Eurozone needs a German sovereign wealth fund

 
By Daniel Gros and Thomas Mayer

With the advent of the euro, exchange rate risk within the Economic and Monetary Union disappeared, and Germans were able to invest their excess savings in the common currency. As a result, German surpluses grew to become ingrained at 6 per cent of gross domestic product, more than a quarter of national savings.
 
However, German investors’ appetite for eurozone public and private debt has diminished sharply. Investment outside the eurozone is not an alternative, since a large part of German savings are intermediated by banks, which cannot take exchange rate risk. To avoid a breakdown of the financial system, the public sector has had to step in, with the Eurosystem – the network of eurozone central banks – becoming the main intermediary of savings from surplus to deficit countries. Its role is reflected in the imbalances within Target 2, the interbank payment system, which broadly correspond to eurozone countries’ accumulated current account positions since the introduction of the single currency.
 
The Eurosystem’s intermediation of large private sector savings surpluses is not necessarily abnormal. On the contrary, there are few countries in which large external surpluses are intermediated for long periods exclusively by the private sector. In most countries running persistent current account surpluses, the government or the central bank has accumulated foreign assets through either a sovereign wealth fund or foreign exchange intervention. Saudi Arabia and Norway are classic examples of surpluses based on natural resources intermediated by the public sector through a sovereign wealth fund. Switzerland and Japan illustrate the tendency of nations with structural private sector surpluses to rely on central banks.
 
The question is whether the public sector intermediates large surplus savings efficiently. From a German perspective, intermediation by the Eurosystem is inefficient. True, the Bundesbank shares credit risk incurred through the accumulation of Target 2 claims against the European Central Bank with other countries, through the distribution of any losses according to their shares in the ECB. But the Target 2 claims represent a portfolio concentrated both geographically and across asset classes. Target 2 claims are ultimately backed by the securities of banks in deficit countries delivered as collateral for ECB credits under the various facilities. A large part of these securities is probably of dubious quality.
 
Moreover, the ECB offers German banks a nominal interest rate of zero, which translates into a negative real return for German savers. Meanwhile it demands only 75 basis points on its lending to banks in the eurozone periphery – insufficient to cover the risks of the ECB’s operations. Finally, the ECB is unable to offer German savers any longer-term investment vehicles.
 
An alternative to the present system for managing Germany’s savings surplus would be a German sovereign wealth fund. Imagine a government agency offering German savers a secure vehicle, guaranteeing a positive real interest rate, with a top-up when investment returns allowed. It would invest the funds in a diversified portfolio, including assets outside the eurozone, which given stronger growth prospects would be more likely to generate positive real returns in the long run. Since it would channel a significant amount of funds outside the eurozone, the euro would depreciate. This would help countries presently struggling to revive growth through exports and to close their external deficits. Imbalances would gradually disappear and German foreign assets would move from zero interest nominal claims on the ECB to diversified real and nominal claims on various private and public foreign entities in a variety of asset classes.
 
One might, of course, object that our proposal presents a typically German mercantilist view, which transfers the burden of adjustment to the rest of the world. But under the current circumstances, one has to choose the lesser evil: a strong euro combined with ever-increasing internal tensions that threaten global financial stability; or a weaker euro without internal tensions. We believe that the global economy will be better off under the second scenario.
 
Daniel Gros is director of the Centre for European Policy Studies in Brussels. Thomas Mayer is senior adviser to Deutsche Bank
 
Copyright The Financial Times Limited 2012.