Are Things Looking Up for the Eurozone?

Looking at the Aggregate Is a Mistake

by Elliott Morss, Morss Global Finance

Introduction

We often talk of the Eurozone as a single entity: “the Eurozone grew by…; the unemployment rate fell by….” The Eurozone should not be viewed as a single economic entity. It is a group of quite disparate economies tied together by a single currency.

And using the same currency creates real problems. With no home “printing press”, a Eurozone government or country can literally “run out of money”:

• A government deficit will ultimately use up a government’s Euros.
• A country running a current account deficit will ultimately use up its international reserves.

Given their economic differences, is there a meaningful way to look at Eurozone countries? In earlier postings, I have broken Euro countries into two groups: the “weak sisters” (Greece, Ireland (for a while), Italy, Portugal, and Spain) and all the rest. This is not good enough. So below, I develop a new set of categories based on the economic circumstances of each country.

Preliminary Analytics

The primary task of most government is to keep unemployment at reasonable levels. In the Eurozone, unemployment rates run from Austria’s 4.8% to Greece’s 27%. The most effective policy tool to reduce unemployment is the government accounts: increasing the government deficit will reduce unemployment while reducing the deficit will cause unemployment to rise. Of course, there are limits to what government’s can do with deficits. This is particularly true for countries with large debts.

I mentioned above that countries can run out of money. A key indicator here is a country’s current account balance. If a country runs negative current account balances for extended periods of time, it will exhaust its international reserves and “run out of money.”

Categorizing Eurozone Countries

Having examined unemployment rates, government deficits, debt, and current account deficits, I have come up with five categories for Eurozone countries: Not Sustainable, Extremely Dangerous, Serious Problems, OK, and Economic Powerhouses. In the following table, data are in bold if:

• the unemployment rate is 10% or more;
• the government deficit by 3% of GDP or higher;
• the government debt is greater than 90% of GDP; and
• if the current account is negative.

Red data indicate an unsustainable situation

Source: FocusEconomics
Click to enlarge

Not Sustainable

Both Cyprus and Greece are on non-sustainable paths. Cyprus has a high unemployment rate and a huge fiscal deficit. And any reduction in the government deficit will mean higher unemployment. Greece remains nearly hopeless. Its stated unemployment rate and debt are higher than any other Euro country. And it is estimated that 60% of younger people do not have jobs. The government will have to default on a large chunk of its debt in the near future. And the anti-German, anti-austerity Syriza party has made large gains in the recent elections – a very dangerous and unstable situation.

Extremely Dangerous

The economic conditions in four countries are extremely dangerous. So far, France has flown largely under the radar screen. No longer. France is facing problems on all four of the economic indicators. Italy’s debt is extremely high and growing as a result of its government deficits. Its debt is only sustainable as long as the European Central Bank continues to aggressively buy up European government debt to hold interest rates down. Portugal has ended its bailout program but problems remain: a high unemployment rate and high government debt. Spain, like Greece has very high unemployment. It is also running a large government deficit which means its debt, already high, will continue to grow.

Serious Problems

Ireland has ended its bailout, but problems remain. Its unemployment remains high as does its deficit. Slovenia’s situation is similar to Ireland’s, but its debt is much lower.

OK, these five countries are not problem-free, but their problems are manageable.

Economic Powerhouses

These five countries are in good shape, and therein lies the problem for the Eurozone. Countries in the Not Sustainable and Extremely Dangerous categories cannot compete with Austria, Germany, and the Netherlands. When they had their own currencies, differences in competitiveness were neutralized by their currencies weakening. With that option no longer available the balance of payment deficits of weaker countries will grow, and the cycle will repeat itself.

Conclusions

The “Eurozone” is not out of the woods. And while I have emphasized above that it is inappropriate to look at aggregates, it is worth noting that the region’s overall unemployment rate is still a high 11.8%. Should you invest in the Eurozone via, for example, the iShares EMU ETF (EZU)?  I would not.