Eurozone Finances Have Deteriorated

Despite negative interest rates and money printing by the European Central Bank, which conveniently allowed all Eurozone member governments to fund themselves, having gone nowhere Eurozone nominal GDP is even lower than it was before the Lehman crisis.

Then there is the question of bad debts, which have been mostly shoveled into the TARGET2 settlement system: otherwise, we would have seen some substantial bank failures by now.

The Eurozone’s largest banks are over-leveraged, and their share prices question their survival. Furthermore, these banks will have to contract their balance sheets to comply with the new Basel 4 regulations covering risk-weighted assets, due to be introduced in January 2023.

And lastly, we should consider the political and economic consequences of a collapse of the Eurosystem. It is likely to be triggered by US dollar interest rates rising, causing a global bear market in financial assets. The financial position of highly indebted Eurozone members will become rapidly untenable and the very existence of the euro, the glue that holds it all together, will be threatened.


Understandably perhaps, mainstream international economic comment has focused on prospects for the American economy, and those looking for guidance on European economic affairs have had to dig deeper. But since the Lehman crisis, the EU has stagnated relative to the US as the chart of annual GDP in Figure 1 shows.

Clearly, like much of the commentary about it, the EU has been in the doldrums since 2008. There was a series of crises involving Greece, Cyprus, Italy, Portugal, and Spain. And the World Bank’s database has removed the UK from the wider EU’s GDP numbers before Brexit, so that has not contributed to the EU’s underperformance. Furthermore, since 1994 the gap between Eurozone and non-Eurozone member nations GDP growth has increased from 9% of the total to 15%, even adjusted for new memberships. It tells us that despite all the ECB’s money-printing, non-Eurozone members facing the same regulations and trading restrictions using their own currencies have outperformed the Eurozone.

The ECB has enforced negative interest rates since June 2014, cutting its deposit rate four times since its initial -0.1% rate to -0.5%. The monetary policy planners clearly thought negative rates would boost credit demand for investment and consumption, provide fiscal space for governments and thus increase aggregate demand. It didn’t turn out like that. The principal aspect which negative interest rates has boosted is government debt, which in the Eurozone at the end of 2020 had risen to 98% of GDP overall for Eurozone members.

Admittedly, bungled management of covid and vaccines have not helped. Not only did they increase government spending, but tax income suffered from the economic consequences. The global logistics crisis has seriously impacted the highly productive German economy, with major manufacturers seeing their production grinding to a halt for lack of components. And in many jurisdictions covid lockdowns have continued, delaying hoped-for recoveries, and hitting tourism in the highly indebted PIGS.

As Figure 1 demonstrates, these troubles are in addition to the economic stagnation that has been a feature of the Eurozone since the Lehman crisis. The consequences of covid do not yet appear to be adequately reflected in official GDP figures, which will have been pushed higher by an acceleration of growth in euro money supply.

Broad money increased significantly in 2020, as shown in Figure 2 below, mainly due to the expansion of central bank balances in the Eurozone.

At the same time, having recovered somewhat since the series of crises following Lehman, government finances took a sharp turn for the worse, as shown in Figure 3.

The reason for the Eurozone’s underperforming GDP relative to that of the US revealed in Figure 1 is not hard to discern. The chart below from the St Louis’ FRED shows how bank lending to the non-financial sector has broadly stalled since the Lehman crisis.

Instead, monetary growth has been in the Eurosystem, comprising the ECB and the national central banks. From €2 trillion at the end of 2008, total Eurosystem balances grew to €7 trillion at end-2020, some of this due to rising imbalances in TARGET2 which are reflected in expanded central bank balance sheets.

Government deficits in the Eurozone are persisting into the current year, expected by the ECB itself to rise to 8.7% of 2021 GDP. That’s on an estimated GDP of €13.476 trillion, giving a public sector deficit of €1.2 trillion, taking the debt to GDP figure to 103% for 2021. But this increase is mainly on the back of planned infrastructure spending and assumes a sharp recovery in tax revenues on the back of improving employment and higher consumer spending. That has already been overtaken by events, and fiscal deficits will be far higher than forecast.

In official forecasts by the ECB there is a strong dose of neo-Keynesian optimism in expectations, which we have seen time and again with the Eurozone’s economic establishment. Furthermore, under the presidency of Christine Lagarde, the ECB is meddling in non-monetary affairs, giving precedence to a green agenda over fossil fuels, and creating precedents for the politicization of monetary affairs. It seems that the uses of the ECB’s magic money tree are one of the few aspects of economic affairs which are growing…

Of one thing we can be certain, and that is blindness at the ECB to the global credit cycle driven by America and the dollar. Officially, US prices are rising at 5.4%, while in the Eurozone they are at the goal-sought target of 2%. We know that in the US independent analysis confirms the true rate of rising prices is over 13%,

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