All hail the Euroglut, that oh so corpulent result of Europe’s (read: Germany’s ) huge excess savings — which hit a record €234bn at the end of last year as oil prices collapsed and are projected to hit €300bn over the course of 2015 if oil prices stay that way.
You can, in part, blame said Euroglut (along with ECB QE and negative rates) for this type of thing…
As to the eventual size of these outflows? Well, Deutsche’s George Saravelos and Robin Winkler, they of the original Euroglut conception back in September, have attempted to go beyond just “massive”. They’re guessing the adjustment being talked about here will eventually demand net capital outflows in the region of €4tn – that would mean a continuation of the current pace of outflows for the next eight years. Nice to know roughly what “massive” means, at least.
First though, from Deutsche, on those yield-hungry ouflows so far (with our emphasis):
The large current account surplus combined with ECB easing and negative rates has initiated a process of large-scale capital outflows from Europe. In the second half of 2014, the euro area saw record net investment in foreign portfolio assets, reaching €135bn in Q4 (Figure 3), or around half a trillion in annualized terms. There are no indications that this trend has reversed or slowed down since. More than 90% of these flows are attributable to fixed income, though equity outflows accelerated markedly in December. At the same time, ‘other investment’ outflows- –mostly bank lending in the European periphery—have diminished relative to the financial account. The expansion of the Eurozone’s financial account has thus been driven by portfolio outflows. This stands in stark contrast to the pre-crisis decade, during which the Eurozone recycled its intermittent and meager surpluses through EUR-denominated loans to the European periphery.
Portfolio outflows from the euro area have been searching for yield overseas. Relative to the allocation of the EMU’s total stock of foreign portfolio assets, recent flows have disproportionately favoured assets in the US, the UK, and Canada (Figure 4). By contrast, the rest of the European Union—Scandinavia and Eastern Europe—have seen disproportionately small outflows as a result of being drawn into the Eurozone’s disinflationary spiral. If one plotted outflows against assets at the beginning of the four-quarter period, the new investor bias towards the Anglo-Saxon countries would be even starker.
And, thing is, the euro area is far from being a Japan-style net creditor — it currently owes the world roughly 10 per cent of its GDP and Deutsche say it “will take trillions of Euros worth of further investment outflows as well as significant depreciation over several years for the euro area to accumulate the net foreign wealth position associated with mature creditor economies.”
In other words, ” like Japan, Europeans will need to turn into net creditors to the rest of the world to mirror structurally higher saving preferences. In turn this means that Europe’s negative net international investment position needs to turn positive. Europeans will need to own more foreign assets than foreigners do in Europe.”
Obviously, not all euroland net international investment positions (NIIP) are created equally and the imbalance represented by the euroglut can be seen replicated within the eurozone itself . Fun, particularly considering the Euroglut will now become the key determining factor driving European policy:
The Eurozone’s incomplete transition is palpable when plotting average G10 current accounts against the latest NIIPs for Q3 2014 (Figure 7). All countries except the euro-area are in balance, with their structural surpluses (deficits) reflected in positive (negative) NIIPs. The EMU cuts a lonely figure in the bottomright quadrant. 3 We also include South Korea, which scraped into the first quadrant only last autumn following a twenty-year adjustment process. Korea is further advanced than Europe on a similar path towards economic Japanization, and we therefore study its case in more detail below.
The external accounts of individual member states vary significantly.4 Germany and the Netherlands are long-standing creditor nations. Germany’s NIIP remained positive even as it borrowed heavily during the 1990s to finance reunification. Yet while Germany and the Netherlands account for much of Europe’s surpluses, others are behind the structural shift: the GIIPS. Those states whose governments were on the verge of default in 2012 had also accumulated vast external debt ratios. Post-2012 austerity extends to their external accounts, but despite painfully sustained current account surpluses, it will take a generation for Greece and Spain in particular to align their NIIPs with their newly found prudence.
Now comes the actual guesswork and, as Deutsche admits, modelling stationary conditions for NIIPs is one of the most central and contentious exercises in modern macroeconomics… But:
The most data-driven approach is to pool all stock-flow observations for the G10 space ex-Sweden over the past twenty years. A simple regression suggests that the current external surplus of the euro area would be consistent with a NIIP of roughly 30%. This estimate varies by a few percentage points as one includes time and/or country effects, effectively running a panel regression. 6 Yet while this exercise necessarily remains indicative, it does yield a strong sense that the stockflow adjustment will not be complete at any NIIP levels below 30% of GDP.
On this baseline estimate of a terminal NIIP of 30%, the Eurozone would need to invest 40% of its current GDP abroad in net terms, at least in the absence of valuation and growth effects. This amounts to a staggering €4 trillion. Assuming net financial outflows of €150bn a quarter, this process will take the rest of the decade.
With the exchange rate being endogenous to this process, the depreciation of the Euro caused by large outflows will both speed up the process and reduce the outflows required for adjustment. A weaker Euro raises the value of European assets abroad, mechanically raising the NIIP. A sensitivity analysis indicates that further Euro depreciation by 20% would shave only around 10% off the outflows implied by a 30% NIIP.
To summarise, that suggests the Eurozone’s NIIP needs to rise from -10 per cent of GDP to at least 30 per cent for Europe’s CA surplus to become sustainable and that even if negative rates and ECB QE have and will accelerate this process it’s still going to be decades before it’s finished. Which in turn suggests that euro weakness — along with a more general pressure on foreign asset prices, bond yields and an urge to use Exorcist gifs — is here to stay.
As Deuctsche suggest (while forecasting a EURUSD move down to 1.00 by the end of the year and a new cycle low of 85cents by 2017) :
Importantly, the fall in the Euro since Q3 cannot have fully priced these outflows due to its sheer magnitude. Even the speculative FX market would be too small to price this immense shift in Europe’s economy ex ante even if participants fully understood the massive implications of Euroglut.
Ultimately, portfolio outflows are likely to exceed the euro area’s current account surplus even under extremely conservative assumptions as to the pace of NIIP adjustment. The current pace of portfolio outflows is double the current account surplus, explaining the recent weakness of the Euro. Even if one assumes that the pace of adjustment slows and that it would take a decade for the new NIIP equilibrium to be reached, portfolio outflows would still exceed the current account surplus, maintaining downward pressure on EUR.
In closing, Europe is the new China and will be the new Japan. Or something.
UPDATE at : Via Raja Korman here’s some Gabriel Zucman demonstrating the opacity of this stuff and a further warning that DB’s guesswork is, er, guesswork. From Zucman’s abtract (our emphasis as usual):
This article shows that official statistics substantially underestimate the net foreign asset positions of rich countries because they fail to capture most of the assets held by households in offshore tax havens. Drawing on a unique Swiss data set and exploiting systematic anomalies in countries’ portfolio investment positions, I find that around 8% of the global financial wealth of households is held in tax havens, three-quarters of which goes unrecorded. On the basis of plausible assumptions, accounting for unrecorded assets turns the eurozone, officially the world’s second largest net debtor, into a net creditor. It also reduces the U.S. net debt significantly. The results shed new light on global imbalances and challenge the widespread view that after a decade of poor-to-rich capital flows, external assets are now in poor countries and debts in rich countries. I provide concrete proposals to improve international statistics.
Related links: All about the eurodollars – FT Alphaville The Japanisation of Europe – Fistful or Euros Negative rates coverage – FT Alphaville Global macroeconomic imbalances are shrinking (and not) – FT Alphaville Financial globalisation not so great – FT Alphaville