While commentators throughout this year have generally pointed a finger at the Euro Zone, it's trading statistics in spite of all it's problems are impressive. For calendar year 2014 it will have a current account surplus of €280 billion, this is slightly distorted by a certain amount of aid money from the IMF flowing into a few areas like Greece, however as the bulk of this aid money is coming from the Euro Zone itself the impact is not so great, certainly at least €260 billion is coming from the trading/financial relationship with the rest of the world.
This achieved in an environment without growth!.
As I pointed out in my article on the UK 2014 GDP figures, GDP is a measurement of the cost equation of an economy, that in the absence of increased output, increasing GDP can be a sign of loss of competitiveness by the economy. If we consider the economy as a whole then we must surely define outputs as the net amount the economy receives from the rest of the world for trade and investments. GDP growth without an increase in outputs is simply inflation and the nation will become less and less competitive, while a stagnant GDP in the light of an increasing current account surplus indicates improving efficiency or relative competitiveness.
Based on my contention that current account (excluding transfers or aid) represents the output of the economy, the lack of growth in GDP points to an increasing competitiveness of the Euro Zone relative the rest of the world. One initially assumes that this comes from Germany alone, however a quick look at the current account surpluses in the Euro Zone one finds that virtually all members have moved into positive territory, Germany accounting for around 75% of the total surplus.
Immediately, one must question the Euro exchange rate, however, in view of the structural unemployment, it is unlikely that policies aimed at boosting the exchange rate will be adopted. A higher Euro value would simply exacerbate the unemployment issue in the medium term. That said, one should expect to see a gradually strengthening Euro, or relative weakening of other currencies over a two to five year time frame.
The effect of sanctions against Russia and Russia's counter sanctions will result in a loss of market, initially for a portion of agricultural output, however if the sanctions continue for a long period the impact will spread to other manufactured goods. The net result of the sanctions will be a surplus of certain goods and products in the Euro-Zone possibly to the extent of half a percent of GDP creating a mild deflationary impact.
The drop in oil price has a further deflationary impact. Because oil imports to the Euro-Zone represent 2.5% of GDP they will prove the major beneficiary … most other major economies outside of Japan have a proportion of own production of oil and do not benefit as much from a fall in oil prices (in the case of the UK where we produce 55% of the oil we consume the gain from lower import prices is more than offset by loss of income to our oil producers). While both the sanctions and the oil price drop will have a deflationary impact on Euro-Zone prices, the overall result should be a further increase in the Euro-Zone current account surplus.
Commentators and the media have raised deflation as tantamount to a catastrophe beyond imagination. A recent study by Bank of International Settlements suggests that mild deflation can in fact be good for an economy. If however the deflation is so significant that it results in wage cuts exceeding the rate of deflation, then the situation that the commentators predict becomes a reality. Mild deflation without wage cuts actually represents a growth of incomes in real terms leaving the consumer better off.
Naturally the impact on an economy where banking profits are a significant proportion of GDP, a deflationary environment resulting in lower demand for loans, without increased interest rates, will result in a falling profits in the banking sector.. We can therefore say that the Jury is out on whether deflation is actually bad.
More significantly the Euro-Zone has a structural unemployment problem. The increase in unemployment levels particularly in Southern Europe can be directly attributed to a bursting of the property speculation boom (or bubble) when easy financing dried up. A similar situation arose in the new members of the EU where access to easier financing created bubbles and distortions as governments struggled to manage their economies in a way that would maintain their currency values against the Euro.
When one considers that in order to drop the unemployment rate from 11% to 6.5% involves creating employment for an additional 8 million people, the enormity of the problem becomes apparent. Pandering to the commentators' call for quantitative easing à la UK/USA has no hope of succeeding, Such a policy can only impact on asset prices, which might create an illusion improvement but will not create jobs on the ground to any measurable extent. The holders of Government bonds are not going to go out and buy goods when their bonds are turned into cash, these bonds are their savings for the future, they are more likely to attempt to convert that cash into other assets, which will only create either a stock exchange or housing price bubble compounding the widening gap between rich and poor.
The solution requires a project of breath taking scope, but as we have seen from their current account surplus, is not beyond the financial capability of the Euro-Zone.