The latest eurozone bailout package was welcome – but it will fail to address the underlying debt problem, says Andrew Bosomworth, head of Pimco portfolio management in Germany
We divide eurozone member states into three groups: one that has generated large and persistent current account surpluses, one whose external accounts are broadly balanced and one that has generated large and persistent current account deficits.
A country running a current account surplus saves more than it invests and produces more than it consumes. Conversely, a country running a current account deficit is able to maintain higher levels of investment than would otherwise be possible without foreign financing.
Through cross-border lending and borrowing, surplus countries accumulate financial claims on, and deficit countries obligations to, those with whom they trade. These financial claims and obligations are captured in a country’s net international investment position, which is analogous to the cumulative current account balance.
The eurozone’s current account surplus countries have accumulated claims on the rest of the world worth about 40% of their gross domestic product (GDP) while the deficit countries owe obligations to the rest of the world worth about 80% of their GDP.
Large and persistent current account surpluses and deficits are ultimately unsustainable in a fixed exchange rate system.
Germany’s current account surplus is as equally problematic as Spain’s current account deficit, so long as their exchange rate is fixed, labor mobility limited or they do not engage in fiscal transfers.
In a floating exchange rate system the currency acts as the adjustment mechanism. In a fixed exchange rate system without labor mobility or fiscal transfers, output and non-tradable goods and service prices adjust. This adjustment process can be destabilizing when accompanied by capital flight.
Faced with a large and sudden withdrawal of capital, current account deficit countries in a fixed exchange rate system have to raise domestic savings the hard way: by stopping spending.