Is the
eurozone insolvent? In the past few weeks, we have all focused on the solvency of Greece, Spain and Portugal. But we never seriously questioned the solvency of those who actually guarantee all those southern European debts.
The first thing to note is that you cannot answer that question with a cursory reference to the debt-to-gross domestic product ratios of eurozone countries. This macro perspective is of little use here. Those numbers tell us that the eurozone is in a better position than the US, the UK or Japan. The problem is that those headline numbers exclude contingent debt and the interconnectedness of financial flows.
In last week’s column I remarked that it was no accident that the eurozone created a
special purpose vehicle to manage this bail-out. It is not just the name that reminds us of those notorious financial structures that brought us the subprime crisis. There are in fact substantive parallels.
Like a dodgy subprime collateralised debt obligation, the eurozone’s SPV lacks transparency. The operational rules are not clear, and have been subject to disputes among member states since political leaders announced agreement. If you want to understand it, you had better read the small print.
... As long as the eurozone governments can generate sufficient tax revenues, all is well. But if that were to stop, the eurozone’s debt edifice might break down like a house of cards. Even a 150 per cent debt-to-GDP ratio would be feasible if the eurozone had an intelligent growth strategy. But it never did, and it still does not.
