External Imbalances &The Economic Crisis In Europe

For long, the aggregate euro area current account balance was roughly balanced, with only very small surpluses or deficits. But hidden behind that aggregate were large surpluses in a few countries, most notably Germany but also for example Holland and Finland, and large deficits in others, for example Ireland and Spain. The Germans, the Dutch and the Finns were in effect lending to the Irish and the Spanish to finance the housing bubbles in Ireland and Spain. A similar story was seen in the Baltic sea, where Sweden had a large surplus while Estonia and Latvia had large deficits, meaning that the Swedes lended to the Balts to finance the Baltic bubbles.

Now that the bubbles in Ireland, Spain, Estonia and Latvia have turned into busts, we now see the current account imbalances starting to unwind too. Ireland, whose deficit was roughly similar to America’s deficit relative to GDP (7%) at its peak, has seen its deficit vanish completely in Q4 2008. Considering how the trade surplus continued to vanish almost completely in Q4 2008. Considering how the trade surplus continued to increase in the first quarter,it is possible that there was a surplus in the first quarter of this year.

Spain's deficit hasn't decreased as much as Ireland's, but it is down from €32.3 billion in Q1 2008 to €23.3 billion in Q1 2009, or from roughly 12% of GDP to 8.5%.

In Estonia and Latvia, the improvement has been even more dramatic than in Ireland. Estonia had a deficit of 18% of GDP in 2007, but in the first quarter of this year they had a surplus. Similarly, Latvia who at the peak of its boom had a current account deficit of 24% of GDP has similarly seen a surplus in the first months of 2009.

But reduced or eliminated deficits in some countries must mean that surpluses in other countries decline. Germany saw its surplus decline from €65 billion in the first four months of 2008 to €25.9 billion in the first four months of 2009 , or from roughly 8% of GDP to 3.5%. Finland saw its surplus vanish during Q1 2009. Holland has not yet released Q1 2009 numbers, and during Q4 2008 the surplus had only dipped slightly (From €13.1 billion in Q4 2007 to €12.4 billion in Q4 2008), but a big drop in the Q1 2009 trade surplus suggests that the current account surplus will likely fall more during that quarter.

The Swedish surplus dipped from SEK 81.5 billion in Q1 2008 to SEK 53.2 billion in Q1 2008 (From roughly 10% of GDP to 7%), despite the weak SEK.

All of the aforementioned countries have in the recent year experienced economic contraction. The difference is however that while the previous deficit countries have seen their balances improve because of the end of the boom, the previous surplus countries have seen their economies contract mostly because their net exports to the deficit countries have fallen so much. The current account balance adjustment is in other words an effect of the slump for the deficit countries, while being a cause of the problems in the surplus countries. The surplus countries participated in the booms as lenders and suppliers, and now suffer because the booms have turned into busts.