at 7.2% and food at 4.4%.

This was reinforced only yesterday by this.

the index of import prices increased by 6.0% in January 2017 compared with the corresponding month of the preceding year. This was the highest increase of a yearly rate of change since May 2011 (+6.3%). In December and in November 2016 the annual rates of change were +3.5% and +0.3%, respectively. From December 2016 to January 2017 the index rose by 0.9%.

As you can see there are inflationary pressures in the system and it looks as though imported raw materials will impact the system especially the price of oil which was approximately half the rise. If German economic policy was set by the Bundesbank then there is no way it would have a negative interest-rate in the face of such pressure.


This has traditionally been a weaker link in the German economy and that seems to be continuing as the numbers below have an extra day in them compared to last year.

According to provisional data turnover in retail trade in January 2017 was in real terms 2.3% and in nominal terms 4.5% larger than that in January 2016.

We do get a like for like update on a monthly basis.

Calendar and seasonally adjusted (Census X-12-ARIMA), sales in January 2017 were 0.8% lower than in December 2016 and 0.2% lower in nominal terms.

If we look back to 2010 and mark it at 100 we see that January 2017 was at 106.1 which shows the German economy is not powered by retail sales.

Economic output

This has been a better phase for Germany as this official data shows.

The economic situation in Germany in 2016 thus was characterised by solid and steady growth (+0.7% in the first quarter, +0.5% in the second quarter and +0.1% in the third quarter). For the whole year of 2016, this was an increase of 1.9% (calendar-adjusted: +1.8%).

I am not sure that 0.7%,0.5%, 0.1% and then 0.4% is steady but it was solid! To be fair it was more consistent in annual terms although if we look further at the year it had a feature you might not expect.

government final consumption expenditure was up by as much as 3.2%.

Also Germany did shift a little in terms of one of the world economic issues which is the balance of payments surplus.

exports of goods and services rose by 3.3% compared with the previous year. There was however a larger increase in imports (+4.5%) in the same period. Consequently, the balance of exports and imports had a downward effect, in arithmetical terms, of –0.2 percentage points on GDP growth compared with the previous year.

There was also another sign of a German economic strength ticked away there.

the economic performance in the fourth quarter of 2016 was achieved by 43.7 million persons in employment, which was an increase of 267,000, or 0.6%, on a year earlier.

This performance allowed the headline writers some click bait. From the Guardian.

Germany overtook the UK as the fastest growing among the G7 states during 2016. Europe’s largest economy expanded at the fastest rate in five years, showing growth of 1.9% last year.

Of course the numbers are not precise to 0.1% after all if they were then this adjustment from 2014 as matters such as military expenditure and Research and Development saw new rules would not be necessary.

The conceptual changes have led to an increase in the level of the German GDP, amounting to roughly 3%

Public Finances

These were very strong in spite of the rise in spending.

A strong economic backdrop has helped Germany post a record budget surplus of €23.7bn in 2017 ( they mean 2016), fuelled by higher tax revenues, rising employment and low debt costs. It was the highest budget surplus since reunification in 1990 and the third successive year the government has had a budget surplus.

The old argument is of course that it would help the European and world economy if Germany loosened the public purse strings. This would also presumably reduce the balance of payments surplus in a beneficial double-whammy. The catch in terms of Euro area rules is that the national debt to GDP ratio is at 69.4% above the (supposed) 60% limit although of course rather good compared to the vast majority of its peers.

Looking ahead

The immediate future certainly looks bright for German manufacturing.

The PMI rose from 56.4 in January to 56.8 in February, the highest since May 2011. The increase in the headline figure reflected the output, new orders and suppliers’ delivery times components, while employment and stocks of purchases also made positive overall contributions. The current 27-month sequence of improving manufacturing conditions is the longest observed in over eight-and-a-half years. (Markit)

This led to an improvement also in forecasts for the year as a whole.

The survey results suggest that manufacturing will contribute to a strengthening in overall economic growth in the first quarter. IHS Markit currently expects q/q growth of at least 0.6% in Q1, up from 0.4% in Q4 last year, and is forecasting a 1.9% rise in GDP over 2017 as a whole.”

This has been reinforced by the service sector survey which has just been released.

the rate of expansion in total business activity accelerated and was slightly stronger than the trend shown over 2016 as a whole. Moreover, new business rose at the fastest rate since February 2016 and employment growth was the strongest since June 2011.


Let me leave you all with a question. The US Federal Reserve is hinting ever more strongly at an interest-rate rise this month although of course we await th words of Janet Yellen later. But in 2016 the German economy grew more quickly than the US one and may well do so this year. It also has inflation above target. Where would German interest-rates be if the Bundesbank was back in charge?

If you want a real mind game then imagine where a new German Mark would be and the implications from that?!





Inflation is back!

Regular readers will be aware that as 2016 progressed and the price of crude oil did not fall like it did in the latter part of 2015 that a rise in consumer inflation was on the cards pretty much across the world. This would of course be exacerbated in countries with a weak currency against the US Dollar and ameliorated by those with a strong currency. This morning has brought an example of this from a country which I gave some praise to only on Monday so let us investigate.

An inflationary surge in Spain

This mornings data release from the statistics institute INE was eye-catching indeed. Via Google Translate

The estimated annual inflation of the CPI in January 2017 is 3.0%, according to the An advance indicator prepared by INE.This indicator provides an advance of the CPI which, if confirmed, would increase of 1.4 points in its annual rate, since in December this variation was of 1.6%.

Okay and the reason why was no great surprise to us on here.

This increase is mainly explained by the rise in the prices of electricity and The fuels (gasoil and gasoline) in front of the drop that they experienced last year.

So as David Bowie put it they have been putting out fire with gasoline. As we investigate further I note that El Pais labels it as an Ultimate Hora and gives us some more detail.

The agency blames the acceleration of inflation to the rise in electricity prices, which this month has exploded, affecting mainly consumers in the regulated market of light, 46.5% of households, Which pay according to the hourly evolution of electricity prices in the wholesale market.

Actually that sounds ominous in the UK as the National Grid was effectively promising no blackouts yesterday but at the cost of more volatile ( which of course means higher) domestic energy prices. The actual numbers for Spanish consumers are eye-watering.

The average price of the megawatt hour (MWh) in the wholesale electricity market was on January 1, 51.9 euros. This Tuesday, the last day of January, the average price stands at 73.27 euros, 43.4% more. On Wednesday 25, the average stood at 91.88 euros (78.9% more than January 1), with maximums of more than 100 euros for the time stretches with more demand. Consumers receiving the regulated tariff (Voluntary Price for the Small Consumer, PVPC) will see those increases already reflected in their next receipt of light and have already been noted in the CPI, which has registered the highest level for more than four Years,

I guess they must be grateful that this has not been a long cold winter as such prices would have appeared earlier and maybe gone higher. The push higher in the inflation measure was exacerbated by the fact that fuel prices fell this time last year.

Thus, in January 2016, electricity fell by 13% compared to the same month in 2015. The gas price fell at a rate of 15%, while other fuels (diesel for heating, butane …) went down To 19.9%. Finally, the fuel and lubricants registered a year-on-year decrease of 7.1%.

It would seem that El Pais has cottoned onto one of my themes.

 The evolution of oil prices largely explained the behavior of the CPI in Spain. In January of 2016, the oil marked minimums in less than 30 dollars. Now, with the price of a barrel of brent upwards (around 55 dollars), fuels are rising and expenses related to housing are rising: gas, of course, a byproduct, and electricity, which is generated Partly by burning gas.

So far we have looked at Spain’s own CPI but the situation was the same for the official Euro area measure called HICP ( which confusingly is called CPI in the UK) as it rose to an annual rate of 3% as well. This poses an issue for the ECB as El Pais points out.

In any case, inflation is already at levels above the ECB’s target of 2%

Also it points out that Spain will see a reduction in real purchasing power as wage growth is now much lower than inflation.

already at levels that imply a loss of purchasing power for pensioners – the government will only update pensions by 0.25 %, The minimum that marks the law, for officials, whose salaries will not rise above 1%, and the vast majority of wage earners, since the average wage increase agreed in the agreements remained at 1, 06%.

There are also other concerns as to how it may affect Spain’s economic recovery.

As Spanish inflation is above European, the Spanish economy may lose competitiveness, not only because it may affect exports, but also because it may lead to a rise in wages.


A little more prosaic and also for December and not January but we saw this from Germany yesterday.

The inflation rate in Germany as measured by the consumer price index is expected to be +1.9% in January 2017. A similarly high rate of inflation was last measured in July 2013 (+1.9%).

German consumers will be particularly disappointed to note that the inflation was in essential items such as energy (5.8%) and food (3.2%). Of course central bankers and their media acolytes will rush to call these non-core as we wonder if they sit in the cold and dark without food themselves?!

This poses another problem for the ECB as Germany is now pretty much on its inflation target ( just below 2%) and this morning has also posted good news on unemployment where the rate has fallen to 5.9%.

Euro area

This morning’s headline is this.

Euro area annual inflation is expected to be 1.8% in January 2017, up from 1.1% in December 2016, according to a flash estimate from Eurostat, the statistical office of the European Union.

So a by now familiar surge as we note that it is now in the zone where the ECB can say it is achieving its inflation target. Of course it will look for excuses.

energy is expected to have the highest annual rate in January (8.1%, compared with 2.6% in December), followed by food, alcohol & tobacco (1.7%, compared with 1.2% in December),

Accordingly if you take out the things people really need ( energy and food) the “core” inflation rate falls to 0.9%. But the heat is on now as Glenn Frey would say.


The Financial Times reported this yesterday.

Giles Turrell, chief executive of Weetabix, said on Monday that the company was absorbing the higher cost of dollar denominated wheat but that Weetabix prices were likely to go up later this year by “mid-single digits”.

Sadly the decline of the FT continues as the “may” is reported in the headline as “Weetabix prices hiked” . The Guardian was much fairer although this bit raised a smile.

Although the company harvests wheat in Northamptonshire, it is sold in US dollars on global markets, meaning the cost in pounds to buy wheat in the UK has gone up.


It is hard not to have a wry smile as it was not that long ago in 2016 that the consensus was that inflation is dead and of course before that the “deflation nutters” were in full cry. Any news from them today? Of course the official mantra will be on the lines of this as reported by DailyFX.

ECB’s Villeroy says concerns about rising inflation are exaggerated.

What was that about never believing anything until it is officially denied? It was only yesterday that another ECB board member was informing us that there would be no change in monetary policy for 6 months when today’s inflation and GDP data suggests it is already behind the curve, as I pointed out on the 19th of this month. Although as ever Italy ( unemployment rising to 12%) is lagging behind. As Livesquawk points out not everyone has got the memo.

Spanish EconMin deGuindos: Inflationary Trend In Europe Could Lead To Tightening Of MonPol, Higher Interest Rates

So we see a problem and whilst some of the move in Spain is particular to one month it is also true that the pattern has changed now and so should the response of the ECB as it looks forwards.

UK National Statistician

Thank you to John Pullinger for meeting a group of inflation specialists including me at the Royal Statistical Society last Wednesday. I was pleased to point out that his letter to the Guardian of a week ago made in my opinion a case for using real numbers for owner-occupied housing such as house prices and mortgage-rates as opposed to the intended use of an imputed number such as Rental Equivalence. This will be more important when the UK makes the changes planned for March. Here is the section of his letter which I quoted.

And there is a real yearning for trustworthy analysis that deals with both the inherent biases in many data sources and also the vested interests of many who try to cloak their own opinions and prejudices as “killer facts”.






The confusion around the Target2 system of the Euro

As the Euro crisis developed there were a wide range of discussions and disagreements. One of the longest lasting and most polarised was and indeed is the one over the Target2 settlement system. There has been a new outbreak of this which has been triggered by a letter published on Friday by ECB (European Central Bank) President Mario Draghi. Let us cut straight to the chase.

If a country were to leave the Eurosystem, its national central bank’s claims on or liabilities to the ECB would need to be settled in full.

Boom! This opens more than one can of worms and one rather large one is opened if we step bank in time to July 2012 and the emphasis is mine.

And so we view this, and I do not think we are unbiased observers, we think the euro is irreversible. And it’s not an empty word now, because I preceded saying exactly what actions have been made, are being made to make it irreversible.

That speech was also famous for something else which is relevant to the discussion.

Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.

So how can you leave something which is irreversible? Accordingly you will not be settling up partly because Mario will not let it happen. That July 2012 speech was a success for keeping the Euro going forwards although reading it again exposes a fair bit of hot air and boasting about relative economic success of which the clearest critic is the ECB’s 1.5 trillion Euros plus of QE (Quantitative Easing) and -0.4% deposit interest-rate.

But as I read the crucial sentence in the letter to Mr Marco Valli (MEP) and Mr Marco Zanni (MEP) my other thought was that Mario Draghi had just boosted the credibility of those who have argued that Target2 balances matter.

How has this come about?

Ironically this is another side-effect of the QE programme.

the recent increase in TARGET2 balances largely reflects liquidity flows stemming from the ECB’s asset purchase programme (APP).

Oops! Also the change is how can one put it? Geographically concentrated.

Almost 80% of bonds purchased by national central banks under the APP were sold by counterparties that are not resident in the same country as the purchasing national central bank, and roughly half of the purchases were from counterparties located outside the euro area, most of which mainly access the TARGET2 payments system via the Deutsche Bundesbank.

As we note that foreign investors have been selling Euro area bonds to the ECB on a large-scale we see this as a consequence of who they have chosen to sell them too.

This, in turn, resulted in an increase in the Deutsche Bundesbank’s TARGET2 balance vis-à-vis the ECB.

With Germanic accuracy we are told that this amounted to 754,262,914,964.24 Euros as of the end of 2016. It may be hard to believe now but back in the early 2000s there were occasions when the German Bundesbank was a debtor in this system but the amounts back then were far far smaller. You will not be surprised to read it became a creditor as the credit crunch hit and at the end of 2008 that amounted to 115.3 billion Euros. At the time of Mario’s “whatever it takes” speech the balance was 727.2 billion Euros. This of course poses the problem that it we are in so much of a better place now why are we seeing a new record surplus? Here is the official reply.

However, the current increase in TARGET2 balances is not a symptom of increased stress and is therefore inherently different from the previous episodes of rising balances.

Ah, so this time is different!

What is Target2?

It is a settlement system which represents the monetary side of transactions described below by the Bundesbank.

These payment transactions can take a wide variety of forms, such as payment for a goods delivery, the purchase or sale of a security, the granting or repayment of a loan or the depositing of funds at a bank, among many others.

Now this reminds me of the case of the way changes in UK £M3 were represented some 30 years or so ago. This is because back then just because there was an accounting identity we were told there had to be a causal identity as well. Sadly that did not go so well. However the scale of Target2 leads to worries.

An average of around 350,000 payments with a value of just under €2½ trillion are processed using TARGET2 each working day, a figure which is broadly equivalent to the size of Germany’s GDP.

Other central banks have settlement systems but you see where the difference is comes from the fact that the Bank of Japan works in an environment of political and monetary union so nobody worries much about balances between Kobe and Osaka. The problem is created because the Euro is an economic concept which crosses national boundaries. Thus these cash-flows cross national boundaries. But the Target2 balances are not a causal force they are a consequence of financial actions elsewhere. For example back in 2011/12 they built up because of the banking crises seen and now they are building up ironically as part of the ECB’s response to that and the subsequent economic problems.

How could it go wrong?

There are two possibilities. The mildest would be something that cannot be settled under the current structure as described by Beate Resazt here.

in Target2 there is always a danger that one leg of a transaction is paid and the counterparty is not willing or able to fulfil its part of the business. For this eventuality banks have to provide collateral. If collateral turns out to be insufficient to realize the full amount the resulting loss is shared by the euro area NCBs in line with their capital shares.

So a risk but after so many stresses we have avoided that so far meaning it is there as a risk but the ECB has so far kept on top of it. The bigger issue is of course someone leaving the Euro as Mario Draghi stated. This poses all sorts of questions. The current fractious state of Brexit negotiations would presumably be considered to be something of a tea-party compared to this so there are genuine dangers. In such an environment the worst case scenario would be if the departing state refused to settle its deficit as after all it would likely be in deficit. Some argue that there is no deficit only claims and perhaps they have a point when everyone is still in the Euro as you can then argue that in essence this is simply a settlement system run by the ECB. But we return to what if you leave when you are now outside the system and refuse to settle up what would now be a deficit?


As I indicated earlier to my mind rather than being a problem in itself the Target2 issue indicates problems elsewhere. For example the German current account surplus or the way that ECB QE is settled mostly at the German Bundesbank. So when we see headlines like “debt” or “profit and loss” I am not convinced as it is an accounting system telling us about flows of cash. Of course cash flow leads many companies to come a cropper and indeed can do to governments as we are reminded again that this would not be a subject for debate beyond regional policy if there was fiscal and political union.

Somebody leaving seems likely to be an explosive event both politically and economically and in the turmoil lots would happen. For example a new currency for the country concerned and probably an element of default on debts too. This would bounce around the Target2 system but it would be an accounting identity rather than a cause.

Is Germany an economic miracle or a deflationary force?

There has been a raft of economic data out of the Federal Republic of Germany this morning but before we get to that there are two major themes I wish to point out. These come from its membership of the Euro which has given its exporting industry in particular an enormous competitive boost. To get an idea of the scale of these we merely need to consider where the Deutschmark would be trading now if it existed. The musical theme is “higher and higher it’s a living thing” by ELO. If we look at the most similar currency which is the Swiss Franc we see that a new Deutschmark would have soared like a bird and created all sorts of problems for the German Bundesbank in trying to cope with it and German industry. If the Swiss pattern was repeated then the Bundesbank would also be an enormous hedge fund with a central bank on the side. As for the exchange rate well it would be more like 1.50 to the US Dollar ( and perhaps higher) rather than the 1.05 that Euro membership has brought,

In addition Germany has seen low and more recently negative interest-rates with the deposit rate of the European Central Bank currently -0.4%. If there is anywhere that sees this translated into lower borrowing rates for businesses and consumers in the Euro area then Germany will be at the top of the list. Whilst I doubt that negative interest-rates themselves help much Germany has seen low interest-rates for quite some time now. In an example of the sort of “Not Fair” sung about by Lilly Allen we also see that the German government has benefited from some 304 billion Euros ( and rising) of its debt being bought by the ECB. It is seldom asked how wise or indeed necessary this is/was but for now let me simply point out that the ability to issue debt at low and negative yields has added further to Germany’s ability to run a budget surplus.

The trade problem

This is usually presented as an economic triumph for Germany and in many ways it is but with it problems have been created and we see these in this mornings data release.

Germany exported goods to the value of 108.5 billion euros and imported goods to the value of 85.8 billion euros in November 2016. These are the highest monthly figures ever calculated both for exports and for imports. Based on provisional data, the Federal Statistical Office (Destatis) also reports that German exports increased by 5.6% and imports by 4.5% in November 2016 year on year.

So not only a large trade surplus in goods but one which is growing so much it is a record. If we widen our outlook to services then the position changes but by a relatively small amount.

services (-1.8 billion euros)

If we look at the Euro area we see that Germany continues to be a deflationary influence on the other nations.

In November 2016, Germany exported goods to the value of 63.2 billion euros to the Member States of the European Union (EU), while it imported goods to the value of 56.9 billion euros from those countries.

This is not explicitly due to the exchange rate of course but makes us wonder what other gain have been provided by a lower exchange-rate such as possible economies of scale for its vehicle producers. If we move to outside the Euro area than the numbers speak for themselves.

Exports of goods to countries outside the European Union (third countries) amounted to 45.2 billion euros in November 2016, while imports from those countries totalled 28.9 billion euros. Compared with November 2015, exports to third countries increased by 7.6% and imports from those countries by 3.9%.

So we see not only a large and growing surplus but one that seems to be accelerating and here of course the value of Euro membership can be explicitly seen.

When the credit crunch hit there was a lot of talk about the German trade surplus being a factor ( along with the Chinese and Japanese ones) yet we see that as we sadly see so often if anything it has grown. The initial impact is to raise German GDP via net exports but the way that it happens year after year means that demand is sucked out of other countries. If you throw in the budget surplus I mentioned earlier then you have plenty of fuel for my argument that the theme that Germany keeps losing with regards to matters such as ECB policy needs the counterweight that in areas which it considers most important Germany continues to get what it wants.


This morning has seen another consequence of this.

In November 2016, production in industry was up by 0.4% from the previous month on a price, seasonally and working day adjusted basis according to provisional data of the Federal Statistical Office (Destatis)

This follows a 0.5% monthly increase in October but to see the overall picture we need to look deeper. If we look at the manufacturing output index then it was 100.2 in November 2008 and was 110.5 in November of last year. So we see growth over what has been a very difficult period for western manufacturing. Now those two months make it look better than I think it is but in general 2016 is better than 2008 whereas if we look at my country the UK we see a different situation.

In Quarter 3 2016, production and manufacturing output remained below their Quarter 1 2008 levels by 8.0% and 5.7%, respectively.

There has been good news this morning from both Rolls Royce and Jaguar Land Rover with their 2016 figures but it is plain that the UK has quite a bit of ground to catch up.

The outlook

The future is bright if the Markit business surveys are any guide. According to them Germany had a solid last quarter in 2016 and 2017 looks okay as well.

With services expectations also improving in December, the outlook for 2017 is bright – IHS Markit is forecasting solid GDP growth of 1.9% for the year as a whole.


If you are looking for support for the theme of Germany being something of an economic miracle then one would look at the trade position combined with this which was reported by Eurostat earlier.

the lowest unemployment rates in November 2016 were recorded in the Czech Republic (3.7%) and Germany (4.1%).

As we move to youth unemployment we see a further example but also a hint that perhaps a deflationary consequence has been seen elsewhere.

In November 2016, the lowest rate was observed in Germany (6.7%), while the highest were recorded in Greece (46.1% in September 2016), Spain (44.4%) and Italy (39.4%).

If we look back at the history of the Euro we see that it has benefited Germany hugely and that monetary policy has in general been set for it. There are doubts rising from the latest phase of negative interest-rates and 1.5 trillion Euros of QE ( Quantitative Easing) which have seen consumer inflation rise to 1.7% in some German regions with the likelihood it will push higher as 2017 progresses. Or as Die Welt puts it.


Actually in a link to my next part they are discussing Mesut Ozil who of course is trying to get a large pay rise from Arsenal football club which has to be inflationary. But many think that an increase in wages in Germany would improve things as highlighted by this below.

2017 price-wage loop check: wage bargaining rounds kick off in Germany with unions asking for 6% pay rise for 800k regional public servants. ( h/t @MxSba )

Of course in both cases asking is one thing and getting is another. But it has long been argued that higher wages in Germany would set off a beneficial cycle as follows. Workers would be able to consume more ( the original Ford motor car strategy as discussed in the comments a few days ago) thereby boosting imports and shrinking the trade gap as well thereby benefiting both the German and overseas economies. As Germany is estimated to be 5.5% of world economic output this could have a solid effect in world terms.

As ever life is unlikely to be that simple as for example what if the higher wages set of an inflationary push? Or make companies uncompetitive? But in general I think it is hard to argue that a nudge higher would be what economists call a Pareto gain.

How are our banks still in so much trouble?

A major theme of the credit crunch era has been the banking crisis in so many places followed by the many bailouts under the Too Big To Fail or TBTF strategy. The catch is that this week has seen more signs of distress for various banks more than 8 years after the collapse of Lehman Bros which by definition shows that the strategy such as it was is continues to fail. What is supposed to happen is that the can is kicked into the future via the bailouts and then we pick the can up later in better times. Indeed in the past central bankers have been able to bask in the reflected glamour of a successful intervention.

Economic policy has been warped to suit the banks

It bears repeating that the economic response has been more for the banking sector than the real economy. The initial slashing of interest-rates benefited them and the proliferation of QE improved the value of their bond holdings. Also in a rather transparent move countries cut interest-rates to a lower bound for their banks. What I mean by this is that the Bank of England stopped originally at 0.5% because it was afraid that the creaking IT systems of the UK banks could not cope with any negative numbers.

More recently we have seen blatant subsidies to the banking sector. The UK started one this week which is the Term Funding Scheme where UK banks will be able to borrow up to £100 billion at an interest-rate of 0.25%. This of course follows on from the Funding for (Mortgage) Lending Scheme which not only gave then cheap finance but boosted one of the main assets house prices. Only yesterday the Bank of Japan warped its buying of equities towards an index in which banks are more strongly represented. The TOPIX bank index rose by 7% on the day.

Also banks are often excepted from negative interest-rates either by also being given money at the negative interest-rate ( i.e even better than free money) like the TLTROs of the European Central Bank or simply being excluded from them like in Japan. Actually the -0.1% interest-rate there is more honoured in the breach than the observance.

House prices

A big gain for banks is rising house prices a subject I have covered extensively in the UK. This week has given us some news on this front from the Euro area as some countries respond to all the monetary easing. From Netherlands Statistics.

Prices of owner-occupied houses (excluding new constructions) were on average 6.0 percent higher in August 2016 than in August 2015. This is the most substantial price increase in 14 years.

And on Tuesday Portugal Statistics joined the party.

In the second quarter of 2016, the House Price Index (HPI) registered an increase of 6.3% when compared to the same period of the previous year….When compared to the first quarter of the year, the HPI increased by 3.1%

Now these are only 2 of the Euro area countries but we do get a clue that the picture has changed for this major part of banks asset books.

UK Banks

The Bank of England has summed up the situation only this morning.

Market valuations of major UK banks remain, in aggregate, well below their book value.

This poses a direct problem for the TBTF strategy as the investments of the UK taxpayer are currently well underwater especially in the perpetually crisis ridden Royal Bank of Scotland. It symbolically has fallen another 2 pence today to £1.81 which compares to a peak over the past year of £3.34. With the travails of the world shipping industry it was sadly typical to find the accident prone RBS affected. Lloyds Banking Group at 56 pence is also well below the price at which the UK taxpayer invested although some of the shares were sold in better times. Whilst HSBC for example has done much better in share price terms the two main bailed out banks have hit more trouble after all these years. Also there is an implicit admittal from the Bank of England that it is still providing a subsidy.

bank funding costs remain significantly lower than during previous episodes in which market valuations have been well below book value.

Deutsche Bank

The topic du jour in banking and semaine and mois. For all the official proclamations that everything is fine we see rumours continue to circle particularly about the derivatives book. Yesterday its share price fell back close to its lows again and whilst it has rallied today the current price of 11.44 compares to a high of 27.98 Euros over the past 12 months. It faces a conundrum where it would like more share capital but that is increasingly difficult due to the low share price. A vicious rather than a virtuous circle is in play as represented by this from Bloomberg.

Leverage ratio — a lender’s capital measured against its assets — at Deutsche Bank lags behind the rest of the world’s major banks, according to data released Tuesday by Federal Deposit Insurance Corp……While it’s not an official scoring by the FDIC, Hoenig’s calculations put more emphasis on derivatives exposure,

There are obvious issue such as the upcoming fine over mortgage miss selling in the US. It is likely to be a fair bit below the US $ 14 billion mooted but none the less Deutsche could do without it right now. Of course it has not actually been bailed out except implicitly but we have to ask how it has such problems 8 years down the road.

Monte dei Paschi

The world’s oldest bank seems like an old friend on here now. It was only a few short weeks ago when we were told that everything was on its way to being fixed and yet yesterday Reuters reported this.

Monte dei Paschi shares fell for eight sessions in a row, shedding 26 percent of their value, after the unexpected resignation of CEO Fabrizio Viola on Sept. 8 added to uncertainty over the lender’s future.

This particularly matters right now because it does this.

a string of losses that have shrunk the bank’s market capitalisation to one ninth of the size of a planned 5 billion euro (4.31 billion pounds) share issue.

You get an idea of the scale of the change as I remember making a mental note that it was one fifth back then as opposed to the one ninth now. Ouch!

If we move to the wider issue of the Italian banking sector it is true that the Non Performing Loans look like they are topping up. The problem is that share prices and hence bank capital have fallen much more quickly.


As time passes it becomes ever more glaring that many of the banks were not fixed but simply patched-up and told to carry on. It is not just a European issue but that area is making the news right now with Fitch pointing out problems for Portugal earlier today a subject I covered on the 25th of July.

But asset quality is still a major weakness for the banking sector and, in our opinion, makes banks vulnerable to downside risks from the highly indebted Portuguese economy. The unreserved portion of problem assets exceeds 100% of capital at CGD, BCP and Montepio.

Indeed there was not much sign of European solidarity in this reported by Reuters about Italian Prime Minister Renzi on Monday.

Italian Prime Minister Matteo Renzi said on Monday that Germany’s central bank chief Jens Weidmann should concentrate on fixing the problems of his own country’s banks, after Weidmann had urged Italy to cut its huge public debt.

Renzi told reporters in New York that Weidmann needed to solve the problem of German banks which had “hundreds and hundreds and hundreds of billions of euros of derivatives” on their books.

So after all these years the words from Alice In Wonderland sum it up well.

In another moment down went Alice after it, never once considering how in the world she was to get out again.

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