Market
volatility has surged lately, apparently vindicating those who have
warned of lofty equity valuations. But, even as the US stock market
suffered one of its worst weeks since the financial crisis, the
eurozone’s public-debt market has remained relatively stable, with risk
spreads – which have usually increased amid market volatility – scarcely
changing, even for the peripheral eurozone countries.
The eurozone
owes its ostensible immunity from financial-market gyrations to major
improvements in the peripheral economies’ fundamentals: growth has
picked up, and unemployment, though still high, is declining rapidly.
The question is whether these improvements are stable enough to ensure
the eurozone’s continued resilience.
Here, the key concern is that
the current recovery is too dependent on low interest rates: if
borrowing costs rise, the periphery’s debtor countries would suffer. But
it is no longer accurate to view the economies of the periphery as weak
debtors. Indeed, with the exception of Greece, they are all now running
current-account surpluses, meaning that far from depending on capital
inflows, they are repaying their foreign debt.
And, yes, this
includes Italy, which, despite its high public debt, is running a
current-account surplus at the aggregate level. In the past, Italy’s
external deficits and surpluses were of roughly similar size, meaning
that the country is not a net debtor. Because its net international
investment position is balanced, a generalised interest-rate hike would
not necessarily be bad for the country. The government would face higher
debt-service costs, but citizens would earn more on their savings.
Spain
and Portugal, by contrast, would probably suffer, owing to their
still-considerable external debts. Nonetheless, if interest-rate hikes
are aligned with accelerating global growth, even these countries might
not be much worse off, because growth will help them to service their
foreign debts.
But the implications of today’s constellation of
current-account balances extend beyond shorter-term interest-rate
considerations. If the situation persists for a few more years, the
eurozone might get to a point where it consists only of creditor
countries, some with a large net foreign asset position (Germany and the
Netherlands) and others (the peripheral countries) with a small
positive external position.
This would have important political
consequences. For starters, the conflicts of interests within such a
eurozone might be much less acute than those that emerged during the
crisis a decade ago, when creditor countries were obliged to bail out
the debtors, which in turn felt squeezed by forced austerity.
More
broadly, the relative power of the creditor countries – particularly
Germany – will be diminished. The concerns expressed by some observers,
such as George Soros, that the eurozone will remain a two-tier club, in
which the creditors impose their conditions on the debtors, thus seem
exaggerated.
But that does not mean that this new dynamic is
risk-free. If former debtors, facing diminished pressure from major
creditors or risk premia, adopted less prudent fiscal policies, their
public debt would continue to accumulate. Against that background, the
next crisis might be very different from the last one.
When the last
eurozone crisis began, large capital flows into the periphery were
generating inflationary pressures; resources were shifting away from
exports; and government revenues appeared to be strong. Then the capital
inflows abruptly reversed, which demanded a decline in domestic wages
and prices, relative to the eurozone average, in order to shift
resources back toward exports. In most countries, government revenues
fell, as domestic activities, such as construction, contracted much
faster than exports increased. As a result, the peripheral economies
fell into a deep recession.
Making matters worse, because an
export-led recovery yields less revenue – value-added taxes are rebated
on exports, but collected on imports – seemingly strong government
finances quickly turned into large deficits. In Greece’s case, the
problem was compounded by the fact that, during the boom years, the
large fiscal deficits had been financed entirely by capital inflows.
When these flows stopped, the bottom fell out of public finances.
Today,
eurozone countries are not subject to large capital inflows, so a
crisis would not cause them to face external disequilibrium. They would
not need a large downward adjustment in wages and prices, and government
revenues would remain relatively stable.
If risk premia increase, it
would be a result of creditors’ doubts about a government’s ability to
finance itself in the long run, owing to a downward revision of growth
expectations or a domestic political stalemate in which taxpayers oppose
bondholders. Domestic bondholders might be the first to recognise
potential risks, spurring escalating capital flight.
In these
circumstances, a loan from the European Stability Mechanism – the
eurozone’s bailout fund – would merely provide fuel for even higher
outflows. Yet transforming the ESM into a “European Monetary Fund” is
currently one of the main issues in the debate about eurozone governance
reforms. The implicit role model is the International Monetary Fund,
which has made its reputation by addressing the fallout from sudden
capital-flow reversals. Again, that is not the type of crisis that
today’s less inflow-dependent eurozone is likely to experience.
Instead
of trying to copy the IMF, Europe’s leaders should be focused on
strengthening the resilience of the financial system, so that it can
provide a safety valve for whatever pressures inevitably arise from the
build-up of excessive public debt in some eurozone countries. If a
crisis does occur, the ESM’s resources could perhaps be used to prevent
contagion within the eurozone financial system, rather than to provide
loans to countries with deep-seated domestic problems.
After a decade
of struggles, the eurozone is an island of relative stability in a
turbulent sea. To ensure that it stays that way, its leaders must
remember a fundamental truth: no predominantly domestic problem will
ever be resolved by a loan or transfer of resources from abroad. –
Project Syndicate
* Daniel Gros is Director of the Center for European Policy Studies.
The eurozone’s public-debt market has remained relatively stable.