The Euro Zone Loses Its Raison D’Etre

Foreign ownership of debt in euro-area countries is dropping

Peter Coy

Share of Spanish government bonds owned by foreigners

The euro was launched in 1999 to increase prosperity by smoothing the flow of trade and capital within Europe. But as Europe lurches from crisis to crisis, ties are fraying. Trade and investment between euro-zone nations has diminished — which means the euro zone is slowly losing its main reason for being, regardless of whether it remains intact on paper. As T.S. Eliot almost said: This is how the euro ends, not with a bang but a whimper.

Germany has found a way to keep its export machine going even as its traditional European trading partners founder. In 2007 its exports to Italy, Spain, Greece, Ireland, and Portugal were 27 percent higher than its exports to China and the U.S. By last year, Germany’s exports to those five nations were 35 percent lower than its exports to China and the U.S., according to Bloomberg Businessweek calculations from data collected by Eurostat, the European Union’s statistical agency.

Even in the euro’s salad days, intra-European trade wasn’t entirely healthy. Instead of buying imports from its fellow Europeans, Germany plowed much of its export earnings into bonds, loans, and other financial assets of debtor countries. When the global financial crisis hit in 2008, Germans lost their appetite for paper IOUs. Debtor nations must now try to raise money by selling bonds to their own hard-pressed citizens and banks. The euro zone is “fragmenting,” says Hung Tran, deputy managing director of the Institute of International Finance, which represents more than 400 banks worldwide. “Credit is becoming national again,” Michael Dawson-Kropf, a Frankfurt-based senior director at Fitch Ratings, said last year.

The chart accompanying this story shows a case in point: a decline in the share of Spanish government bonds owned by people and institutions outside Spain, to 34 percent late last year from 55 percent in 2006, according to the Bank of Spain, the nation’s central bank. There have been declines in foreign ownership of sovereign debt in Greece, Ireland, Italy, Belgium, Portugal, and France as well, according to data compiled by Bruegel, a Brussels-based think tank. (In Germany and Finland, foreign ownership continues to rise.)

From 1999 through 2007, banks in the euro zone added $5.7 trillion to their portfolios of loans, bonds, and deposits in other Western European nations, according to a report last month by McKinsey. Since then, though, through the middle of 2012 they have cut their exposure by $2.8 trillion, McKinsey says.

Guntram Wolff, deputy director of Bruegel, speculates that the trend toward reconcentration of risk within national borders may be abetted by national governments, which are desperate for someone to buy their bonds. Weak banks that take a chance on risky home-country debt may be figuring they might as well invest in it, says Wolff, because “if the government goes bust you’re dead anyway.”

Even when capital does venture across borders these days, it’s not always an expression of confidence. European Central Bank President Mario Draghi said at his monthly press conference in March that imbalances “continue, by and large, to improve.” He was referring to data showing money that had fled to Germany began flowing back to Spain last year, and to a lesser extent Italy.

But a paper by Frank Westermann, an economist at Germany’s University of Osnabrück, shows that the money returning from Germany to Spain isn’t going to increased bank lending, or even to pay off long-term borrowings from the ECB by Spanish banks. Instead, Westermann writes, a big chunk of the money appears to be going to new government bonds. Westermann can’t tell who’s buying, but even an investor with no faith in Spain’s future — whether German or Spanish — might be attracted to two-year Spanish notes that are currently yielding 2.26 percent and can be bought by the ECB if Spain suffers a funding squeeze.

Officially, the Economic and Monetary Union is integrating even further, as shown by the banking union agreed upon in December. Facts on the ground say otherwise. Capital controls imposed in Cyprus are the latest example of unraveling. Draghi’s best efforts notwithstanding, the euro zone is slowly coming apart.

The bottom line Euro-zone banks have cut their holdings of bonds, loans, and deposits in other Western European nations by $2.8 trillion since 2007.


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