Centralised risk sharing must be part of solving crisis, says IMF

The flow of money from Germany and other core eurozone countries to Ireland from the start of monetary union helped create a huge current account imbalance that undermined competitiveness.

Centralised risk sharing and fiscal transfers have to be part of the solution, according to a paper just released by the IMF called External Imbalances in the Euro Area. The German view of the crisis is that periphery countries used the euro as cover to live beyond their means.

These profligate countries must now pay back these debts.

In Ireland’s case, it means it is much harder to get a deal on the bank debt. A communiqué issued by the finance ministers of the creditor countries — Germany, Holland and Finland — last Tuesday, appeared to rule out a deal on legacy bank debt.

Ireland has pumped roughly €64bn into bailing out the banking system. About €34bn of this relates to Anglo Irish Bank and Irish Nationwide.

But the IMF paper finds that a much more complex set of factors caused current account imbalances across the region since the inception of the single currency, which eventually pushed Ireland, Greece and Portugal into bailout programmes when the debt crisis erupted.

The most important development was the rise of China as an economic powerhouse. Germany was able to post a huge current account surplus for over a decade through a surge in capital goods exports to China. But imports from China to the eurozone had a much different outcome.

Exports from periphery eurozone countries to core countries like Germany dropped substantially over the same timeframe and were replaced by much cheaper imports from China.

Moreover, central and eastern Europe became a foreign direct investment hub for German companies over the 15 years, whereas before this, most of that investment would have gone to periphery eurozone countries.

The escalating oil price over much of the past decade contributed to the current account deficit between eurozone periphery countries and the rest of the world.

Currency devaluation is the normal safety valve open to countries running current account deficits. However, over the past decade there has been an appreciation of the euro.

There was huge international investor demand for core eurozone government debt. But since the launch of the single currency, bond yields among eurozone member states narrowed to historically low levels. The eurozone began to function like a de facto single bond market.

German and other core eurozone financial institutions hoovered up huge amounts of public and private periphery eurozone debt. In Ireland and Spain these flows found their way into their property markets.

Overall, there was a huge increase in private sector debt levels among the eurozone’s periphery members.