EU Flags The Risk Of Debt Snowballs In Southern Europe – Irony Or Tragedy?

Thursday, June 17, 2010
By Paul Martin

By: Claus Vistesen

As it seems that we are finally about to get something which resembles a stable summer here in Denmark it may seem strange to suddenly start talking about snowballs. Yet, the idea of debt snowball is very relevant in the current environment as it relates to the potentially unstoppable development in public/domestic debt levels despite a country’s best efforts in the form of austerity measures. Specifically, the combination of a year long loss of competitiveness, excessive domestic debt levels (private as well as public) and being caught up in a fixed currency union means that as austerity measures enforced to rein in debt levels also push the economy into deflation and growth, by virtue of the loss of competitiveness, remains absent the debt problems essentially worsens despite efforts to the contrary. Recently, I penned a paper on, in part, this very subject and the following passage sums up the main learning point;

Thus, Greece et al are effectively caught in a catch 22. Specifically, the need to simultaneously rein in fiscal stimulus in order to preserve long term debt sustainability as well as to correct an external deficit proves a decisively unattractive macroeconomic medicine which may not only prove difficult to administer, but also effectively impossible to pull through in the current Eurozone setup. The vice which then locks in
uncompetitive economies in the Eurozone is twofold.

Firstly, the deflation in prices and wages needed to restore external competitiveness and thus growth must be relative in excess of other economies’ correction. In this sense, Greece et al are fighting a moving target in the form of relative deflation compared to other member economies and indeed other global economies facing similar pressures to deleverage. In short, the battle for relative market share on export markets will increase in conjunction with the amount of economies pursuing a deliberate export oriented growth strategy. Secondly, deflation increase the real value of overall government debt thus requires even more in the way of austerity measures to keep the debt level sustainable. Moreover and as a complicating factor; Greece, Spain, and Portugal are currently paying a large premium over the base rate (German Bunds) for lending money.

This may sound terribly complicated, but the argument is apperently not more complicated that it made it into a recent EU draft report according to Bloomberg who has obtained a copy of the report. Specifically, the report notes that while the measures already taken are the right way to go they may not prove enough;

(quote Bloomberg)

Debt levels in Spain and Portugal may “snowball” in coming years and additional budget cuts are needed to meet deficit targets announced just a month ago, according to a draft European Commission document.

The Rest…HERE

Leave a Reply

Join the revolution in 2018. Revolution Radio is 100% volunteer ran. Any contributions are greatly appreciated. God bless!

Follow us on Twitter