Here's Why Europe Must Do More to Save Its Currency Union

Wipe our Debt (Photo credit: Images_of_Money)

Paris, Oct. 17, swing trading .- The battle to save the euro turns on one question: Can large governments, notably Italy and Spain, get their debts under control? Because they are in a monetary union, they can’t take the easy way out by devaluing their currencies to make their obligations smaller and exports cheaper relative to those of other countries. Instead, they have to make painful budget cuts and slash workers’ wages to restore their competitiveness -- moves that, in the short term, can make their debts less manageable by eroding economic growth. If the belt-tightening proves too much to bear, or if markets lose faith in their ability to succeed, the euro area will break apart. As Europe’s leaders meet for their two-day summit in Brussels this week, they can take credit for considerable progress in containing market panic and demonstrating their commitment to the currency. They have pledged to share responsibility for overseeing and shoring up euro-area banks, potentially relieving struggling governments of a big liability. More important, the European Central Bank has promised unlimited support to keep countries’ borrowing costs in check, as long as they act in a fiscally responsible manner.

So how much has all the activity achieved? To get a better picture, we built a model to assess the solvency of euro-area governments.

Fiscal Challenges

One way to judge a sovereign’s finances is to compare its current fiscal challenges to what it has achieved in the past. We did so by measuring the difference between two numbers. One is the largest primary budget surplus (excluding interest payments) that the government has maintained for any 10-year period in the past few decades. The other is the primary surplus it must achieve to ensure its debt burden doesn’t grow faster than its economy. If the first number is larger than the second, then history suggests a government’s debts are manageable. The answer can change from day to day -- minute to minute, even -- along with market interest rates and the country’s economic outlook. (See attachment for our methodology.)

The results are both encouraging and daunting. Crucially, the ECB’s open-ended bond-buying program, announced Sept. 6, has calmed markets enough to bring Spain and Italy back from the brink (see attached graphic). As recently as July, high borrowing costs had pushed both sovereigns into insolvent territory. As of Oct. 12, with the yield on its 10-year bond down to 5.6 percent, Spain could squeak by with a primary budget surplus of about 1.3 percent of gross domestic product, below its maximum 10-year historical average of 2.1 percent. Italy, which has a larger debt burden, would have to run a surplus of 2.3 percent to get over the bar. It is on course to best that number this year. ... Continue to read.

Related articles

• Here's Why Europe Must Do More to Save Its Currency Union - Bloomberg (bloomberg.com)
• Spain's Dangerous Waiting Game (stocktipsinvestment.blogspot.com)
• EU Leaders Gird for Summit as Nobel Glow Fades on Greece, Spain (bloomberg.com)