The plight of Deutsche Bank, as it struggles under the burden of a heavy impending fine from the US justice department over mortgage securities mis-selling, serves to highlight the extraordinary contrast between the fragile financial condition of German banks and the robust finances of the German non-financial corporate sector. This is symptomatic of a wider global malaise.
In the case of Germany the story is one of a country that has long been overbanked, with a mass of regionally entrenched co-operative and public sector savings banks that are overdue for consolidation. Yet they are so cosily bound up with local politics that consolidation never happens and banks remain undercapitalised. Now their condition is deteriorating further as a result of the European Central Bank’s negative interest rates that impose a further squeeze on bank margins.
Deutsche Bank understandably sought to escape from this fragmented market in which it had a poor retail presence by breaking into investment banking in London and New York. That has proved to be a less than happy experience, culminating in the recent share price collapse.
Meanwhile, the big German companies that used to constitute Deutsche’s core clientele are awash with cash. In normal times the corporate sector is a net borrower from the household sector, courtesy of the intermediation provided by bond markets and the banking system. Not so today. The corporate sector became a net lender to the rest of the economy before the financial crisis. Since then its net savings — net profits minus dividends — have accelerated, rising from 1.7 per cent of gross domestic product in 2013 to 3.5 per cent of GDP in 2015.
Germany is not alone in this. Since 2000 all the G7 economies apart from France and Italy have experienced the same phenomenon. In part this reflected the bursting of the dotcom bubble and the investment shortfall that followed. After the financial crisis, investment once again weakened, while reduced interest payments resulting from the central banks’ asset-buying programmes became an important contributor to the corporate savings glut, as did the windfall gains arising from the oil price fall. In the extreme case of Japan, net corporate saving has been running at close to 8 per cent of GDP.
In flow of funds terms, if one sector of the economy runs a surplus the rest of the economy has to run an offsetting deficit. In Germany’s case it is the overseas sector that balances the net savings of the corporate sector, along with savings surpluses of the household and public sectors. So corporate sector behaviour is a key driver of an outlandish German current account surplus that is approaching 9 per cent of GDP, which is a drag on demand not only in the eurozone but in the rest of the world.
The overseas sector performs a similar task, though on a much smaller scale, for the other corporate savings glut countries with the single exception of Japan. There the glut has been partly a result of the adverse impact of demography and deflation on investment. It also reflects an imbalance in an economy that suffers from a structural deficiency of consumer income leading to weak consumer demand. Excess corporate savings have been offset by the public sector, with the consequence that gross government debt has risen to a frightening and potentially unsustainable level of about 250 per cent of GDP.
Leaving Japan aside, the rise in corporate savings is a wider matter of concern and just because of the emergence of low or negative yields. Economists at the Federal Reserve have found a strong link between corporate net lending and macroeconomic performance in a survey of 26 OECD countries. Their data suggest that countries with the greatest shortfall in growth since the financial crisis have been those with larger increases in corporate lending. And they conclude that this appears to represent a significant leakage of demand.*
For policymakers at the big meetings in Washington this week the lesson is that any escape from today’s low interest, low growth world must entail putting the corporate savings glut high on the agenda, with serious consideration being given to the tax treatment of depreciation, dividends and retained earnings.
* The Corporate Saving Glut in the Aftermath of the Global Financial Crisis, Joseph W. Gruber and Steven B. Kamin, June 2015.