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Analysis
Creditors versus debtors

Creditors versus debtors

Mutual entrapment and the euro area

by David Marsh

Tue 7 Jun 2016

The creditors versus debtors struggle within the euro area is losing none of its power to polarise. Just a month after Mario Draghi blamed Germany for generating a new, destabilising ‘savings glut’ in Europe through persistent high current account surpluses, the European Central Bank president has again astutely put his finger on the continent’s long-running sore.

In a speech in Vienna on 2 June commemorating the 200th anniversary of the Austrian National Bank – an institution with a history rich in tales of war, gold and inflation – Draghi emphasised perhaps the most potent reason why the ECB is trying to tackle low inflation through energetically unconventional monetary policy: to counter a transfer of income and wealth from debtors to creditors.

‘With fixed nominal debts, lower inflation would trigger redistribution from borrowers to creditors, which would prolong the debt overhang and exacerbate the contraction due to the different propensities to consume and invest of those two groups.’

Draghi has been graphic in spelling out the principal fault line in monetary union. In a speech in May 2013 in Rome, he accurately portrayed Europe’s division between ‘countries with positive trade balances and sound budgets from those with growing budget deficits and external deficits… No one ever imagined that the monetary union could become a union divided between permanent creditors and permanent debtors, where the former would perpetually lend money and credibility to the latter.'

In the meantime, and especially since the lowering of interest rate spreads after Draghi’s ‘do whatever it takes’ pledge to rescue the euro in July 2012, the position of the peripheral countries that formerly ran large current account deficits has improved – but their overall status as large-scale debtors has not.

Debtors and creditors appear trapped in a symbiotic relationship of mutual resentment and recrimination. The creditors, led by the Germans and Dutch, claim that the debtors’ built-in majority on the ECB council has led to a persistent accommodative monetary policy that has forced down interest rates to disruptively low, negative levels. This, the creditors say, undermines the business models of many domestic banks and insurance companies, generates unhealthy property speculation and credit-generated takeovers, and exposes economies to the perils of monetary financing.

The debtors retort that they are penalised by inability to expand economies or raise price levels sufficiently to expand their way out of debt entrapment. Instead they face years of grindingly low growth and only slow escape from debilitating debt burdens. Meanwhile, the debtors say, creditor country exporters are reaping giant benefits from an ECB-induced low exchange rate, symbolised by Germany’s current account surplus, which the Organisation for Economic Co-operation and Development says will rise to 9.2% of GDP this year from 8.6% in 2015.

According to latest OECD figures, general government gross public debt as a proportion of GDP will be 176.9% for Greece in 2016 against 109.6% in 2008 before the financial crisis, 132.8% for Italy (against 102.4% eight years previously), 128.3% for Portugal (against 71.7%) and 100.3% for Spain (against 39.4%).

Debt across the overall euro area has risen to 92.4% from 68.9% in 2008. The leading creditor, Germany, has done much better than average, with debt up only marginally to 67.7% from 65%. You don’t have to be in the single currency club to show a poor debt record. Britain, firmly outside the euro bloc, has registered a debt rise to 89.9% from 51.7%, while France has recorded a slightly smaller proportional increase, from 68.1% to 96.9%.

Underlining the debtor-creditor gulf, Germany’s overall net foreign assets, according to annual figures on countries’ net international investment positions from Eurostat, the EU statistical agency, rose to 49.2% of GDP at the end of last year, against a mere 3.1% when monetary union started in 1999. The Netherlands, the other major creditor, had net foreign assets of 66.7% of GDP at end-2015. Greece, Cyprus, Spain, Portugal and Italy had net foreign liabilities of 126.4%, 129.2%, 90.5%, 109.4% and 26.7% respectively – in all cases a sharp deterioration compared with before they joined monetary union 18 years ago.

The cleavage between debtors and creditors can eventually be overcome by higher growth and lower inflation in the latter compared with the former. But the adjustment is painfully long. In the meantime, both interest rates and the exchange rate will remain lower in the euro area than would otherwise be the case – a boon for export-orientated companies, but only if the rest of the world expands at a moderate rate.

David Marsh is Managing Director of OMFIF.

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