Thursday 8 December 2016

The complex effects of capital flows was raised in Washington last month. The ownership of foreign assets and the incurring of foreign liabilities has ballooned since the 1990s. Some of this is the result of foreign direct investment, involving companies deepening their involvement in the real economies in countries outside their home base. But much of it is to do with the wizards of high finance. Ireland illustrates this well.

Published 10/05/2015 | 02:30

The complex effects of capital flows was raised in Washington last month. The ownership of foreign assets and the incurring of foreign liabilities has ballooned since the 1990s. Some of this is the result of foreign direct investment, involving companies deepening their involvement in the real economies in countries outside their home base. But much of it is to do with the wizards of high finance. Ireland illustrates this well.

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As can be seen in the chart, Irish residents owned a staggering €3 trillion of non-Irish assets as of the end of 2013 and had liabilities of more than €3.1 trillion.

The lion's share of both were accounted for by Dublin's International Financial Services Centre. But even excluding the IFSC balance sheet, foreign assets and liabilities of Irish residents increased almost tenfold in just 15 years to 2013.

The ballooning of countries' gross external asset and liability positions has particular relevance for the euro area.

Those who downplay the costs of the single currency breaking up, point to the crisis of the European exchange rate mechanism in the early 1990s. It had a limited effect on the real economy. But that was in large part because gross positions were tiny then compared with today.

That means a return to national currencies would have massive balance sheet effects which were almost completely absent a quarter of a century ago.

Much weaker currencies in the periphery would cause liabilities in other currencies to soar, leading to mass defaults. The effects would then feed back to the core countries.

It would all but certainly collapse an already fragile European financial system. There is no unscrambling the euro egg.

Sunday Indo Business

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