European debt still weighing down growth

EUROPE’S massive debt burden continues to depress the region’s growth and explains why central banks intend keeping interest rates down for as long as possible.

If short-, medium- or long- term mortgage and other rates were to rise, many households and businesses would be under water. It is thus curious that US fund managers, in particular, are ignoring risk and pouring money into European stock markets. Average price-earnings ratios of Germany, France, Spain and Italy range between an expensive 16 and 21.

Besides the possibility of a stockmarket downturn, US fund managers could lose if the euro, sterling and other European currencies decline in tandem with an economic downturn.

The hope of fund managers is that the European Central Bank (ECB), Bank of England (BOE) and other central banks will maintain minimal short- term rates, profits will rise, and market forces will not drive global bond yields (or medium- and long-term interest rates) higher.

Latest bleak ECB and BOE financial stability studies indicate that the authorities are concerned about worrisome public and private debt, despite the slight economic recovery from recession. Indeed, the ECB warned that if global bond yields (that is, medium- and long-term interest rates) rose, pressure on sovereign nations, corporations and individuals would be intense.

This fear partly explains why ECB president Mario Draghi slashed bank rates to a record low of 0.25 per cent recently, while BOE governor Mark Carney is also maintaining virtually zero short-term rates despite relatively high inflation in the UK.

The ECB’s report shows that despite austerity, the public debt of Greece as a percentage of gross domestic product (GDP) climbed from 155 per cent in 2012 to 172 per cent in 2013; Italy, 130 per cent; Portugal, 122 per cent; Ireland, 120 per cent; Cyprus, 115 per cent; Belgium, 100 per cent; Spain, 92 per cent; France, 91 per cent; and Germany, 80 per cent.

The Netherlands’ debt to GDP is a lower 70 per cent but because of weak growth, the bursting of a housing bubble and high unemployment, S&P downgraded its rating to AA+. Of the 17 eurozone members, only Germany, Finland and Luxembourg still hold S&P’s top rating.

A stark reminder that the euro crisis could flare up at any time is that member nations need to replace billions of maturing bonds in the coming year. As at end-September, bonds with a residual maturity of up to one year accounted for 20 per cent of total debt securities outstanding in the euro area, says the ECB. Almost a third of the debt securities outstanding will mature within two years, and some 60 per cent within five years.

To some extent, sovereign financing needs could be mitigated via sales of euro government financial assets but their prices “depend on their liquidity and marketability, which is arguably lower in times of crisis”, notes the ECB.

Moreover, private non-financial corporation borrowing in euro-area periphery economies “is particularly high, and has risen since 2007”, says the BOE, noting that these loans in Italy, Portugal and Spain “are around 20 per cent above their long-run sustainable level”. The debt burden could constrain future investment and growth, exacerbate vulnerabilities of highly indebted households and raise unemployment, fears the central bank.

Despite UK Chancellor George Osborne’s confidence in his autumn statement, this problem is especially evident in highly leveraged Britain, which is over-reliant on London’s global financial services and its inflated property ma
rket. The UK’s public sector debt to GDP is currently 75 per cent, but including the private sector, the nation’s overall debt is seriously high. The UK non-financial private sector debt, including corporations and households, is as much as 165 per cent of GDP.

UK household debt has soared to record levels and, according to the BOE, individuals now owe as much as £1.43 trillion ($2.33 trillion), including mortgage debt – slightly above the pre-financial crisis high in September 2008. Unsecured borrowing within that total is currently £159 billion ($259bn).

Since incomes have risen, however, the ratio of debt to household income has fallen from a peak of 167 per cent at the start of the 2008/2009 financial crisis to 140 per cent. Despite that, it is still higher than comparable proportions in both the eurozone and US.

Unsurprisingly, the BOE last week warned banks to limit mortgage lending to only those who could afford it and instead concentrate on viable businesses.

©Neil Behrmann – All Rights Reserved

Neil Behrmann is author of Trader Jack-The Story of Jack Miner

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