Europe’s austerity drive has been focused on the wrong kind of debt. According to new research from the IMF, private debt (debt held by households or corporations) is a greater menace to growth than is government debt. While the Eurozone has been trying to reduce high levels of public debt, most notably in the South, countries throughout the continent have accumulated staggeringly high private debt burdens. The Economist:
The malign effect of high private debt becomes apparent in the busts that follow credit-driven booms. Households that have borrowed too much in relation to their income trim their spending, the main component of GDP. Overleveraged firms avoid investing and concentrate on shrinking their balance-sheets by paying off loans. As bad debts erode their capital, banks become more reluctant to lend. These adverse trends reinforce each other, increasing the overall drag on growth….[In] the Netherlands…private debt is over 220% of GDP mainly because households owe so much. In tiny Malta it is nearly 220%. Private debt is also high in four countries that have had to be bailed out: in Cyprus and Ireland it is over 300% of GDP; in Portugal it is 255%; and in Spain 215%.
As in the US housing crisis, homeowners in countries most afflicted by private debt have fallen into “negative equity,” where the cost of their mortgages exceeds the value of their homes. In Italy, Spain, and Portugal, this is particularly troublesome because the companies that hold the debt are themselves in the red: 30, 40, and 50 percent (respectively) of corporate debt in these countries is held by firms at which costs exceed revenue.Even in the some of the comparably healthier economies of northern Europe, private debt rates are high. While some of that debt will be written down when banks are forced to make retribution for predatory loans, the vastness of the private debt burdens in the eurozone is impairing sustained recovery. Read the whole thing here.