For years, the eurozone has grown more slowly than the US and its growth has been unbalanced. Germany has enjoyed strong external trade and GDP growth while Italy and France stagnate, and some smaller members submerge.
This has led many to condemn the eurozone’s design as fundamentally flawed and predict that it could lose peripheral members – or break up altogether – if the world economy gets hit by an American or Chinese downturn.
But as fears grow of an unruly US derailing a fragile China to cause world recession, the 19-member euro area is starting to look more stable, even if it isn’t growing. Fears that a German slowdown will drag France, Italy and others into recession assume that Germany is the eurozone’s “engine of growth”. In reality its high savings and external surplus have long been a brake, and a downturn that forces Germans to spend more might do their trading partners no harm.
Because its rules compel most members to operate at less than full capacity, with high (5%+) unemployment, the eurozone runs a small but persistent external surplus. It exports more than enough to finance all imports, despite needing external fossil-fuel supplies.
This enables the eurozone to be a small net exporter of capital (accumulating financial and real assets in other regions) as well as a large supplier of remittances to the rest of the world. Despite slow GDP growth, eurozone countries have steadily reduced their budget deficits since the 2008 global financial crisis, and achieved an overall budget balance in 2018.
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That was done largely by strengthening the eurozone’s tax base, to more than 40% of GDP on average, enabling many members to shield public investment and welfare programmes. Its debt is also relatively stable at 86% of its GDP. Though far above the Maastricht Treaty “ceiling” of 60%, this is economically safe since it is denominated in its own currency and owed mainly to its own residents.
In contrast, the US runs a chronic external deficit which is set to widen as rising demand runs up against domestic labour shortages (despite the trade war on China being meant to bring it down). This is matched by an equally enduring fiscal deficit, which had only just begun to fall (thanks to former president Barack Obama’s stimulus plan) when current president Donald Trump’s tax cuts set it on course for an unprecedented rise. On wider measures the federal government debt is already above 100% of GDP, with its budgetary costs set to grow as the Federal Reserve announces interest rate rises.
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China’s economy is looking even more unbalanced, after its own promotion of public and private borrowing to ride out the 2007-08 credit crunch. With official data likely hiding a slide towards recession, there is mounting evidence that high corporate and local government debt could overwhelm the stronger balance sheets of households and central government.
As for the UK, the slide in the pound which fuelled hopes of a pre-Brexit narrowing of the current account deficit has actually raised it to 5% of GDP. This requires financing by foreign investment, which has shown signs of slowing as Brexit approaches. If the UK can’t boost exports, or attract more inward investment, it’ll just have to import less, which invariably means slower growth of income and spending.
De-leverage us from evil
The global financial crisis drew attention to private (household and corporate) debt as potentially much more dangerous than public debt. Where they borrowed too much before 2008, eurozone households have reduced their debt far more effectively than those in the US or UK.
Some are still awash in private sector debt, as the eurozone’s own array of vulnerability measures makes clear. But Italy, Portugal, Belgium and Greece remain the only four members where both private and public sectors have borrowed more than 100% of GDP – with no indication that this will undermine them, if a sharp rise in interest rates is avoided.
The eurozone banking sector still looks vulnerable to external disturbance, since it emerged from the 2008 crash with many weaker and less profitable players than in the US. Some may look even shakier if regulators are right in suspecting ill-gotten capital gains.
But eurozone banks look weak only when judged by the standards of the US, where large firms borrow more directly from the market via bond issues. The obverse is that America’s corporate debt remains almost twice the size of Europe’s, while China’s has grown at unusual speed since 2008, leaving both at greater risk if corporate earnings start to recede.
Because it lacks central fiscal capacity, fears about the eurozone’s future are not overblown. But while it looks like a swamp of stagnation in a reviving world economy, the eurozone is configured to be the island of tranquillity when lands around it submerge.
It trades mainly within itself, re-invests its own savings, and doesn’t rely on large transfers into or out of other regions. So if another financial or commercial shock sends the rest of the world running backwards, the unloved single currency area may defy gravity as stubbornly as it resists reform.