The same holds true for public debt, which amounts to 85% in the euro area while it will soon cross the 100% mark in the US. Many Countries are improving their fundamentals. The primary deficit of Spain for 2011 will be around 4.7%, half that of the US and the UK. Italy will be one of the very few advanced economies to have a primary surplus, around 0.5%. The IMF has recently acknowledged, and even praized, these efforts and commitments. In short, if good fundamentals are an absolute necessity, it is not a sufficient condition. Now can we let liquidity spirals lock a country, just like a financial institution, into a bad equilibrium? We faced that question in 2009 when dealing with financial institutions. We are now facing the same question regarding sovereign risk. Our answer is twofold. First, get the fundamentals right. For European countries, it means reverting to a sustainable fiscal position which requires a significant primary surplus. And second, there is a need for a liquidity backstop to ensure that bad equilibria will not develop. Where that backstop is coming from is a key question. Unconventional monetary policies have led many central banks to purchase significant amounts of Government debt: those purchases amount to 51% of the total debt issued since 2009 in the UK, 21% in the US versus 7.5% in the euro area – where they were fully sterilized. These policy stances have contributed to giving markets an insurance against a potential dry-up in liquidity.
No immediate consequences have been felt so far in the US debt market which remains the most liquid one and the ultimate benchmark for assessing risk. However, a pervasive uncertainty has been created, which might be responsible for the decline in confidence that has occurred over the last weeks. In Europe, on the contrary, sovereign credit risk has had immediate and dramatic consequences. It is difficult to foresee how, in the longer run, markets will assess debt sustainability. BIS central bankers’ speeches  1  But let me challenge some current analyses about debt sustainability in Europe. –  First competitiveness. In the UK, for instance, the effective real exchange rate has depreciated by 23% over the last four years and its exports have grown by a healthy 15%, year-to-year over the first semester of 2011. But Italy, Spain and Greece have done better, with exports growing respectively by 16%, 19% and 37% over the same period, with, of course, no internal exchange rate adjustment. Linking competitiveness with exchange rate depreciation is therefore too simplistic. Improving competitiveness can be achieved by proper domestic reforms with a lasting result. –  Second, the euro is the only major currency area with its external accounts in balance, which is a strong guarantee of long-term solvency. –  Third, the euro area’s aggregate budget deficit will stand at around 4.1% in 2011, less than half that of the UK or the US.