Financial attention remains on the EZ, and understandably so, as debt runs have caused turmoil in sovereign paper from the much of the continent. However, a fundamental distinction should be made clear to those following the crisis. The crisis's original cause was trade imbalances within a fixed-rated currency regime, not total debt.
A very simple observation is that debt becomes an issue only if you fear the counterparty will not be able to pay you back eventually. High debt-to-GDP ratios, persistently negative trade balances, and a uniform rate currency regime have put deficit EU countries under scrutiny. The fear is that trade deficits may be irreversible when debtor nations are not allowed to unilaterally issue (devalue) their own currency.
Is all austerity self-defeating and hopeless? Can these countries reverse their trade balances while remaining on the euro? We can analyze trade data from the WTO to see if there are some glimmers of hope, and which countries may have an easier time than others reversing course.
A metric that I want to call attention to is the trade-to-GDP ratio. This measure is essentially a view of how leveraged a country's product is to their involvement in international trade. It is a measure of total in and out volume as opposed to the more commonly cited net metric - Current Account Balance-to-GDP. Shown below are a handful of Trade-to-GDP ratios.
Trade-to-GDP Ratio = (Total Exports + Total Imports)/GDP
As you can tell, this metric varies significantly between countries. On a stand-alone basis, there is no directional relationship between this statistic and the sustainability of a country's account - it is an indication of volume rather than direction. It should be analyzed together with net trade balance, product distribution, and trade partner distribution. Even then, there are enough moving parts that these figures may be largely open to interpretation.
An analogy that I find somewhat applicable is that of a leveraged investment fund. Let's say hypothetically, an annual arbitrage spread of 1% is available to a certain fund. If this fund leverages their account at 20X, they would return 20% annually. It is in the fund's best interest to leverage this positive (hypothetically risk-free) spread to its greatest extent. Consistent with game theory in market arbitrage, it makes sense that nations with any spare capacity will want to leverage international consumers, and maximize their export component of total trade. By maximizing this export component, they should also be allowed more purchasing power for better quality imports. So long as they maintain a trade positive spread, the country and its citizens, should see a benefit from increasing both components, thereby "leveraging the spread" in a positive feedback loop.
Of course, there are two sides to every trade. For deficit countries there is a behavioral element of wanting to consume and use the best goods and services for cost at near parity. Also, proximity to potential trading partners and tariffs will influence a country's participation.
The deficit country should, at some point, feel compelled to reduce imports, thus lowering the ratio of trade-to-GDP. If they can eventually offset the imports with export growth to find a balance in their own current account, there is no reason to fear that the country would not be able to pay back. As a status quo, the globe is inundated with debt, and to favor one trade-neutral debt over another would not make sense.
Above are current account figures, not expressed in the normal form - per unit of GDP - but as expressed per unit of GDP traded. For the most part these results are consistent with the "leverage your spread" analogy. Switzerland's trade-to-GDP exceeds 100% because they are able to book a current account surplus of ~12% for every unit of GDP they trade, thereby incentivizing them to trade more - and provide their citizens with better quality imports. Germany and China also are higher on this metric and book high per-unit-traded surpluses. Also consistent with the theory, but not pictured, Singapore has the highest trade-to-GDP rate in the world and a current account surplus around 20% GDP.
It is interesting to note that the United States has the lowest trade-to-GDP ratio in the developed world. My interpretation is that this implies: first, a relative weakness in exports, and second, that the collective decision making in the United States recognizes this negative-expectation trade and subconsciously is attempting to minimize the relative effect of imports as it is. If hypothetically, the United States were to leverage its trading account to the level of, let's say Italy, it would be running a Mediterraneanesque 6% current account deficit.
Now, before everyone gets upset - I do realize that scaling this metric may not be linearly appropriate, and this stat can be diminished by a larger domestic base of production and consumption. The fact that we are less trade-leveraged could also imply that capacity exists to be "self-sustaining". That is to say, supply ourselves with whatever array of products needed.
But this is the point - the United States is the least leveraged to trade, and other countries could improve their net current accounts by decreasing their leverage to negative expectation trade, imports. There appears to be less meat on that proverbial bone for the U.S., as it maintains an ~11% deficit per unit of GDP dealt. Shown below is part of the United States' WTO profile.
A reduction in total trade volumes would likely go hand in hand with a recession in most cases, and may be a symptom of austerity. In a fixed exchange rate currency scenario (back to Europe) either less would be consumed, produced, or the product mix would be more heavily domestic. Reductions in production and consumption are recessionary. Alternatively, an abrupt change to domestic products should inferentially cause a decrease in standard of living. This is because if domestic goods and services were of the same quality, there would be no benefit of importing.
Greece started its austerity measures in early 2010. Since then, the trade situation has actually improved. But the political circus, debt runs, and a recession marked with high unemployment have completely confounded what seem like improvements in the trade balance - the underlying cause of the crisis.
It almost seems too perfect, too irrational - just as soon as everyone in the world is talking about Greece, it is actually beginning to improve. I am not arguing that staying on the euro is the best route for Greece and its citizenry, as a more dynamic free-floating currency would allow more of the workforce to be priced back into the labor market. But the trade situation has improved, and after all, the people just voted to keep the euro!
At least based on the trade evidence from the first-to-implement austerity program under this regime, maybe the EU's situation is not completely hopeless after all. Sure, Greece has experienced a recession, and presumably dropping tax receipts - neither of which are good. But while the crisis was becoming perfectly apparent to everyone, maybe Greece was actually beginning to right the ship. Other countries' austerity results are yet to be determined, and yes the process is painful. But maybe - just maybe - deficit nations reduce their imports, lower their leverage to trade, and emerge on the other end with repayable debts. One can hope.
Data source: World Trade Organization
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.