Some thoughts on a German Sovereign Wealth Fund

Over the past couple weeks - in facts months - we have been blogging on the future of the euro-zone and on the economic and political rationale behind recent developments. And the response in the sequential blog debates was rich and interesting to say the least, looked upon from all various angles and for which I would like to thank my faithful little audience. Today, an opinion article appeared in the FT by Daniel Gros (Director CEPS) and Thomas Mayer (Deutsche bank) - "Eurozone needs a German sovereign wealth fund" - based upon their voxeu contribution which can found through the following link :

http://www.voxeu.org/article/german-sovereign-wealth-fund-save-euro

Now I think the article deserves some attention, not because one is pro or counter the idea, but because of other reasons. Daniel Gros for example has been critical in the past upon various solutions put forward to save the euro-zone. But in this article, it goes further than the mere tackling of ponzi schemes or other kicking the can down the road lines of thinking.

The key central point of the authors is that the current eurosystem of intermediation is inefficient, not in the least for Germany for that matter. When the single currency kicked off - eliminating intra-european exchange rate risk - Germans were able to invest their excess savings into euro-denominated assets. The German surplus became structural at 6% of GDP, almost 25% of total domestic savings. But now the appetite of the German investor for EMU government bond assets has waned substantially. And a first problem raised by the authors is that German savings are intermediated by banks which cannot take exchange rate risk (or very limited). So they are tied up as well within the EMU framework.

So to avoid a total collapse, the public authorities came to the intermediation rescue through the Eurosystem channel (central banks and Target2). The problem however here is that the Target imbalances more and more reflect the current account problems between core and periphery, that capital flight from out of periphery banks banks etc. And the total imbalances have become quite large, as presented by the graph taken out of the voxeu study, with Germany in the plus for over 700 bio EUR and Spain the largest in the red for some 400 bio EUR :

Now concerning the inefficiencies, Gros sums them up as follows

1) Target2 claims represent a portfolio concentrated both geographically and across asset classes. And let's not go too deep into the collateral delivered for fr various ECB credits.

2) The ECB currently offers German banks a 0% interest rate (negative real return). At the same time, it only demands 0,75% on its lending towards EMU banks which is insufficient to cover the risk of ECB operations. And finally, the ECB - to some extend equal to German banks - is unable to offer longer term investment opportunities towards German savers. So the authors come up with the following proposition : "Imagine a government agency offering German savers a secure vehicle, guaranteeing a positive real interest rate, including assets outside of the euro-zone"

Before giving a headstart to the discussion, note that for the Norway pension fund, the negative real interest rate situation has also appeared with Norway's sovereign yield curve being 1% on the short end and 2% on the long end. The authors are fair enough to admit the following consequences of their proposition :

"One might object that this is a mercantilist view which basically transfers the burden of the euro problems to the rest of the world (investment out of the euro-zone weakening the currency). But may be one has to choose for the lesser evil : either a strong euro combined with ever increasing internal tensions or a weaker euro without these tensions. In addition, the weaker currency might help strong deficit countries to revive their export growth outlook and hence GDP outlook"

So the question remains whether these arguments and propositions are a track to follow, either for the greater political good, the benefit for an investor being able to escape ground zero rate land or which other reason one can come up with. Or is it just an episode in the global saga of currency wars ? The floor is yours and feel free to add more arguments for the sake of an open debate.