Eurozone Crisis Shows That Imbalanced Trade Leads To Disaster

 |  Includes: EU
by: Howard Richman

The 13-year-old Eurozone experiment gave the world a laboratory in which to test the theory that free trade leads to prosperity. The results of the experiment prove, instead, that free trade, when imbalanced, leads to disaster.

The common perception is that the Eurozone crisis is due to the huge national debts of the Southern European countries. Although government debt is clearly part of the problem, it is not the only part or even the main part. The following graph shows the weak relationship between national debt (government debt divided by GDP) and unemployment rates.

Although Greece, the worst off of the Eurozone countries, has a huge government debt at 165% of its GDP, Spain and Portugal are close to bankruptcy even though Spain's government debt is a modest 69% of GDP and Portugal's government debt is just 108%. Both Germany (81% of GDP) and Belgium (98% of GDP) have similar government debt levels, but no crisis whatsoever, since they have trade surpluses.

When a country has a chronic trade deficit, its people go ever further into debt to buy imports. As a result, trade deficit governments tend to owe their debt to foreigners while trade surplus governments tend to owe their debt to their own people.

The Southern European governments grew their debt in an attempt to spend their way out of their high unemployment rates. They failed because, as the following chart shows, their high unemployment rates were related to their trade deficits:

Balanced trade can grow forever. Imbalanced trade eventually bankrupts the trade deficit countries.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.