Stupid German Money
How you own the world and still lose.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
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An interesting headline popped up on my screen today: After 30 years, Germany has taken the crown from Japan for being the largest net creditor to the rest of the world. What sounds like the manifestation of economic prowess is in fact a tragedy for the German people.
TLDR Summary
Germany’s €3.5tn net international investment position is the result of currency suppression due to the Euro introduction which suppressed wages and consumption and made its economy hypercompetitive in international trade. This impoverished and enslaved its population and robbed the domestic economy of its growth potential.
Technological innovation now happens in the US and China, aided by German capital, but not for the benefit of the German people. The level of the country’s foreign assets is egregious, but bizarrely not as high as it should be given even higher cumulative trade surpluses. Germans have lost almost $1tn over the last 20 years from suboptimal foreign investments. In the long run, German trade surpluses have to be viewed as a donation.
Based on Bundesbank data, Germany had €13.9tn total external financial assets at the end of 2024 against liabilities of €10.4tn, leaving a net international investment position (NIIP) of €3.5tn. You may have seen slightly different figures floating around citing the Japanese government as the source. I suppose those differences have to do with currency conversion.
The NIIP is the difference between all foreign assets held by German residents and all domestic assets held by foreign residents. It’s a huge amount. More than €40,000 per citizen.
This brings up a few questions. How did that happen? Why did that happen? And is it a good or a bad thing? Let’s tackle those questions separately.
How did that happen?
Trade surpluses are obviously the key. When people discuss international trade, they tend to focus on the trade balance. But to understand the macro environment these days, the capital balance is at least of equal importance, if not more. When a country has a trade surplus, it means that it sells a good or service to another country and reinvests the proceeds abroad.
As evidenced in the chart below, Germany has had enormous trade surpluses over the last 25 years. The cumulative trade surplus over that period is €4.4tn. As a result, its net international investment position grew from pretty much nothing to €3.5tn.
Why did that happen?
This data suggests that there was a major paradigm shift in the early 2000s. At that time (and most of the times before), Germany had a fairly balanced NIIP.
Then, Germany formally introduced the Euro in 2002. Pegging its currency to its southern neighbors weakened Germany’s currency. It suppressed wages which suppressed consumption and made its economy hypercompetitive in international trade. The result is that Germans frantically produced for foreigners, especially the US and China. I elaborated on that in more detail in the article below.
And is it a good or a bad thing?
Some Germans and German residents have benefited from this development, most importantly those owning domestic production facilities. They were able to convert this FX dividend into profits and in a second step into claims on foreign assets generating income for them. But for most of the German population, it’s a tragedy for several reasons.
Firstly, exporting capital drains the economy and robs it of its growth potential. Imagine if Germany had invested €4tn domestically rather than sending it abroad. For example into (IT) infrastructure and education. It could be a technology powerhouse right now. Instead, virtually all innovation now happens in the US and China. Some of that is facilitated by German capital, but not to the benefit of the German people at large.
Secondly, other export nations have used their trade proceeds to build large sovereign wealth funds. For example, the Japanese government pension fund has $1.5tn in assets, half of which is invested abroad. Norway has a $1.7tn fund that invests nearly all of its assets abroad. The China Investment Corporation has $1.3tn in assets, much of which is invested abroad. And Germany? There is nothing of that sort. Germany’s foreign investments are primarily in the hands of private entities which aggravates inequality. The public pension plan is entirely unfunded and requires €100bn in tax money every year to continue its operations because contributions fall short of payouts. And that is already before the greatest retirement wave in its history.
Thirdly, as evidenced in the chart above, Germany’s net international investment position is lagging its cumulative trade surpluses by about €900bn. This is the cumulative return that Germans have earned on their trade surpluses over the last 25 years. A loss of about €10,000 per citizen.
Germans have invested their trade proceeds very poorly. First into subprime mortgages, then excessively into bonds and not enough stocks. Germans have a very pronounced volatility aversion and a desire to own income assets which have underperformed greatly over the last few decades.
This paper is a bit dated, but it tells the same story. German investors underperform.
T2 balances are the most egregious example of capital misallocation. These are central bank claims against other central banks within the Eurozone and account for about a quarter of Germany’s NIIP.
T2 balances
When entities from two Euro countries trade with one another, their banks don’t transfer money to each other directly. Instead, they transact with their domestic central banks which will then transact with the ECB.
For example, if an Italian buys a car from Germany, the Banca d’Italia sends money from their account with the ECB to the Bundesbank’s account with the ECB. The Banca d’Italia ends up with a liability against the ECB and the Bundesbank has a claim against it.
These balances are not just accounting artefacts. It’s important to understand what they represent. Imagine that we did not have a legal currency union in Europe. Instead, we wanted to accomplish it synthetically through open market operations. If we wanted to fix currencies with market forces, central banks would have to buy and sell currencies to counter market swings.
For example, if the Mark appreciates because of Germany's trade surplus with Italy, the Bundesbank would have to buy Lira against Marks. The T2 balances represent exactly that. They are the FX reserves against other Euro countries that Germany would have acquired over time if they had fixed their Mark against other local currencies through market operations. Since the introduction of the Euro, the Bundesbank has accumulated €1tn in T2 balances.
The problem is that Germany can never use these FX reserves in a way that China does it right now. They cannot liquidate them to deploy the capital elsewhere. These liabilities are not tradable and are never settled. They remain in the system forever with a pitiful interest rate equal to the ECB policy rate.
Sincerely,
Rene