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06.22.11

Europe’s Surprise Economic Boom

Led by Germany, the economies of northern European countries are forecast to be strong.

Here’s a shocking piece of news you don’t read every day: Never mind the headlines about the debt crisis hitting Europe and the euro currency, Europe is actually on its way to a balanced budget. Because Germany and the other north European economies are roaring ahead, flushing tax money into government coffers, the overall government deficit of the countries using the euro is plummeting from 6 percent of GDP in 2010 to 4.1 percent in 2011, according to an estimate by Holger Schmieding, chief economist at Berenberg Bank. Germany, which makes up almost one-third of the eurozone economy, is getting such a tax windfall that the country will return to a balanced budget next year, 2012. In the first five months of 2011, Germany's tax revenues grew by €17.2 billion ($24.7 billion), compared to the same period the year before. That's 17 times the €1.04 billion drop in the amount of taxes collected in struggling Greece.

Europe's overall fiscal health, the current crisis notwithstanding, compares with a U.S. deficit projected to hit a stunning 8.8 percent of GDP in 2011, with some estimates even higher. Unlike in Europe, where most governments have already made tough and painful decisions on tax hikes and entitlement cuts, U.S. lawmakers are hopelessly at odds over how to tackle the deficit. Last month, the U.S. government hit its $14.3 trillion debt limit, and has only a few more weeks’ worth of accounting tricks left before it would officially default. Should we should stop worrying so much about Europe when the real debt problems are in the U.S.? Schmieding thinks so. “The overall numbers look much worse for the U.S.,” he says. “If Europe wanted to, it’s in such good shape that it could easily handle the debt problem.”

That, however, is a big “if.” Tuesday, despite weeks of violent protest in the streets of Athens, Greek Prime Minister George Papandreou miraculously survived a no-confidence vote in parliament. His demise would have put an end to all Greek efforts to clean up its dysfunctional economy and overspending government, a precondition for continued bailouts. For weeks, the French and Germans have been haggling over the size and nature of the bailout, with the French pushing for lavish payments with few strings attached, which the Germans, as Europe’s biggest economy and paymaster, naturally reject.

But a method seems to have developed in the madness. The Germans have huffed and puffed but always caved in, in the end. That's because at bottom, says Berlin financial analyst Achim Dübel, the crisis is not a euro or Greece problem, but a problem of rich-country banks—first and foremost, French banks, but also German ones—which bought Greek and other junk bonds with abandon, and have so little capital that they'd go under if Greece were to default. Schmieding says the German show of resistance makes sense: first, to mollify German voters (who don’t like paying for Greek debt, or for the failed investments of French banks) and second, to bluff the Greeks into agreeing to tough bailout conditions. German Chancellor Angela Merkel is also convinced that a deepening crisis would endanger Germany's stellar growth—GDP was up 5.2 percent year-on-year in the first quarter, the fastest pace in 20 years—another reason why she continues to pay up.

The richer parts of Europe agreeing to pay means that the worst tremors of the crisis could soon be behind us.

Despite Merkel's show of toughness, wrote Deutsche Bank analyst Gilles Moec in another report this week, Europe is already far down the road to what's known as "fiscal union"—a system where all eurozone members are liable for each other's debt. It’s bad for taxpayers in the northern countries, as it shifts much of the mess from the southern countries, including the junk bonds owned by French and other banks, into their laps. By one estimate, each family in the eurozone already guarantees €535 of Greek debt alone, rising to as much as €1,450 in 2014. But the richer parts of Europe agreeing to pay also means that the worst tremors of the crisis could soon be behind us. That’s another reason why investors could soon turn their attention on America too.