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Economy in Brief

EMU Current Account Swings to Deficit
by Robert Brusca  April 18, 2012

The trends in EMU show the 17 country Euro Area current account deficit swinging widely first to a surplus and now plunging to a deficit. It is no longer clear if there is an improving trend in train or not. Goods imports are out pacing goods exports, that will tend to push the current account balance to the negative. But services exports have nudged ahead of services imports and that will tend to diminish any deterioration. However, current transfers loom large in the Euro Area due to wage repatriations for 'guest' workers who send a large chunk of their pay back home.

This means that EMU must run trade surpluses to have enough left to pay for the outflows related to their current transfers, an outflow that is quite large and relatively stable.

This development may tell of some stress building on the currency. But as we know the real stress on the Euro Area is from its current internal tensions.

New data show that the ECB LTRO program has resulted in diminished cross border flows. Richer countries have been cutting their exposure to poorer countries. Typically this means that government bond purchases across borders have slowed or reversed. To replace these monies there are the new LTRO funds. Local banks in Spain, Portugal and Italy have increased their participation in the LTRO program using the low interest proceeds to buy local government debt. Based on no mark-to-market this is a very profitable trade for the banks as government bond coupons in these countries are high and LTRO loans are cheap. Still, you won't see this transaction done in Germany where two year government obligations just traded at a yield 0.14% (yes fourteen basis points) for a two-year investment. LTRO loans are not cheap enough to make that trade work.

For those countries where banks have participated in this scheme there is a day of reckoning. Since local government bond markets in the peripheral countries have weakened, the all the 'juice' in the high government bond coupons is being soaked up (and more!) by capital losses as government bond yields rise and bond prices fall. Of course if these bonds are not marked-to-market the loss is submerged, and disappears into the vagaries of accounting.

The only solution, of course is more LTRO, so more bonds can be bought to reduce bond yields further and to protect bond prices... On second thought, maybe not.

The real problem of course continues to be ignored. And more LTRO will just make the 'hidden loss problem' even larger. The solution is not austerity although balancing local budgets would take pressure off local bond markets, dropping yields and raising bond prices. But the very things that shrink budget deficits harm growth and lower growth reduces tax revenue subverting this process, leading to a really evil vicious cycle of reduced growth and larger budget deficits.

To break the cycle you have to deal with the causal problems not with the symptoms (like deficits).

What has spawned the problems in the Euro Area, is that members have allowed various regions to endure differential rates of inflation for extended periods of time. Now these gaps, added up and compounded over time, reveal huge competitiveness differentials INSIDE the zone. These differentials have been exposed by the collapse of the bubble economy. With Spain's real estate bubble gone, with Italy's and Greece's financial fudging of the books revealed, and with lower growth and reduced tax revenues there is no good solution is sight. The problems have gone beyond the ability to use fiscal tools to fix fiscal problems. Macroeconomic tools are now needed.

The revelation of the extent of the problems has chased lenders away (except the ECB) and the only reason that the German's are not complaining about this use of the ECB balance sheet is that German banks are using the time as a chance to reduce direct lending exposure to troubled countries and to transfer this exposure as official exposure though the ECB lending presence in LTRO.

If competiveness is at the core of the issue it cannot be fixed without devaluation. And it is.

The competitiveness gaps are just too large to be handled by what some call internal devaluation and what others call deflation. Europe is in denial, trying to save the Union. Or maybe it's just that countries like Germany are trying to rearrange the deck chairs on the Titanic into something that can make escape feasible and less painful when the union finally does collapse. There really seems to be no other solution. Unless EMU can agree to a bank holiday to reset currency parities and reform the union immediately there is no escaping its destiny. Such a move would make sense economically but it would raise all sorts of questions and in fact it would generate all sorts of losses across the Zone and beyond it. And then there would be the legal challenges…In the end there may be nothing more to do than to let the Zone fall apart. LTRO is only postponing the day of reckoning. And as the entire EMU weakens it has fewer resources to use and more obligations. The weakening current account position is not a good sign and it suggests that the pressure is ramping up. This means Europe's options are increasingly limited.

Euro Area Current Account Major components
  Month-to-Month Period Changes
Mlns, Euros, SA Feb-12 Jan-12 Dec-11 3Mo 6Mo 12Mo
Current Account -1,300 3,700 3,000 -5,500 -2,200 400
Goods Balance WDA 3,655 5,252 7,107 -868 6,358 6,915
Services Balance 4,700 4,100 5,400 -1,000 -200 600
Income Balance 1,200 4,200 3,800 -2,700 -1,800 -1,400
Current transfers -8,700 -7,900 -8,400 -500 -800 -400
Details %
Goods Month-to-Month At Annual Rates
Exports 0.7% 1.3% 0.5% 10.4% 9.8% 6.7%
Imports 1.9% 0.6% 0.9% 14.7% 9.0% 5.7%
Exports 3.8% -3.9% 0.0% -0.9% 2.6% 3.6%
Imports 2.7% -1.2% 0.7% 9.1% 4.0% 2.5%
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