Europe desperately needs better economic growth to help remedy its governments' financial ills. To get there, its leaders will have to focus as much on fixing banks as on pumping in more cheap money.
Low yields on Spanish, Italian and even Portuguese bonds suggest that markets expect the European Central Bank, faced with falling inflation, to start buying up bonds in an extraordinary effort to stimulate growth. At the same time, in its latest Global Financial Stability Report, the International Monetary Fund issued a warning relevant to Europe: "It is time for financial systems to move beyond this dependence on easy money and transition to an environment of self-sustaining growth."
The IMF has a point. To date, the ECB's monetary easing has done a lot more to help governments maintain giant debt burdens than it has to stimulate actual business activity. Gross sovereign debt stands at 174 percent of gross domestic product in Greece, 133 percent in Ireland, 129 percent in Portugal, 94 percent in Spain and France, and 95 percent in the euro area as a whole, according to the latest data from the IMF. The indebtedness of all these governments kept rising through 2013 -- even Greece is preparing to issue a new five-year bond. Only Germany managed to reduce its debt to GDP ratio.
Meanwhile, consumers and businesses have been forced to cut their debts, in part because of a dearth of credit from a banking system weighed down by some $1.1 trillion in nonperforming loans. In the euro area, household and corporate debt have dropped by 1.8 percent and 5.6 percent of GDP, respectively, from recent peaks. Much of the banks' available money -- including financing from the ECB -- has tended to go toward buying government bonds, which now represent 10 percent of euro-area banks' total assets.
In its recently issued 2013 annual report, the ECB described a "creditless recovery," noting that "the real growth rate of loans has been considerably lower in recent years than in the past for all levels of GDP growth." The bank believes, optimistically, that this will change soon if the European economies keep growing: Loan activity always picks up with a few quarters' lag. The IMF, however, points out that the euro-area banks' bad loan problem has been getting worse, with nonperforming loans doubling since 2009. The need to increase provisions is holding back lending and hampering the transition to self-sustaining growth.
Pumping more liquidity into the market won't resolve the enormous post-crisis legacy of bad debt. If regulators and policy makers concentrate on getting banks to recognize their losses, recapitalize and move on, the euro area will be in much better shape to live in a world without easy money.
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