The problem with Greece is that it was less efficient than its European counterparts. The good news is that it is relatively easy to get an indication of which countries are inefficient.
A burger produced in Germany costs less than a burger produced in Greece simply because the Germans can do it cheaper and better. Demand for German exports is therefore strong, and that also used to increase the value of the deutsche mark before the euro was introduced. Importers used to pay more in terms of their domestic currency when buying German currency.
Accordingly, the cheaper cost of production used to be largely offset by the appreciating deutsche mark. Likewise, the Greek drachma used to depreciate in value because demand for Greek goods was weak. However the Greeks could still compete in international markets because the weak drachma reduced the cost of the expensive Greek products in foreign currency terms.
This mechanism is a critical stabiliser in international trade but the introduction of the euro dismantled it completely. The euro effectively pegged the currencies of the bloc forever. Germans are driven to reinvent themselves and became even more competitive while Greeks grew complacent. Greek imports shot up while its exports dropped.
In economic terms, this shift is measured in terms of the “current account”. It is a key indicator which all investors need to consider when investing in bonds, property or taking over a company established abroad. The current account largely refers to the difference between the country’s imports and exports. A nation with a large current account deficit means it is not able to compete with its European peers. Would a company survive if it is inefficient? The same goes for a country.
Current account deficits bring along a second problem. Current account deficits are financed by capital inflows. Examples of capital inflows are the purchase of local government bonds, immovable property and foreign direct investment in the country that is running a current account deficit. Foreigners will continue to buy these assets when times are good but those capital surpluses will dry up immediately and turn into a capital flight when things go wrong. Think of Cyprus.
Capital flight brings a eurozone country to its knees. A capital deficit needs to be financed by a current account surplus but euro nations cannot depreciate their currency to increase exports and decrease imports. A nation that was inefficient for years will not become efficient overnight. Governments take the only way out and cut salaries so that local produce becomes competitive again but this causes riots and disruptions in production, which exacerbates productivity.
On many counts, a constant current account surplus is critical. Few, however, look at this indicator because they do not understand the mechanics of the current account. The table shows the current account deficits of EU and other selected countries between 2010 and 2012.
The current account gives even more information. Investors think “now is the time to buy” after a nation experiences financial difficulty. Compare the current account position of Greece and Ireland in 2010. The huge Greek current account deficit tells you loud and clear that it is not yet the time to buy. On the other hand, the Irish registered a current account surplus in 2010 and indeed its economy has been stable since then. No additional bailouts were required, unlike Greece.
It is also promising to see that Malta’s current account position has improved so much. Historically, Malta registered persistent current account deficits but last year, Malta registered a positive result. One of the main reasons driving this improvement was increased export of services.
Lately, Cyprus has been compared to Malta many times, yet few noticed that the current account of Cyprus is one of the worst in Europe.
The views and opinions expressed in this article are solely of the authors and do not reflect the views of the users of the website, its affiliates or of any financial institution. This article is published solely for informational purposes and is not to be construed as a personal recommendation, a solicitation or an offer to buy or sell any securities or related financial instruments.
Chris Grech and Calvin Bartolo are co-founders of financial website http://blackdigits.com.mt .