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1、,November 1,2012Issue No:12/28European Economics AnalystEconomics ResearchEverything flows:The flow of funds,stagnation and divergence,Facing stagnation at the area-wide levelThe Euro areas flow of funds suggests stagnation at the area-wide leveland divergence between parts of the Euro area.Both fea
2、tures seem likelyto persist for as long as ECB policy finds transmission to the peripheraleconomies problematic and structural reforms,especially in the periphery,take time to pay off.,Huw Pill+44(20)7774-8736 Goldman Sachs InternationalKevin Daly+44(20)7774-5908,Goldman Sachs InternationalArea-wide
3、 picture captures disinflationary forces,Private-sector deleveraging(i.e.,running a financial surplus)and public-sector austerity(i.e.,reducing the public-sector deficit)require,through thelogic of financial balances measured in the flow of funds,a rising currentaccount surplus.It is also likely to
4、result in the public-sector balance beingweakened by stagnation,while the current account improves throughstagnation.Overall,balance sheet adjustment has implied stagnation,which itself complicates the process of completing the desired adjustment.while a Germany versus Spain comparison captures dive
5、rgenceThe fact that deleveraging and austerity apply to different degrees betweencore and periphery contributes to divergence.A comparison of Germanyand Spain captures this.In Germany,a falling private-sector surplus hassupported activity.This has also limited the area-wide fall in activity.InSpain,
6、a substantial swing in the private sectors financial balance hasended what was substantial debt accumulation.But it has not yet deliveredmuch outright deleveraging.The private sectors financial surplus in Spainis still smaller than that in Germany.Bank balance sheets reflect and reinforce wider dele
7、veragingThe mirror image of private-sector deleveraging and economic stagnationis shrinkage in bank balance sheets.Yet banks have also spurred onprivate-sector deleveraging through their own attempted deleveraging andtightening of credit conditions.As the flow of funds also shows,the(non-,Dirk Schum
8、acher+49(69)7532-1210 Goldman,Sachs&Co.oHGAndrew Benito+44(20)7051-4004 Goldman Sachs InternationalLasse Holboell Nielsen+44(20)7774-5205 Goldman Sachs InternationalNatacha Valla+33(1)4212-1343 Goldman Sachs InternationalAntoine Demongeot+44(20)7774-1169 Goldman Sachs InternationalSebastian Graves+4
9、4(20)7552-5748 Goldman Sachs International,financial)corporate sector has tried to bypass the banking system in orderto contain this forced deleveraging.But that is a difficult thing to do in theface of a heavily bank-based financial system especially in peripheraleconomies such as Spain.Investors s
10、hould consider this report as only a single factor in making their investment decision.For Reg AC certificationand other important disclosures,see the Disclosure Appendix,or go to,The Goldman Sachs Group,Inc.,Goldman Sachs,1,2,November 1,2012,European Economics Analyst,Everything flows:The flow of f
11、unds,stagnation and divergenceThe Euro areas flow of funds suggests stagnation at the area-wide level and divergencebetween parts of the Euro area.Both features seem likely to persist for as long as balancesheet adjustment(by private and public sectors)is ongoing,particularly as ECB policytransmissi
12、on to the peripheral economies remains problematic and structural reforms inthe periphery have yet to pay dividends.The flow of funds measures investment and saving decisions,how these are financed andwhat such flows imply for aggregate balance sheets.Where balance sheets start from iscritical.Balan
13、ce sheets capture the legacy of past decisions(about borrowing,lending andasset prices)that,in many cases,have needed correcting.Defaulting on past debts is oneway of correcting balance sheet positions(the stocks).But the more that option is ruledout,the more that adjustment comes through investment
14、 and saving decisions(the flows)and stagnation.Private retrenchment has combined with fiscal austerity.Because external demand hasstruggled to fill the gap,flows of funds are being brought into balance through area-widestagnation.The process of aggregation and satisfying the adding-up constraint imp
15、lied bythe flow of funds complicates households and companies plans for deleveraging resulting in stagnation.This happens because the saving plans of private and publicsectors designed to adjust balance sheets combine to imply deficient demand.That these effects operate differently in different part
16、s of the Euro area contributes to risingdivergence.A comparison of Germany and Spain is especially instructive.While Germanyavoided a pre-crisis credit or asset price boom,Spain experienced both on an intense scale.Although uncertainty weighs on the outlook in Germany,other factors make for a resili
17、entexpansion of its domestic demand.Private-sector deleveraging both contributes to and is spurred on by a reduction in banksbalance sheets.The resulting effects of tight credit supply on money,activity and inflationhave only been partially offset by the ECBs policies.1Exhibit 1:Company sector accou
18、nts for falling area-wide saving,20151050-5-10-15-20,%yoy,NFCsFinancial corporationGeneral government,Gross saving,-25-30,00,01,HouseholdsEuro area domestic economy02 03 04 05,06,07,08,09,10,11,12,Source:ECB,GS Global ECS ResearchSee European Economics Analyst 12/27 Potential ECB easing:When,how and
19、 the zero lower bound,October 25,2012.Goldman Sachs Global Economics,Commodities and Strategy Research,3,November 1,2012,European Economics Analyst,Budget constraints will be satisfied but not always as intendedMacroeconomics matters because certain constraints must be satisfied at an aggregatelevel
20、.Moving from a households or a companys saving and investment plans to theaggregate requires that those constraints are met.Yet that may only be possible bychanging the aggregate output,employment and prices(including asset prices)that theindividual household or company was initially inclined to tak
21、e as given.This is the logic we look for in the flow of funds.Using area-wide flow of funds,we findthat:A decline in company saving(retained profits),partly on account of fallingcorporate incomes,was the major factor behind lower area-wide saving up to Q1(Exhibit 1).But because investment has fallen
22、 more than saving(Exhibit 2),the Euro areascurrent account position with the rest of the world has improved(Exhibit 3).The adding-up constraint across sectors their net lending balances must sum tothe current account balance has been satisfied through stagnation.Stagnationhas pushed up the fiscal de
23、ficit(at the same time that austerity reduces it)and hascontributed to an improvement in the current account.The flow of funds highlights households and corporates cautiousattitude at the area-wide levelSaving flows(Exhibit 1)indicate that a decline in saving by the corporate sector(i.e.,fallingreta
24、ined profits)accounts for much of the overall fall in the growth of savings in the year toQ1.Investment by each sector(Exhibit 2)also highlights the role of the corporate sector inaccounting for the fall in rates of growth in investment at the area-wide level(see EuropeanEconomics Analyst 12/26 Unce
25、rtainty weighing on investment spending).Yet,it is also notable that this weakening in investment is by no means comparable to thepost-Lehman collapse in investment.At that time,declining company investment saw area-wide investment fall at annual rates of 10%.Recent quarters have instead seen compan
26、yinvestment,and with that aggregate investment,stagnate on an annual basis.Net lending brings together each sectors saving and investment decisions.Net lending(or the financial balance)indicates(Exhibit 3):In the aftermath of the crisis,the household sector has run a somewhat largerfinancial surplus
27、.This surplus is the household sectors means of deleveraging.Compared with the pre-crisis period,the corporate sector has also delevered,moving from incurring a significant financial deficit to a surplus.The financial systems deleveraging sees both sides of its balance sheet contract(or stabilise in
28、 nominal terms).This can imply very little for the sectors net lendingposition.Nonetheless,Exhibit 3 shows that financial corporations surplus hasbeen steady to rising in recent quarters,as financial corporations have rebuiltcapital in addition to shrinking the size of their balance sheets.In the pa
29、st year(to Q1),the most important development in sectoral net lendinghas been the decline in the government deficit.This has been the main counterpartto the narrowing of the current account deficit.Overall,the net lending positions and the underlying saving and investment flows capturethe twin effec
30、ts of private-sector deleveraging and fiscal austerity.Goldman Sachs Global Economics,Commodities and Strategy Research,4,November 1,2012Exhibit 2:Weaker company investment growth accountsfor slowing total investment,European Economics AnalystExhibit 3:A smaller government deficit sees currentaccoun
31、t deficit close,%yoy,Gross fixed capital formation,800,bn,Net lending,94-1,6004002000,-6,NFCs,-200,-11-16,00,01,Financial corporationGeneral governmentHouseholdsEuro area domestic economy02 03 04 05 06 07,08,09,10,11,12,-400-600-800,00,01,NFCsFinancial corporationGeneral governmentHouseholdsEuro are
32、a domestic economy02 03 04 05 06 07 08,09,10,11,12,Source:Eurostat,ECB,GS Global ECS Research,Source:Eurostat,ECB,GS Global ECS Research,Deleveraging and fiscal austerity imply stagnation at the area-widelevel and a rising current account surplusThis sectoral view also implies a weak outlook for the
33、 Euro area economy as private-sector caution gives rise to an ongoing private-sector financial surplus,while the publicsector tries to get closer to balance through fiscal austerity.Although the net trade positionof the Euro area is expected to improve further,that occurs primarily through weak inte
34、rnaldemand(and imports)rather than from strong external demand(and exports).Thisdescription accounts for how,in the very latest data beyond the Q1 cut-off for the flow offunds,the Euro area has moved to a current account surplus of 0.8%of GDP.On this area-wide view,external demand has not been suffi
35、ciently robust,or the Euro-areas supply-side sufficiently flexible,to make up for the deficient domestic demandassociated with private-sector deleveraging and fiscal austerity.Can some sectors compensate for other sectors caution?In European EconomicsAnalyst 12/26 Uncertainty weighing on investment
36、spending,we describe why we do notexpect the Euro area corporate sector to return to running a significant financial deficit.German companies are best placed to attempt this owing to easy financial conditions,strong balance sheets and resilient domestic demand yet even here we do not expect thisto o
37、ccur,given that:The effects of generalised uncertainty are weighing on investment.Companies have reassessed the likelihood of a sharp fall in activity,and theirvulnerability to any such fall.Within this area-wide picture,the household sectors saving ratio has been steady ataround 13%-14%of disposabl
38、e income since mid-2009.Temporary(yet persistent)weakness in potential output growth discourages a reduction in saving,as does above-target inflation.Uncertainty weighs on spending growth and supports the saving ratio.Against that background for the corporate and household sectors,the adding-upconst
39、raint on sectoral balances(which,taken together,add to the current account balance)is met through a combination of:Goldman Sachs Global Economics,Commodities and Strategy Research,5,November 1,2012,European Economics Analyst,Headline fiscal balances not improving as much as the planned cyclically-ad
40、justedtightening,as weak activity affects tax receipts and cyclical public spending.The improvement in the current account.Yet the fact that some households or companies move towards running a financial deficit those in Germany are sufficiently numerous to matter for the aggregate outlook haslimited
41、 the downside to growth at the area-wide level.This has helped the Euro area avoida repeat of the falls in GDP growth seen in the 2008/09 period.Convergence in financial balances consistent with economicdivergence in the Euro areaThe flow of funds also reflects the second key feature of recent exper
42、ience and a featureof our outlook namely,divergence.We show here how convergence in the financialbalances of Germany and Spain has contributed to these economies growth divergence.In a comparison of Germany(the major external surplus economy)with Spain(untilrecently,the major external deficit econom
43、y),we find:In Germany,the household sector has reduced its financial surplus.This hashelped the Euro area avoid a repeat of the sharp falls in activity of 2008/09 whenthe German household sector displayed greater caution and increased its financialsurplus.In Spain,notwithstanding a very large swing
44、in the private sectors financialbalance to reach a surplus,those private-sector surpluses are still small.Whilehouseholds and companies are not accumulating liabilities in the same way theywere before the crisis,the rate at which they are deleveraging is still comparativelyslow.In Germany,private-se
45、ctor surpluses in the corporate sector are similar to those inSpain,and in the household sector they are larger than those in Spain.YetGerman corporate balance sheets are much stronger than in Spain and theGerman household sector enjoys full employment,unlike the mass unemploymentin Spain.This compa
46、rative exercise highlights the risk for Spain:that householdsand companies will embark on even more pronounced deleveraging,to accountfor their weaker balance sheets compared with their counterparts in Germany.Thisin turn implies that consumer spending and investment would continue to fallsharply.Ex
47、hibit 4 shows the household sector balance for Germany and Spain.Germany is apicture of stability and normality a household sector that has run consistent financialsurpluses of 4%-6%of GDP.Spain,by contrast,is a picture of volatility and only a recentcorrection towards the normality of a household s
48、ector that runs a financial surplus.In the decade-long run-up to the crisis,Spains household sector ran increasingly largefinancial deficits.Household debt rose from 50%of GDP in 2000Q1 to over 90%of GDP by2009.The subsequent correction of the sectors financial deficit in the crisis was associatedwi
49、th a dramatic 10%of GDP swing in the household sector balance.Yet this surplus hasonly seen the household gross debt ratio stabilise(at a little below 90%of GDP)ashouseholds accumulated financial assets alongside stabilised debts.Goldman Sachs Global Economics,Commodities and Strategy Research,6,Nov
50、ember 1,2012Exhibit 4:Stability versus volatility in a comparison ofhousehold sectors,European Economics AnalystExhibit 5:A bigger swing towards corporate sectordeleveraging in Spain than in Germany,8.0,%GDP,Households-SpainHouseholds-Germany,6.04.0,%GDP,Non-financial companies-SpainNon-financial co
