Current account is the major driver of net lending/net borrowing of an economy; it provides important information about the economic relations of a country with the rest of the world. It covers all transactions (other than those in financial items) that involve economic values and occur between resident and non-resident units.
By analyzing [source of data] the performances of some countries in the euro area (Germany, Italy, Spain, France, Greece and the Nederlands) in three different periods (1995:2000; 2001:2007; 2008:2011) we can note that:
A) the northern countries (Germany and the Nederlands) have had significant benefits from the introduction of the euro, generating huge surpluses in the balance of payments (and in the trade balance). This effect on the balance of payments sustained their gross domestic product, and allowed the reinforcement of their ratio of debt over gross domestic product.
B) The peripheral nations, have had serious drawbacks by the introduction of the euro, with strong negative outcomes in the balance of payments (and in the trade balance). The consequence was either the blowing up of the private debts, which in turn became public debt in recent crises (clear case of Spain and Greece, but similarly we would conclude about Portugal, Ireland), or the depression of the gross domestic product and the real economy and production (as happened in Italy).
Figure 1. Current Account Balance vs. government debt.
In the period prior to the introduction of the euro (from 1995 to 2000), all the reported countries (except from France) showed a decrease of the current account balance (CAB) in percentage of the gross domestic product (Y). Germany presented an increase (around +5%) of the ratio debt/Y (B/Y) while Greece recorded +6,4%. Interestingly, Italy reached -12,4%. The performance of the Nederlands (-22,3%) was the most progressing. Things became to change in the successive period (from 2001 to 2007) where Germany (+7,4%) and the Nederlands (+4,1%) experienced the reversal of ratio CAB/Y, Spain and Greece enlarged the decrease (beyond -5%) of this ratio. Italy almost controlled the unbalance of the ratio CAB/Y around -1,6%. France turned to negative area of CAB/Y (-2,7%). The government debt over the gross domestic product still increased in France and Germany and Greece, while further reductions took place in Italy (-4,9%), and in the Nederlands (-5,4%). Spain produced the largest shrinkage (-19,3%) of the ratio B/Y (from 55,6% in 2001 to 36,3 % by the end of 2007) !! Along with the big-crisis (last period 2008:2011) the ratio B/Y increased in all the countries. But for Greece and Spain we need to describe it in dramatic terms: +57,7% Greece, +29,1% Spain. Amazingly, these two countries also showed positive values of their CAB/Y ratio. Likely, it might derive from the massive reduction in their aggregate demand and hence of their imports and by the net outflow of financial resources. Italy nearly balanced its current account (-0,2%), but the ratio B/Y rose 14,6% and reached the alarming level of 120,7% by the end of 2011.
Figure 2. Current Account Balance vs. private debt.
The dynamics of the private debt offer the key for interpreting the unbalanced euro-zone macroeconomics. The nullification of the risk of exchange rate and the approaching of the interest rates in the euro-zone countries towards similar low values leveraged the aggregate demand for consumption and investment of the private sector in the weaker economies (say, the peripheral countries). The inflow of financial investments from outer countries (say, the central countries) was necessary for feeding this expansion.
From another point of view, the central countries financed the purchaise of their goods and services by the peripheral countries. This resulted in the improvement (worsening) of the balance of payments of the central (peripheral) countries and during the first stage of euro the peripheral countries did also profit by the improvement of their gross domestic product. But the global crisis of 2008 has triggered the shrinking and call back of financial funds such that the peripheral countries have lost large amount of resources for sustaining the expenditures of both the government and the private sector.
The cycle of Frenkel enables us to realize the present division into the euro-zone macroeconomics.
According to the theory of Frenkel, this situation as before mentioned benefits the center twice:
- Because the interest rates are higher in the peripheral countries.
- Because capital flowed in the periphery, induces it to borrow for the purchase of products from the center, without the risk of devaluation of the capital.
Even the periphery appears to take advantage from this situation, which gives rise to a boom dummy, because increases its gross domestic product and public debt decreases. At this stage, however, there is a simultaneous increase of inflation which being cumulated over the years, determines a considerable loss of competitiveness (real appreciation); the result is a deterioration in the balance of trade.
The peripheral country get into debt gradually towards the center. When lenders understand that it provided "too much", or because of the occurrence of external shocks, suddenly they stop the flow of capital and tend to abandon the periphery. Creditors considerably raise their interest rate, due to the increased risk factor. At this point the Government goes to the rescue of the banks, and other subjects in difficulty, and often "the debts that were originally private become public".
Normally, the cycle ends with the abandonment of monetary parity and the return to exchange rate flexibility.
In the eurozone the "spread", relative to government bonds, which are accentuated at this stage, are not due to excessive public debt, as usually stated , but the imbalances in trade balances, which would require currency devaluations to their readjustments (adoptable by peripheral countries, if they decide to leave the euro). The risk of depreciation of the securities, if they were renamed in the new currency, justifies the high interest rates.
Table 1. The ratios of current account balance, government debt and private debt over the gross domestic product: averaged values in the observed periods.
This table shows that the imbalances of the current account affect the euro zone. Actually, deterioration of the ratio government debt/gross domestic product (B/Y) by itself would not suffice to explain the crisis within the euro zone (e.g., see the case of Spain). Rather, the private debt out of control might contribute to the budget deficit. In fact, the current account balance is equivalent to the net flow of capital (i.e., difference between saving and investment): CAB = S - I, therefore if CAB is less than zero, the country spends more than it saves (I is greater than S) then it needs to obtain loans from outer. Neither, in this occurrence, the private sector could sustain the public sector expenditures. The budget deficit should be covered by bond issue to be sold at the international markets at the cost of possible growing interest rates.
Observations about the effect of the private debt must consider the macroeconomic context. In an expansive economic phase, private sector debt would signal in the short term the growth of the aggregate demand for consumption and in the middle-long term the return of the investment expenditure would benefit the economy (e.g., the Nederlands). On the contrary, in a recessive phase, a large imbalance of the private sector casts doubt on the sustainability of the financial sector and bottles up the long term growth (e.g., Spain).
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