Current accounts in Euroland: not good news

There are an increasing number of reports suggesting that the Euroland crisis must be easing at a fundamental level since current account imbalances in the region seem to be shrinking.  It is certainly the case that the current account deficits in the periphery are disappearing or have disappeared but would that this was unambiguously good news. The problem is that it isn’t.

If we dig into the details, with Italy for example, the three month average current account balance has moved to a small €250mn surplus from a €2bn deficit this time last year but this ‘improvement’ has not been due to rising exports. Italian exports in euro terms have been flat since August 2011 and certainly there are no signs of a revival at present. Italian nominal imports, on the other hand are down by 8-10% since August 2011 as demand has fallen away.

Clearly, the drop in Italian imports has been intensely bad news for its trading partners such as Germany, France, China, Sweden and even the Holy See, all of whom have seen substantial declines in their exports to Italy over the last few years, and this will in turn have adversely affected their own economies and the improvement in the current account balances for the peripheral economies has been behind the recent weakness in intra Euro Zone trade.

If the drop in Italian imports was the result of a sharp rise in the market share of Italy’s domestic producers, one might hope that there was a possible ‘zero sum game’ occurring on a global basis but in fact we find that Italian industrial production is down by 10% since August 2011, which suggests that domestic producers might have actually fared worse than foreign exporters in Italy’s slump.  On a GDP basis, Italian import penetration seems stuck at around 26% – notably lower than it was in 2009 – but essentially unchanged from its average over the 2000s.

The contraction in Italy’s current account deficit has not been based on a job-creating increase in Italian exports and a useful improvement in world trade but instead it has been based on a sharp fall in Italian demand which has led to a contraction in world trade and incomes – both in Italy and abroad.  Of course, some might suggest that Italians had previously been spending too much and that the decline in their spending and consumption of imports was long overdue and that it represents a return to normality and the real world.  This may of course be true but it cannot obscure the fact that the ‘improvement’ in the current account deficits of the peripheral economies in Euroland remains a profoundly negative event for world trade and incomes.  At the very least, it is certainly not consistent with the notion of global recovery.

Moreover, we would also note that at the current level of current account surplus, it could still take over 50 years for Italy’s banks to be able to reduce their level of net foreign liabilities back to their pre-Euro level.  In order for Italy to emulate Asia’s post Asian crisis repayment of its banks’ external liabilities, Italy’s current account surplus needs to be one hundred times larger, which would presumably involve another 10% fall in imports. Such a decline in imports would of course in all likelihood involve further sharp declines in domestic Italian purchasing power. This raises difficult challenges for politicians – and the peripheral Euroland economies have only been able to produce current account surpluses by running their economies so far below full employment that the longevity of the policy stances that have generated these surpluses is not clear.

For investors, it is yet another reason to stick to quality.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla