The EU likes to sell itself as the high priests of the 'rules-based' system, as the bedrock of financial stability worldwide. So much so that 'stability' was one of the main arguments of the remain side back in 2016 - and remains a prominent argument for rejoining today. In this Bruges Group publication, "The shadow liabilities of EU member states and the threat they pose to global financial stability", masterfully written by Bob Lyddon, he outlines how EU and Eurozone member states' accounting does not factor in significant shadow debts and shadow contingent liabilities - effectively making the EU financial system a riskier one, and increasingly more questionable bet than it initially seems. Understated liabilities, overrated debts from the public credit rating agencies - a potent mix that leads to a system that sets aside 'too little capital to account for the risks'.
Mr Lyddon, an experienced management consultant, formerly with PwC, excoriates the EU's institutions for taking on more liabilities than set out in Eurostat, the main statistical database for EU debt. His book seeks to prove it.
In this book, Bob Lyddon lifts the veil on the European Union's financial system and the monetary policy that powers its federalising project. Beneath the patina of financial stability, of strength, and of an economic superpower, lies some deep seated vulnerabilities.
Lyddon discussed the concepts of shadow debts - debts not captured in the EU's official statistical database Eurostat, which can be created via the issuance of a debt security or the contracting of a loan. The issue laid out here, according to Lyddon, is that debt figures, and hence the compatibility of member states to remain members of the EU's Stability & Growth Pact an the Fiscal Stability Pact ('cornerstones of the euro project'), do not factor in borrowing of shadow debt, borrowed by non-government entities which don't fall under the 'General government' categorisation, such as private companies. In other words, Lyddon writes that 'there is more debt than is shown in the Eurostat figures but no more debt servicing capacity.'
While, due to the opacity of the EU's Covid Recovery Fund, how much was paid out in grants and how much in loans could not be identified, Mr Lyddon still came up with a series of shocking revelations. According to Lyddon's findings, 'Eurostat's Debt-to-GDP Ratio for the EU of 90% understates the situation by 44% if one takes account of the shadow debts, and by 70% if one factors in the shadow contingent liabilities as well.'
"The situation of the Eurozone member states is considerably worse than that of the non-Eurozone ones" - Bob Lyddon
Public rating agencies of the EU itself and the European Stability Mechanism are inflated by several notches, Lyddon writes. "The credit quality of its backers is much lower than it currently appears."
Larger economies in the EU are worse affected by this. Investors will, according to Lyddon, see Germany's good for its shadow debts of around €10.2 trillion in shadow debts and contingent liabilities in addition to its existing debt of €2.5 trillion (69% of its GDP), equating to a debt-to-GDP ratio of 353%. Consequently, clearing houses which accept collateral in the form of public sector debt, might well have wafer-thin security margins given the true scale of the EU's public sector debt and liabilities.
The calculations and statistics that emerge in this book provide for some truly shocking reading, and tell us more about what the eurozone financial system is based on. He goes into detail to explain how this pans out during the major crises of the EU's existence, namely the 2008 financial crisis and, more recently, the pandemic. On the question of calculations, the author makes it clear the difficulty of coming up with these figures due to the numerous complications, ranging from the divergence in the nature of the EU's programmes to actually distinguishing a shadow debt from a shadow contingent liability. All in all, Mr Lyddon's book deftly combs through the detail and the accounts of the European Union to reveal some fundamental weaknesses in this behemoth of an institution.