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Eurozone crisis

Private sector hides a mountain of European debt

As Europe's economies recover, debt levels continue to grow. But national budgets are only a few of the trees in a highly flammable forest of private debt, and government austerity may not be able to put out the flames.

For business analyst and financial crisis expert Daniel Stelter, what the West has been living through for the last half-decade is neither a banking crisis nor a case of ballooning public debts. It's a general debt crisis in the entire Western world. Since 1980, governments, businesses and private households have doubled their debt - from 160 percent to 320 percent of the gross domestic product (GDP), Stelter wrote in his book "Die Billionen-Schuldenbombe" ("The trillions debt bomb").

Why have governments and private individuals indebted themselves to such an extent? According to Stelter, it's the result of the misguided economic and monetary policies.

After the fall of the Berlin Wall and China's accession to the World Trade Organization, industrial nations have felt enormous cost pressures, particularly from Asia. Politicians and their constituents, he said, failed to invest in education and innovation and instead took the easy path: debt. While Americans were mortgaging themselves silly to buy dream homes, Europe financed its welfare model on credit.

The bubbles pop

That debt orgy was celebrated in advance of the euro currency's unveiling, particularly in southern European countries. "The euro was announced at the Madrid Summit in 1995. Two years later, interest rates [in countries adopting the euro] practically dropped to German levels. Then countries went into debt and, financed on credit, raised wages," said Hans-Werner Sinn, president Munich-based economic research center Ifo Institute. That policy worked well as long as financial markets were prepared to provide fresh loans.

A sign pointing at a foreclosed house reads 'Bank repo, Open house'

Many Americans had purchased homes with no money down and at variable interest rates

But in 2007 the real estate and credit bubbles popped, first in the United States, then in Europe. When Greek public debt threatened the eurozone with a wildfire, the phrase "sovereign debt crisis" entered the public lexicon.

But according to Moritz Schularick of the University of Bonn, Greece was the exception. Problems in Ireland and Spain, for example, had nothing to do with sovereign debt. "Those were fairly classic real estate bubbles that were financed through credit, some of it from abroad, that then popped at some point," he told DW.

Looking at 90 crises

Although public debt has risen rapidly in those two countries as a result of bank bailouts, it's the private sector that holds the lion's share of loans. More than 70 percent of Spain's 2.5 trillion euros ($3.46 trillion) in debt is held by the private sector. Though Ireland has left the bailout fund, the one-time Celtic Tiger has combined debts amounting to 400 percent of GDP; the private sector accounts for well more than two-thirds of those.

In other words, it's in the private sector that the larger risk is hidden. This conclusion was also reached by the team of Bonn economists led by Mortiz Schularick after examining 90 financial crises since 1870.

Moritz Schularick Wirtschaftsprofessor Uni Bonn

Watch the private sector, says Mortiz Schularick

"As a rule, financial crises and collapses of the financial system, such as we've just experienced, are the result of debt cycles in the private sector," Schularick said.

Thus far, the common diagnosis was that states had unleashed the storm. The resulting prescription: Save, and lower public debts.

Wrong remedy?

Previous austerity measures have negatively impacted growth, which also puts a break on lightening debt loads, said Stelter.

Conversely, however, new debt would not help countries escape the debt trap. In his opinion, the only thing that helps is a drastic "haircut," or forgiving of debts. For crisis countries, he proposes a debt reduction of up to 30 percent of GDP. Realistically, he wouldn't implement the measure in any case, excepting that of Greece.

"It's probably economically sensible to do that, because otherwise Greece is doomed to operate on the knife's edge over many decades with this extremely high debt."

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