New Bank Austria Analysis:
The Euro in its 13th year – at risk, but better than its reputation suggests

  • Euro has limited most European countries' national debt
  • Low interest rates and high inflation have provided an impetus for debt
  • Economically strong countries in particular have benefitted enormously from the euro
  • Austria's economic performance would fall by 5 per cent if there was a floating exchange rate within the euro area
  • Overcoming present financing problems most important current issue
  • Study recommends: European Financial Stability Facility should act as a vendor of credit default swaps in the market

The euro area is facing some important decisions over the next few weeks. In a recent analysis, Bank Austria economists have examined the first twelve years of the euro and the options for the next few years. "Contrary to the view frequently expressed, the euro was not a mechanism that caused national debt," says Stefan Bruckbauer, chief economist at Bank Austria. On the contrary, debt in the Euro area rose on average significantly less sharply than in the USA. "Even if control over national debt has failed in some euro countries, in general, it has worked well," says Bruckbauer. If all the euro area countries had met the Maastricht target every year since the introduction of the euro and had had a deficit below 3 per cent, national debt would now be only 6 percentage points lower than its actual current level. In the USA, on the other hand, this figure would be 14 percentage points.

The study also shows that today's very high national or private debt in some at-risk countries can be attributed to the "real interest rate shock" following the introduction of the euro. Low interest rates and high inflation accelerated both debt and the deterioration in countries' competitiveness. Once again, some smaller euro area countries were particularly affected. The situation was aggravated further by Germany's particularly restrictive wage policy. All euro area countries have lost their competitive edge compared with Germany in the last twelve years. The combination of strong growth fuelled by high wages and debt and poor competitiveness meant that current account balances differed significantly across the euro area. Germany in particular benefitted and was able to turn a negative current account balance with the euro area into a surplus of some 2 per cent annually. "In total, since the introduction of the euro, Germany has sold some EUR 600 billion net more in goods and services to the euro area than it has bought from there," analyses Bruckbauer. He continues: "This is all the more impressive as Germany had had a deficit with the other euro countries in the previous ten years."  Austria's balance with the euro area moved into the black thanks to the euro, although as is the case for most other euro countries, it remained in the red with Germany. "Leaving Germany aside, Austria was able to turn its current account balance with the euro area from a deficit into a clear surplus," says Bruckbauer, "in some years over EUR 6 billion in net terms."

Inflation differentials in the first twelve years of the euro were significantly greater than, for example, between the largest US states. "A comparison with the USA shows that economic growth and level of income within the USA differed in a similar manner as to how it does within the euro area – only inflation was more harmonised in the USA," says Bruckbauer.

European banks only finance a third of national debt
The Bank Austria study also analyses the current debt problems and shows that banks in the euro area only assume one third of public financing. Another third comes from the private sector, insurance companies and businesses, while around a quarter is financed by foreign countries and a further 8 per cent from funds. The fact that banks are more significant in public financing in the euro area than in the USA, where the banks' share is only 4 per cent is simply due to the fact that private households in the euro area hold more than twice as much of their wealth in the form of bank deposits than in the USA. In this way, the banks act as intermediaries between the household sector, which has a surplus, and the state sector, which has a deficit. The study also shows that banks' claims on Greece, Ireland, Portugal and Spain are clearly lower than is often quoted, representing some 0.6 per cent of total bank claims in the euro area. Nevertheless, the public financing crisis, particularly in the at-risk states, is putting pressure on the banking sector in the euro area and is forcing the European Central Bank to focus its financing on these countries.

The EFSF as a vendor of credit default swaps could ease the burden on debtor countries
The Bank Austria analysis also deals with possibilities for overcoming the current crisis. According to the study, the currently available resources of the EFSF (European Financial Stability Facility) would certainly suffice if they are used flexibly. The study takes a critical view of the proposal to buy back old debts. Although repurchasing all Greece's old debts at the current price would reduce the country's debts by 25 percentage points of GDP, it would be fraught with enormous political problems as the EFSF would have to finance all the debts. In addition, many borrowers would not be prepared to sell at a loss. A new proposal was therefore put forward in the study for overcoming the current crisis.

This would see the EFSF using its resources in the financial market to act as a vendor of credit default swaps, allowing a country such as Portugal to issue bonds at the current price, with the EFSF insuring them for a fee. An investor would come out of this with a net profit, without assuming a higher risk than that of financing, say, Germany. The other countries would receive a fee which they in turn could pass on to a country such as Portugal in order to reduce the latter's interest burden. "If the EFSF were to operate flexibly in the market, this could send a clear signal of strength using fewer resources and with less assumption of debts," says Bruckbauer.

Over the next few weeks, politics must send clear signals of solidarity. At the same time, overcoming the current financing problems is for the present more important than the medium-term reshaping of economic policy in the euro area. Although it is understandable that the solution to current problems is opening up concessions, it does entail certain risks. It could be dangerous if both sides turn their thoughts to who has more to lose. "In the short term, the debtor countries have more to lose, but in the medium term it is the core countries," says Bruckbauer. The study thus calculates that, in the years of floating exchange rates before the euro, Austria's exports clearly suffered. Thus Austrian exports as a share of Italian GDP fell from 1.5 per cent in the 1960s to 0.4 per cent in the 1990s. It is only since the introduction of the euro that it has climbed back up: until then, the value of the lira had lost over 80 per cent against the Austrian schilling. "A simple calculation shows that Austria's economic performance would fall by up to 5 per cent if there was a floating exchange rate within the current euro area," says Bruckbauer.

In the medium term, supervision – especially of debt – in the euro area should be improved. "Past experience shows that supervision at a European level must be supplemented by national elements, such as a national debt brake," says Bruckbauer. In addition, a further step should be taken towards a common economic policy – in this regard, the study suggests the use of a new European Stabilisation Mechanism. The study is somewhat critical on the issue of the new competition rules. "The requirements for strict parameters for wage and social policies may make political sense, but not economic sense," says Bruckbauer. Until there is a stronger common fiscal policy, wage and social policies cannot be made uniform. Stipulating targets does make sense, though verifiable quotas are debatable. There are even question marks over the positive impact of greater harmonisation for tax legislation: indeed, the example of the USA shows the very opposite. Bruckbauer concludes: "Those inside the euro area are underestimating the danger to which the euro is exposed; those outside the euro area, for their part, are underestimating the ability of EU policymakers to do the right thing in an emergency. The sooner investors can be persuaded that the EU has a handle on the situation, the fewer resources will be needed to stabilise the situation."

Enquiries: Bank Austria Economics & Market Analysis Austria
 Stefan Bruckbauer, Tel. +43 (0) 50505 - 41951;
 E-mail: Stefan.Bruckbauer@unicreditgroup.at

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