German SMEs and the Russian Market

The German Mittelstand does battle to conquer the Russian market.

Kremlin Embankment ©  Lyudmila Izmaylova
Kremlin Embankment © Lyudmila Izmaylova

September brings more good news to Germany, world champion exporter. The Statistisches Bundesamt – Federal Bureau of Statistics – reports that for the first time ever, German exports of merchandise for the month of July 2014 were in excess of Eu1 billion, a record amount for one month. This result dovetails with the SME survey conducted shortly beforehand and published by Ernst & Young; the analysis, now in its 12th year, quizzed 700 SMEs, and an unprecedented 56% of those interviewed replied that they were fully satisfied with how their companies were faring.

These numbers, however, only reflect a momentary state of affairs. The worsening of the crisis in the Ukraine which has already led the European Union to inflict economic sanctions on Russia could very quickly cast a shadow over the picture or, even worse, backfire over the whole economy, and German SMEs in particular. Another indicator highlighted by the study is that one in five companies today is bracing to withstand losses as a result of the conflict.

Volker Treier, Deputy CEO and Head of Foreign Trade with the Association of German Chambers of Industry and Commerce (DIHT) believes that the machine tool and innovative plant sectors which traditionally are where SMEs are most active in Germany will be the hardest hit. The effect of the European Union sanctions and the lack of clarity in how to apply them, heightened by the devaluation of the rouble and the consequent increase in price for the Russian client all adds up to a heavy drawback to German exports. The political difficulties with the EU is pushing the Russian economy back into the arms of China. None of this, evidently is in the interests of German exports – Russia is indisputably a major market with great potential, above all for German SMEs.

Those directly involved all share the same point of view. A survey carried out by the Russo-German Chamber of Commerce (AHK) showed that some three-quarters of German companies interviewed believe that the long-term potential of the Russian market is high, or very high. It is with this belief in mind that when tensions between the Kremlin and the EU are behind us, German exports to Russia return to reasonable levels . It is of paramount importance that no long-term interruptions be allowed to upset trade, and that preparations be made for a campaign to regain market share in Russia to be launched as soon as the geopolitical situation gets back to normal.



What do business and football have in common?

By Bob Bischof, chairman German British Forum

This article was sent to The Daily Mail for publication on July 20, 2014.

With Germany and Britain seemingly on diverging paths regarding their national football,it may be useful to have a look at what makes Germany tick and kick rather well  these days.

Firstly, it seems that personal involvement and private ownership matter on the field and off. Germany’s success as an industrial powerhouse is to a large extent due to its privately owned so-called Mittelstand and the huge companies that have grown organically from those roots.

German football clubs like Bayern Munich, Schalke and Borussia Dortmund are owned by its local members and fans and are run often by former football stars like Beckenbauer, Rummenigge etc, who are all fiercely tribal as far as their clubs are concerned, but equally keen on seeing the national team do well.

Secondly, it is interesting to have a look at the footballers themselves. As in business it matters whether your workforce is well trained, skilled and motivated. Out of the 13 German players directly involved in winning the world cup eight finished school with an A-level equivalent (Goetze, Hummels, Hoewedes, Schuerle, Merteseker, Mueller, Neuer and Podolski) and five with GCSE eqivialent (Klose, Khadeira, Ozil, Lahm and Schweinsteiger), with two of them also serving apprenticeships ( Klose as carpenter and Schweinsteiger as commercial clerk).

Serving apprenticeships alongside football  is not new and was even more popular in former successful teams; Klinsmann (baker), Beckenbauer (Insurance) Rudi Voeller (office clerk), Lothar Matthaeus (Interior Design)

An education may not help you to kick the ball better, but it will help in appreciating and understanding tactics, working in groups, building team spirit and developing discipline. And an education gives you so much more: it gives confidence to carry on with life after football and helps the many that do not make it to the very top or those whose careers are cut short for other reasons.

Personally speaking, I find the absence of tattoos refreshing as well. All of the 13 players mentioned above speak at least two languages, quite a few three, which makes them not only more rounded and self-confident it also gives them better international mobility. Ashley Cole hit the nail on the head, when he said that English players are afraid of going abroad. So are actually British youngsters in general.

No language skills means low mobility; low skills also means less mobility. As the whole world speaks English, footballers from abroad as well as all those thousands of youngsters serving in British restaurants and hotels find it easy to acclimatise here. I don’t think I have been served by a British waiter on the continent, nor does a top English player play in the Bundesliga – after Hargreaves.

Thirdly, long-term strategy and a proper structure are the two key elements that make businesses successful.  Apart from the youth work that is going on at club level, the DFB, Germany’s FA  together with the heads of the German Clubs decided that they had enough of watching the national team not winning any trophies and have set up a boarding college for talented youngsters. Here they will be coached in football first but also educated to a good standard.

As we have seen, this long term strategy has paid off. Like Britain, when it was decided to hold the Olympics in London, invested in talent and got the results in a never seen before haul of medals. The talent is no doubt there but it clearly needs structure and a long term plan to develop it.

Long term versus short term – in business as in football.

Selling British businesses for short-term shareholder value to foreign predators does as  little for the “national game” as foreign owners of British clubs or an over-supply of foreign players. If the UK wants to develop and grow its own talent pool of youngsters and entrepreneurs equally, then she needs to find a way of allowing the key elements of success to flourish

Supporting private ownership featuring self interest combined with social responsibility, which means the development of a skilled and motivated work force and structure that allows for a long-term strategy of developing  people, products and markets.

In other words growing SMEs into JCBs by remembering the words of Lord Bamford – “if he or his dad had gone to the stock market, JCB would not be around anymore”. When will government and the establishment in the UK wake up and allow British business and the English football team to flourish.


The awesome (and chilling) genius of the Germans: From soccer to supermarkets, and factory floors to battlefields our European cousins are a force to be reckoned with

“This article was written by Max Hasting and was published in The Daily Mail on July 10.
The original article is here.”


Germany — The Home of Smart Innovation


What do aspirin, the electron microscope, the MP3 music format, and Liquid Chrystal displays have in common?

They’re all German inventions. There are thousands of others, but many of them are so specialized that the general public will never hear about them — even though they touch the lives of millions, if not billions, of people. Simply file these under “German ingenuity.”

German companies know that price is not always the deciding factor in the customer’s mind. Germany’s reputation for engineering excellence and innovation means that consumers buying German goods are typically looking for that little bit extra: be it cutting-edge technology or that special, perfectly designed something that simply can’t be found elsewhere. For that reason, Germany’s companies — and particularly the Mittelstand of small and medium-sized enterprises that dominate the economy — are veritable innovators.

German innovation is “often based on very deep technical expertise, which allows even small German firms to become market leaders in very narrow segments,” says Christian Terwiesch, professor of operations and information management at the Wharton School of the University of Pennsylvania in Philadelphia. “These companies succeed by offering the best technology in their segment.”

According to “Competitive Alternatives: KPMG’s Guide to International Business Location 2010,” Germany is — alongside the Netherlands and Australia — an international leader in terms of science and technology industry share of the total work force. Germany, with Japan and the U.S., invests the greatest share of gross domestic product in research and development internationally.

Germany ranks eighth out of 139 countries for innovation in the World Economic Forum’s (WEF) “Global Competitiveness Report 2010-2011.” According to the WEF, Germany is the international leader in terms of capacity for innovation, occupies fourth place for company spending on R&D, and secures sixth spot for quality of scientific research institutions.

“We invest where the brains and the knowledge are,” says Martin Strobel, spokesman in Munich for Intel Corp., the Santa Clara, California, chip maker. Last May, Intel decided to invest €12 million ($15.2 million) over five years in the Intel Visual Computing Institute, located at Saarland University in Saarbrücken. And this June it opened a cooperative lab with the Jülich University research center; one of three locations in Germany that have very fast supercomputers. The investment sum wasn’t disclosed. “They really know what high-performance computing is about,” says Mr. Strobel. Intel also recently agreed to pay $1.4 billion for the wireless chip business of Infineon Technologies AG of Munich.

Germany has hundreds of research institutes, including internationally famous ones such as the Max Planck Society and the Fraunhofer Society, both based in Munich. “Max Planck is funding and conducting research in almost all fields in the natural and life sciences,” says Dr. Terwiesch of the Wharton School. “They have repeatedly won Nobel Prizes, and they have been very successful in knowledge transfer. They created the seeds of many innovations that have been commercialized.”

German companies file the third most Patent Cooperation Treaty patents (per million workers) in medium-high and medium-low-technology sectors (after Switzerland and Sweden), and in high-technology sectors they rank eighth, according to the Organization for Economic Cooperation and Development (OECD). Germany ranks third, after Japan and Sweden, for patents filed simultaneously with the U.S., Japanese and European Union trade offices.

Getting innovations off the drawing board and into the market — the realization of innovation — is one of Germany’s strengths. According to the innovation indicator of the Berlin-based German Institute for Economic Research (DIW), Germany is among the top five of 17 analyzed countries — including the U.S. and U.K. — for the development and marketing of high technology. “Scientists in Germany are highly efficient. No other countries under study, besides Sweden, have generated more economically viable new developments from a given R&D budget,” says senior DIW research associate Jens Schmidt-Ehmcke.

Germany is also very strong in implementation and networking in DIW’s innovation indicator, says Alexander Kritikos, vice president and head of innovation, manufacturing and service at DIW. German companies are very good at cooperating in networks — or so-called “clusters” — to innovate, improve technology or create new products. According to Mr. Kritikos, this is particularly true in the chemical, automotive industry, medical engineering, electrical equipment industry, and mechanical engineering sectors.

The biotechnology cluster in Munich, where one particularly rich research seam being sown is personalized medicine, is a case in point. Germany’s rigorous environmental regulations have also given birth to a number of innovations from renewable energy to emissions control and energy efficiency. German researchers are working to make coal a cleaner and more environmentally friendly fuel, as well as ways to capture carbon from heavy industries says Claudia Kemfert, head of energy, transportation and environment at DIW. The chemical industry is seeking substitutes for oil, while the automotive sector is exploring alternative fuels such as hydrogen and electricity.

Germany also actively encourages its researchers to network internationally. It has set up centers for research and innovation in countries such as Brazil, Russia, India, China, and the U.S.

“The BRIC nations and the U.S. and Canada are exciting partner countries for German players, both in academia and industry,” says Joann Halpern, director of the German Center for Research and Innovation in New York. “All of these countries are making significant investments in research and development, and Germany is also committed to long-term investment in R&D.”

The centers “were created to bring together international experts and researchers from academic institutions, industry and government, thereby enhancing communication on the critical challenges of the 21st century,” she says. “Innovation is enhanced by collaboration. We bring the greatest minds together and play a facilitator role.”

Both international researchers and foreign investors find a positive partner in Germany, Dr. Halpern says. “The collaboration between research and industry makes Germany attractive.”

The government also supports R&D with solid financial backing. Launched in 2006, the government’s “High-Tech Strategy” directs around €4 billion a year to R&D, including in the form of grants. The federal government spent a total of around €12 billion on R&D in 2009.

The main funding for R&D comes from the private sector. Businesses financed 68% of R&D expenditure in 2007, according to Eurostat, the EU’s statistical body. The German regions of Braunschweig and Stuttgart led the EU in R&D intensity or R&D expenditure as a percentage of GDP. Indeed, Germany had 11 regions among the top 25 for R&D intensity in 2006. As a whole, Germany has an R&D intensity level of 2.54%; putting it in the top 10 among developed countries, according to Eurostat.

One reason the government and private companies account for so much of R&D is that venture capital in Germany is fairly thin on the ground — a possible opportunity for foreign investors. Last year, Germany counted just 33 to 41 “business angels” per million inhabitants — compared with 850 in the U.S. — according to the Commission of Experts for Research and Innovation, a group that advises the German government.

Some high-tech start-ups have certainly had great success. SAP AG was started by five Germans in 1972, and today is one of the world’s biggest software companies, with almost 50,000 employees in 50 countries.

“The German model of industrial exports has been very supportive of innovation,” says Dr. Terwiesch of Wharton. “Innovation is a part of an export economy. It creates a feedback loop where strong exports benefit from innovation and innovation benefits from strong exports. They feed on each other. It helped Germany keep a strong industrial base even at times when it was a high-wage country.”

News Views

Scottish independence and UK leaving the EU – Both a mistake

This article by GBF chairman Bob Bischof was published in the Daily Mail, June 29 2014

—–    —–    —–

In less than three months the Scots will be voting whether to leave the Union.

They may decide to head out on their own, or they may choose to stay within the United Kingdom and be given as yet unspecified further powers to determine their own affairs.

Although the difference between those two choices might not be that great in the end, a separation following a majority Yes vote would be a significant set-back for the Union, Europe and the Scots themselves.

However, the debate could bring about some good.

As the nation states of the European Union head towards closer economic and political integration, its citizens are feeling that they are losing too much of their national identity and are therefore rebelling.

In some cases this manifests itself in protests against immigration, in others through the resurgence of regional and tribal issues, and in others again, in anger against Brussels ‘red-tape’ and the desire to win back powers for national governments.

The recent European elections gave an increasing share of the vote to the parties on the right arguing against immigration, citing the threat to jobs and criticising EU meddling in home affairs – as UKIP did in the UK.

In my view the real underlying fear is what in Germany we call Ueberfremdung, which translates as ‘foreignisation’.

That is linked not only to immigration, but also to overseas ownership of huge chunks of British industry, including ports, airports and utilities.

This is of course not just a British phenomenon. The same feelings are at the heart of the rise of populist right-wing parties in France, Austria, Greece and Spain.

The only countries that have reacted differently so far are Germany – my native country – and Italy.

Perhaps citizens in these two nations are not as easily reeled in by demagogues with simple messages because they have been there before.

Although the EU has talked much about the rule of subsidiarity – the principle by which decisions must be taken at the appropriate local level – Brussels has failed its member states by not delivering on it and by not making it clear enough.

The rising support for the ‘Yes’ campaign and ‘Scotland for the Scots’ is, I believe, an expression of similar concerns and must be taken seriously.

It is not good policy to try to scare the Scots about losing the pound and being economically worse off, or even by raising doubts about whether an independent Scotland could secure membership of the European Union, as Alex Salmond wishes.

This is much more an emotional issue and should be treated as such by the ‘No’ campaigners.

Far better, then, to concentrate of the positive aspects of the Union. There are not only economies of scale in business but also in politics. Size matters, as every business knows, when it tries to sell in global markets.

Paddling your own canoe economically and politically in a more and more globalised world is difficult, to say the least. The threat of Britain leaving the European Union is similarly counterproductive in my opinion.

Most importantly, the men in Brussels and Angela Merkel in Berlin must have a close look at the results of their actions so far. In the long run they can’t ignore the deep seated fears and mistrust of the peoples of Europe.

Britain may appear isolated following the row over the appointment of Jean-Claude Juncker, but should continue to lead a push for change.

As for Scotland and the UK, the West Lothian Question – whether Scottish, Welsh and Northern Irish MPs should be able to vote on matters involving only England – is unresolved, and the relationship between Scotland and the other countries that make up the Union is not very efficiently structured.

It might be an idea to take a look at the constitution that the Allies gave Germany after the last World War, which has a clear separation of national, state and local powers. It could serve as a model for the men in Brussels.

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You can read more articles by Bob Bischof on his website.

News Views

What Paul the Octopus could never predict

The German British Forum would find it hard to be neutral about the outcome of the World Cup quarter final this afternoon.

One of us has already predicted Germany for the final on the basis of trade patterns (  For a Brit, it’s a bit like supporting a League 2 team to demonstrate that you are a “real” football supporter but supporting Chelsea or Manchester City in the Premier League to make sure that you get some of the upside of liking football…. After England’s parlous performance, what Brit wouldn’t secretly be hoping that Germany will win tonight?

And who needs an octopus when trade data will do to predict scores?

Delta Economics Q2 forecast is that the UK’s trade will decline by 1.3% in 2014 so why are we surprised that the English teams in cricket and football have under performed and Andy Murray is out of Wimbledon?  By the same token, Brazil’s coffee exports are forecast to grow by 8% this year and Colombia’s by 4% so 2-1 is the obvious result for that quarter final.So what does this tell us about the game that kicks off in just one and a half hours from now.

Well, Germany’s export trade is forecast to grow by 1.2% while France’s will decline by 1.4%.  Germany’s car exports will grow by nearly 1% this year while French car exports are likely to contract this year by over 10%.  We’ve tried desperately to find an area where France might excel, but even here, German wine exports could grow by as much as 4% this year; we are forecasting that French wine exports will shrink by nearly 1%.Whichever way you look at it, things don’t look good for France this evening.

Score prediction – Germany to win 3-0 and France to have a player sent off in the first half.  This will ruin the game as a spectacle of course, but then so far this World Cup, although Germany have won, they have still not achieved Joachim Low’s goal of winning pretty as well as winning ugly.  But we are all used to that.

News Views

Keeping up with the Schmidts – response to apprentice article in The Economist

Westminster is trying to replicate aspects of Germany’s apprentice system but it is not working. Should it even try? Will Stirling looks at the recent evidence.

This article in The Economist published April 26 illustrates the difficulties with copying systems that work in other countries.

Before the 2008 financial crisis, apprenticeships, while popular with large companies, were not championed. Culturally, society tended to see an apprenticeship as ‘what you do if you can’t get the grades’ at GCSE. Many still think like this.

While the number of apprenticeships in Britain has climbed from 280,000, when the coalition government came into office in 2010, to over 500,000 today, the article criticises David Cameron and Co for two main shortcomings.

Firstly, most of these apprenticeships are Level 2, broadly equivalent to GCSEs. This is not equitable to an apprenticeship in Germany, where there is one standard across the country and all sectors, with a minimum duration of three years. Some, but not many, UK apprenticeships are Level 3 (on par with A Levels) and very few are Level 4 plus (degree level).

Secondly, too many companies and organisations have taken advantage of a system that was flawed. The government has doubled funding provision for apprenticeships = good. Training providers take the money and offer training to employers as prescribed courses and subjects. But quite often the training course is too narrow and not employer-focused enough. Organisations have been accused of becoming training providers just to qualify for the funding, and industry claims the money has been wasted. This explains the why the Employer Ownership of Skills pilot was launched – now in Round 4 – that gives employers funding to tailor-make their own training.

Morrisons, one company, is responsible for one in 10 apprentice starts in the whole UK, and these people are not being trained in hard, ‘value adding’ skills.

Partly due to the disillusionment of industry in this training funding, between 2011 and 2013 investment in training by employers fell by £2.4 billion, and the number of job vacancies without qualified applicants rose from 91,000 to 146,000.

The author rightly highlights the strengths of Germany’s vocational training. A simpler hierarchy of stages to reach the top grade, be it “Ingenieur” or the equivalent in banking or insurance, the pathways and stages are clear. The mighty Handelskammer – an organisation with a budget that dwarfs that of the British business support organs – has a specific mandate to deliver and monitor vocational training. Through compulsory membership of the DIHK – unpalatable to some, but effective – German companies find it difficult to fail to maintain standards – the Handelskammer will find them out. Britain does not have such a robust policing authority.

It is a shame the author did not acknowledge the excellent University Technical Colleges, established by the Baker Dearing Education Trust several years ago.

There are 16 UTCs now, and 47 will have launched by 2016. These engineering schools cover the secondary school map of ages 13 to 18 and follow the national curriculum for GCSEs, but with a strong bent for STEM, engineering-based and IT courses. Each has a speciality: the Silverstone UTC for example, specialises in high performance engineering and business and technical events management – no rpizes for guessing in which industry these youngsters may end up working.

Languages and the main swathe of subjects are covered, not there is less art, more science.

The first one, actually initiated by Lord Anthony Bamford, the JCB Academy in Rocester, posted extraordinary GCSE results in its first academic year – 99% of students achieved grades A* to C in maths and English.

This is the British answer to the successful German Berufsschule, one of the mainstays of Germany’s five school education system, that directs children with practical engineering aptitude into a route to industry and manufacturing.

In Germany it seems – although I may be wrong – parents and kids do not place the Berufsschule on a lower rung than a conventional secondary school education (the Gymnasium). People understand its role and its parity.

With UTCS, far from being perceived as playing second fiddle to the normal secondaries, colleges like the JCB Academy and Black Country UTC are heavily oversubscribed. Indeed, the JCB Academy was criticised by several schools in its catchment area for poaching the brightest 13-year old pupils when it launched. Students come from up to 50-miles away to study here, leaving home at 0700 in some cases. It proves a vocational path to industry not only exists but is proving really popular.

The Economist article says that Britain should play to her strengths.

“Its strong services sector tends to reward people with general skills, lowering the perceived value of specific, technical ones. And its flexible labour market enables employees to move around more freely, making it harder to pin them down for extended periods of training. The Germany-fanciers of Whitehall—perhaps without noticing it—are running up against their country’s own strengths.”

You can have labour market flexibility and a strong services sector and an engineering- or vocational-led education. They are not mutually exclusive.

Will Stirling

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A conference planned by the German British Forum in autumn 2014 on the power of mid-sized companies in Britain and Germany, as a force for jobs and growth in the European Union, will examine the differences of the German-British education systems, and what each can learn from the other.


David Marsh’s weekly column published in the German business newspaper Handelsblatt and on website MarketWatch (part of Dow Jones)


Obama may now take the gloves off with Europe

JAKARTA, Indonesia (MarketWatch) — U.S. irritation with Europe’s inability to solve the euro crisis is likely to come increasingly to the fore after Barack Obama’s re-election. The U.S. president’s relatively compelling victory will have three effects on the further development of economic and monetary union (EMU), none of them positive.

First, after months in which Obama and his team have made clear that they want Greece to stay in the euro to prevent a damaging pre-election financial collapse, the re-elected president will now have a much freer hand to say what he thinks about Europe’s euro irresolution. If Obama decides to take the gloves off with the Old Continent, this could lead to some wounding exchanges, particularly with Berlin.

Obama will probably side more overtly with France and Italy to rail against alleged German intransigence on helping Greece and other problem-hit countries — which will not go down well with Chancellor Angela Merkel.

Significantly, the most resounding approval in Europe for Obama’s win came from France’s president François Hollande, who sees the U.S. as an ally in his anti-austerity campaign against Germany.

Second, now that the election is out of the way, greater optimism about U.S. economic growth may start to take hold internationally — depending, of course, whether the so-far-intractable issue of the U.S. fiscal cliff can be resolved.

This coincides with steadily worsening economic news from Europe. The gap between U.S. and euro-area growth could widen next year to nearly 3 percentage points, the largest since the euro began. This could have an effect on weakening the euro — good news for the deficit-hit states of southern Europe, but bad for resolve and morale in Germany and the other creditor countries of Europe that are being called upon to shoulder larger parts of the financial burdens facing the south.

Third, despite the pressure points, German unwillingness to agree on more generous action over Greece, Spain and the others is likely to increase, not diminish, as the timetable moves into gear for next year’s German federal elections.

A strong reason why the European Central Bank’s much-trumped bond-buying plans are on hold is because the Bundesbank’s negative views on the matter have already been well-circulated in political circles and in the marketplace. The “phoney war” on the ECB’s so-called outright monetary transactions program could continue until the New Year. In fact, in terms of the impact on Spanish and Italian bond yields, we may have already seen the best of the impact of the OMT program.

As the French 18th century philosopher Voltaire once quipped about the Holy Roman Empire — “neither holy, nor Roman, nor an empire” — future historians may say that the OMT was nether outright, nor monetary nor a transaction.

It is certainly taking a long time to get going. This reflects the eye-watering contradictions of the conditionality that requires the Spanish government, the most badly hit contender for funds, to approach Europe for a further bailout deal without being able to tell parliamentarians what it will get in return.


The Bundesbank’s conditions for a successful OMT are the same as it habitually applied to foreign exchange market intervention in the past. Action should be powerful, coordinated and in line with fundamental market trends. In the case of the OMT, it is unclear whether these three preconditions are in place.

The problem with the OMT is that, once started, it will be very difficult to stop. The longer the delay in implementing it, the greater will be the resolve of its opponents. And the larger will be the reluctance to break the seals on a Pandora’s box that, once opened, can be closed only with the greatest difficulty.

All this is compounded by further euro-area brinkmanship on Greece after international lenders failed to bridge differences on how to reduce Athens’ still-disastrous debt levels, bringing the country close to defaulting on a €5 billion debt payment due at the end of this week.

Only nine months ago, Greece benefited from by far the greatest sovereign debt restructuring in history. Yet it is further away than ever in solving its debt problems, since austerity — as many people predicted — has simply made the debt problem worse.

Don’t forget: this calamitous outcome occurred under the aegis of the International Monetary Fund. The combination of circumstances makes the IMF much less likely to get involved in further bailout packages, whether for Greece or other struggling states like Spain.


In his new steely post-election mood, Obama will join with leading emerging market economies such as Brazil, China and India in declaring that Europe must sort out its mess by itself — which can only mean more money from the Germans.

Let’s see how this plays in Main Streets all over Germany as Merkel prepares for her own election in less than a year.


Growing activity by reserve-rich economies could exacerbate European tensions

published in Financial News on 5th November 2007

The debate about the influence of sovereign wealth funds is a rerun of controversies that flared more than 30 years ago after the first oil price shock in 1973.

Last week, the International Monetary Fund called for more transparency from the funds, which are pools of assets controlled by public sector investment vehicles from reserve-rich economies, mainly from the emerging world. The IMF wants to ease concern that the funds are creating undue influence in the west through fast-growing stakes in companies in the US and Europe. The move parallels efforts made in 1974 by West German Chancellor Helmut Schmidt to control the swell of participation by oil-rich countries led by Kuwait in companies such as Daimler-Benz and Hoechst, the German motor and chemicals groups.

The difference is one of scale. In 1974, West Germany was by far the world’s largest reserve holder with about $25bn in official foreign exchange reserves. The Germans then accounted for about 15% of overall world foreign exchange reserves of $160bn. Fred Bergsten, the American economist and later US Treasury Under-Secretary, now director of the Peterson Institute for International Economics in Washington, in 1974 said West Germany was the world’s second superpower after the US because of its international assets.

The contrast with today’s picture is remarkable. Enormous reserves wielded by China and other emerging economies such as Russia, South Korea and Taiwan far outstrip the official holdings of Germany and other industrialised countries. Germany’s published foreign exchange reserves of more than $40bn make up only 0.7% of declared global foreign exchange reserves, which mushroomed to $5.7 trillion as of mid-2007, according to the IMF. Figures for official foreign exchange holdings understate the amounts at the disposal of emerging economies. Studies from Standard Chartered and Morgan Stanley put the funds’ size at $2.2 trillion and $2.5 trillion respectively, double total official currency reserves. Some of the best-known funds have been around since the 1970s.

The Abu Dhabi Investment Authority, with about $875bn under management, was founded in 1978; the Government of Singapore Investment Corporation ($350bn) and the country’s Temasek Holdings ($100bn) in 1981 and 1974 respectively, Norway’s Government Pension Fund ($300bn) in 1990 and the Kuwait Investment Authority ($70bn) in 1960.

Attention in the past few weeks has focused on episodes such as the Qatar Investment Authority’s backing for a potential bid for UK retailer J Sainsbury, the possible purchase by China’s Citic Bank of a stake in US investment bank Bear Stearns and the deployment of a new $40bn investment fund from Libya.

China remains the main focus. China’s currency reserves are growing by about $1bn a day and total between $1.3 trillion and $1.4 trillion. China has been active for some time in acquiring high-profile oil assets in Africa, signalling its shift into such investments by subscribing in May for $3bn in the initial public offering of US private equity group Blackstone.

Schmidt, the world’s oldest senior commentator on global and monetary affairs, is following the development of the emerging world’s riches. He believes China will deploy more of its wealth in companies in the US, Europe and Africa. Schmidt said China will also take further steps away from buying US treasury bills, thought to account for about 75% of its reserves up to now. Schmidt said the Chinese strategy of relying on the dollar is a “ridiculous mis-investment”.

More active management of Chinese foreign exchange holdings creates a conundrum for US Federal Reserve chairman Ben Bernanke and Jean-Claude Trichet, president of the European Central Bank. Much American international monetary diplomacy has been directed at persuading the Chinese authorities to  accept a higher rate for the renminbi as part of an effort to lower the enormous Chinese trade surplus with the US. American policy on the renminbi is inciting a larger role for the euro in overall reserve currency holdings. If the Chinese central bank lowers its purchases of dollars, allowing the renminbi to float higher on the foreign exchanges, the assumption must be that the share of euros in the Chinese central bank reserves will rise in time. According to the IMF, the euro makes up an estimated 26% of world reserve holdings against 64% for the dollar, down from 69% when the euro was introduced at the start of 1999.  Capturing a greater share of world reserve currency holdings was one of the goals for the Europeans, particularly the French, when the euro was established. However, a further rise in the European currency caused by more aggressive reserve management by reserve holders and sovereign wealth funds would inflame tensions within Europe.

The balance of payments of the euro nations is on par with the rest of the world. But this masks a large current account surplus from Germany and growing current account deficits from the other lending euro economies of France, Italy and Spain. A further rise in the euro might not be unwelcome for Germany and the Deutsche Bundesbank would see it as a means of shielding the country from higher inflation caused by climbing oil prices. However, further euro revaluation would set alarm bells ringing in Paris, particularly after last week’s fresh Federal Reserve interest rate easing.

If the Chinese heed Schmidt’s call to channel more funds into the euro, Trichet can expect still more clamouring for lower euro interest rates from the French Government.