Back in 2010 and 2011, the IMF, the EU Commission, the European Central Bank and pretty much every official European economist were preoccupied with the Greek government debt targets for 2020. Deploying a host of unrealistic assumptions and expectations, they produced a magic value: 120 per cent of GDP.
This debt ceiling, as I pointed out back then, was a bogus one – a made-up number designed solely to avoid placing heat on Italy and Portugal, which were hovering around this same level in 2011, and Ireland,which is forecast to reach it in 2013.
The Greek debt target debate was completely detached from the real debt crisis sweeping the euro area economies – as much back in 2010 and 2011 as it is now.
The target ignores the actual, historically established bounds for debt sustainability, which are put at 83-90 per cent of GDP. Once public debt rises above these levels, it starts stymying growth. By this metric, eight euro area countries are currently under water. And based on the latest IMF projections, these countries will remain in the danger zone through 2017. In fact, the entire euro area itself is now sporting a government debt to GDP ratio of 94 per cent.
The target also ignores the realities of other real economic debts, the sustainability of which is associated with the government debt – gross household and non-financial firms’ liabilities. These liabilities, alongside the public debt, have to be covered out of the activity generated by the economy and thus compete for scarce income resources with government debt. It is for this reason that I call all three liabilities taken together “the real economic debt.”
Historical evidence shows that non-financial corporate debt starts to exert significant drag on growth once it exceeds 73 per cent of GDP. This means that pretty much every euro area country, save Finland and Germany, is now on red alert for corporate debt overhang. For household debt, the danger line is at a debt to GDP ratio of 84 per cent. None of which entered the IMF, the EU Commission or the ECB analysis of debt sustainability targets back in 2010-11. Even now, after this week’s IMF admission that the total real economic debt does matter in determining overall economic sustainability, the EU and the ECB continue to deny its role in the crisis.
Don’t take my word for this. The latest ECB monthly bulletin shows that euro-area household liabilities rose from €5.82-trillion in 2008 to €6.19-trillion in the first quarter of 2012. Euro-zone listed debt outstanding for the non-financial corporates rose from €9.31-trillion in 2008 to €9.88-trillion in the first half of 2012. This growth is lauded as a positive sign for the euro-area economy.
The latest IMF data put real economic debt for the euro area at 303 per cent of 2012 GDP. Based on average interest rates reported by the ECB, this means that the debt pile costs the common currency economies some €1-trillion annually in interest charges alone. Between 2013 and 2017, the IMF is expecting the euro-zone economy to add some €195-billion in new income annually on average. In other words, payments on debts will exceed economic growth in the euro area by a factor of five.
The unreality of the European fiscal sustainability analysis is, therefore, a clear-cut case of the decision makers opting to dress up long-term targets for austerity in order to avoid admitting that the entire euro-area economy has been built on the quicksand of leverage.
Dr. Constantin Gurdgiev is adjunct professor of finance at Trinity College, Dublin
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