Question du jour, “Just how important is Europe anyway?”
We know that the United States is the financial centre of gravity for the global economy. But how important are the European economies? The answer is quite important, really.
One way of looking at the data is to look at current accounts as a share of GDP. That tells you about net lending to and borrowing from the ROW. And you would be right to say that the Euro area (and France and Italy in particular) have been borrowing more from the rest of the world than they used to (while Germany just keeps on lending). In fact, France and Italy are beginning to look a little like the reserve currency issuer (the US is the red line second graph) – which I doubt that is because of exorbitant privilege (I digress).
In a crisis, however, money in/money out is much more important if you are worried about systemic effects. By that I mean how much a country is acting as an intermediary for the rest of the world. According to the most recent data on short term portfolio transactions (which, unfortunately, is 2009 data), the US is indeed banker to the world. The sum of assets invested in the ROW plus the sum of the ROW’s short term investments in the US accounts for about 18% of total international cross border short term portfolio asset holdings. That’s all well and good. So how important is Europe?
Source: IMF consolidated portfolio survey, table 8b, my calculations.
It turns out that France is banker number 2 to the world, accounting for just over 10% of global cross border short term portfolio asset holdings (followed by the UK, Ireland, Luxembourg and Germany). This data is 2009, and we know what happened to Ireland (ranked number 4 back then).
If you add together all the Eurozone countries, they account for almost 40% of transactions. This is an overstatement because there is double counting, which I really account for. (But I am not sure how much I should, because the point here is to identify systemically risky countries and subtracting out all intra Euro area transactions would seem to be throwing the baby out with the bathwater). Anyway, how systemically important is Europe? Well, the answer is quite. France seems especially so.
To expand on this a bit, here are a couple of tables that focus on Europe that partially deal with the double counting issue (same IMF data set). Table 1 provides an indication of which countries rely on short term debt funding from European banks, and hence, which countries may be vulnerable to a “sudden stop” if European banks should suddenly experience a liquidity shortage (I zoom in on the EMEs for this). For example, 4%of Argentina’s short term debt issuance is funded from Europe, and almost 80% of Hungarian short term debt financing is from Europe.
Table 2 provides similar data but indicate which European countries are most likely to be the source of the contagion. Once again, the data show that France is an important country for smaller EMEs, as is Luxembourg and the Netherlands. The data aren’t adjusted to take into account country size, so the risks from the Netherlands and Luxembourg are perhaps more of a concern, although the magnitude is more important for France.