Capital flight towards Germany

Peugeot’s holding in Opel sounder than Target-2 claims

Peugeot, the French car maker, is taking over Germany’s Opel. HNA, the Chinese conglomerate, is buying a significant stake in Deutsche Bank. The German Bundesbank’s claims under Target-2 (the euro area’s real-time gross settlements system) have reached a new record. German bond yields have hit new lows.

At first sight these are unrelated. Yet they have something in common. Each signals capital flight towards Germany.

Political uncertainty has instigated a new wave of capital flight out of China since the summer of 2015. Based on estimates from the Institute of Empirical Economic Research at Osnabrück University, up to 2% of GDP annually is moved across borders beyond what is visible in Beijing’s official statistics. After years of exports exceeding imports, China is diversifying its foreign asset portfolio, including the investment in Deutsche Bank. While the official foreign currency reserves are mainly held in government bonds, this private investment helps a more efficient allocation of Chinese savings.

The negotiations by Peugeot to take over Opel is another sign of capital flight towards Europe’s largest economy. Elections in France are scheduled for April and May and Marine Le Pen, the right-wing National Front candidate, is openly advocating leaving the euro area if elected. Clemens Fuest, the new president of the Munich-based Ifo Institute for Economic Research, has called for capital controls if Le Pen wins. French investors and businesses might anticipate this development and start insuring themselves against such an outcome. In the case of a euro break-up, the remaining euro area members, including Germany, are likely to experience a currency revaluation against the new French franc. This would give Peugeot a revaluation gain, even if the sales and profits of Opel do not improve.

In contrast to China, however, good export performance is unlikely to be the main source of funding from France. Instead, the European Central Bank is providing ample liquidity which needs to be invested somewhere.

While German investors simply hand back the money to the Bundesbank’s deposit facility, French investors appear to have a better strategy. Instead of submitting to an interest rate of minus 0.4%, they buy a company that – at least from the outside – does not appear to have a bright future. But the ‘flight to safety’ motive is strong and makes up for other shortcomings.

The new record level in Target-2 claims of the Bundesbank is likewise due to capital flight. Liquidity that is created somewhere in the euro area and transferred to Germany requires the Bundesbank to create the money and credit it to a customer’s reserve account. In return, the Bundesbank gets a Target-2 claim and the counterparty a Target-2 liability. This is the case regardless of whether the markets, or more recently the central banks themselves via QE, are triggering the transaction.

Target-2 claims are part of Germany’s net foreign assets, just like foreign currency reserves. This is often overlooked, as they are recorded in the balance of payments statistics under ‘other investment, monetary financial institutions’. The footnotes explain that this includes the Bundesbank. However, there is a big difference to the official reserves: Target-2 is merely a book-value entry at the ECB, not a marketable asset. Unlike China, Germany cannot diversify the risk of Target-2 holdings, currently €796bn, or nearly a quarter of GDP. There is no due-date, no upper limit and – at least currently – no interest rate.

Target-2 claims hardly constitute a safe asset. Peugeot’s holding in Opel might be a sounder bet.

Frank Westermann is Professor of Economics at Osnabrück University.

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