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Pimco: The Euro Tug-of-War


The eurozone could end up with problems similar to Japan's: a too-strong, overvalued exchange rate, weak growth, very low overall inflation, and deflationary tendencies.

Reversal in peripheral current account positions

The combination of fiscal austerity, private sector deleveraging and structural reforms has led to a substantial drop in domestic demand in European peripheral countries since 2007 (see Figure 1), causing imports in these countries to fall as well.

On the other hand, the economic hardship that came with the necessary structural reforms was not in vain. The international competitiveness, measured by unit labor costs, has improved across the board in the past several years, with Italy the only exception (see Figure 2).
As a logical consequence, the aggregated current accounts of Greece, Ireland, Italy, Portugal and Spain (GIIPS) have now moved from a sizable deficit (-7% in 2008) to a surplus of roughly 1% in Q1 2013 (see Figure 3).
With the current account surplus of Europe's largest economy remaining stable at approximately 7% of gross domestic product (GDP) over that time horizon, the massive swing of the current account balances in the GIIPS countries is therefore the key driving force behind the rising overall euro area current account surplus to approximately 2% of GDP as of June 2013. The strong momentum points to perhaps an even larger surplus in the coming months.
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