In Portugal Crisis, Worries on Europe’s ‘Debt Trap’

PARIS — For the third time in a year the European Union is going through the same ritual, bailing out another insolvent country. Portugal now follows Greece and Ireland to the European welfare office to ask for new loans on the condition of ever more drastic spending cuts.

So far the markets have taken Europe’s third successive sovereign financial crisis in stride. But many economists are a good deal more alarmed, most notably because the bailout formula European leaders keep applying to their most indebted member nations shows no signs of working.

Greece, Ireland and now almost certainly Portugal have access to hundreds of billions of dollars in emergency European aid to help them avoid defaulting on their debt. But the aid is really just more loans, and the interest rates the countries are paying, if a little lower than what the private market would charge, are still crushingly high. Their pile of debt gets bigger with every passing day.

Moreover, the price of these loans has been a commitment to slash government spending far more drastically than domestic leaders would have the desire or the political power to accomplish on their own. And for countries that depend a good deal on government spending to generate growth, rapid decreases in spending have meant sustained economic stagnation or outright recession, making every dollar of debt that much harder to pay back.

Economists call this “the debt trap.” Escape from the trap generally requires devaluation of the currency, which cannot happen among countries that use the euro as their common currency, or strong economic growth, which none of the three have, or some kind of bankruptcy process, which all three forswear. Add to that the likelihood that all three countries will continue to have unstable governments until they figure a way out, and Europe’s financial crisis has no end in sight.

“What has been missing, in the debate about how countries can restore their finances to some kind of sustainability, is the limit of how much they can cut in a period of austerity,” said Simon Tilford, chief economist for the Center for European Reform in London. “There is a limit of how much any government can cut back spending and survive politically unless there is a light at the end of the tunnel, a route back to economic growth.”

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The Austerity Delusion

I rarely agree with Paul Krugman about anything, but in the interest of offering an alternative point of view to what I usually post, here is his latest op-ed. For those not aware of his background; Dr. Krugman is a professor of economics at Princeton University, a winner of the Nobel Prize in Economics and an outspoken liberal and champion of Keynesian Economics.

Portugal’s government has just fallen in a dispute over austerity proposals. Irish bond yields have topped 10 percent for the first time. And the British government has just marked its economic forecast down and its deficit forecast up.

What do these events have in common? They’re all evidence that slashing spending in the face of high unemployment is a mistake. Austerity advocates predicted that spending cuts would bring quick dividends in the form of rising confidence, and that there would be few, if any, adverse effects on growth and jobs; but they were wrong.

It’s too bad, then, that these days you’re not considered serious in Washington unless you profess allegiance to the same doctrine that’s failing so dismally in Europe.

It was not always thus. Two years ago, faced with soaring unemployment and large budget deficits — both the consequences of a severe financial crisis — most advanced-country leaders seemingly understood that the problems had to be tackled in sequence, with an immediate focus on creating jobs combined with a long-run strategy of deficit reduction.

Why not slash deficits immediately? Because tax increases and cuts in government spending would depress economies further, worsening unemployment. And cutting spending in a deeply depressed economy is largely self-defeating even in purely fiscal terms: any savings achieved at the front end are partly offset by lower revenue, as the economy shrinks.

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Foreigners Shun Europe’s Bonds, and Debt Piles Up

ATHENS — Greece. Ireland. And now, it seems, Portugal.

While the circumstances that have driven these debt-ridden members of the euro zone to the brink differ, they share one common characteristic: All three countries aggressively tapped their domestic banking systems for more debt long after they had been shut out of international bond markets.

With its 10-year debt trading close to the historic high of 7 percent reached last week, Portugal will try Wednesday to sustain what many have come to see as nothing more than a form of bond market charades when it attempts to raise up to €1.25 billion, or $1.62 billion, in long-term financing — debt that is expected to come largely from the country’s already depleted banking system.

For Portugal, as it was for Greece and Ireland before their bailouts, borrowing at such high rates from lower-quality lenders may demonstrate its economic sovereignty. But to an increasingly skeptical marketplace, borrowing on such terms reflects nothing more than the country’s unwillingness to accept the rude reality of its fiscal condition.

As a result, the Portuguese banking system takes on more debt, making it harder to restructure and thus requiring the government in Lisbon to impose more pain on its citizens, a dynamic that is now playing out in Greece.

“Eighty percent of Portugal’s debt stock is held by foreigners,” said Jonathan Tepper, an analyst at Variant Perception a research firm in London. “But the flow, now, is being financed domestically.”

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PIMCO advises Greece Ireland and Portugal to abandon the Euro

For those of us on this side of the pond... preview of coming attractions.

Andrew Bosomworth, head of Pimco's portfolio management in Europe, said current policies are untenable in the absence of fiscal union and will lead to a break-up of the euro.

"Greece, Ireland and Portugal cannot get back on their feet without either their own currency or large transfer payments," he told German newspaper Die Welt.

He said these countries could rejoin EMU "after an appropriate debt restructuring", adding that devaluation would let them export their way back to health.

Mr Bosomworth said EU leaders were too quick to congratulate themselves on saving the euro last week with a deal for a permanent bail-out fund from 2013.

"The euro crisis is not over by a long shot. Market tensions will continue into 2011. The mechanism comes far too late," he said.

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I've been saying for going on two years now that Greece is broke and it WILL default at some point. They simply owe far more money than they can pay back. Default is inevitable. The only question is what form it will take. Ireland and Portugal are in tough shape. But they might be able to survive. That said it would certainly be in their interest to abandon the Euro (a technical default) and print their way out of the hole they have dug. In any event bond holders are looking to take a really big hit.

Forget Greece; next crisis Portugal

LONDON — Next target: Portugal.

Speculators have begun to zero in on another small member of Europe’s troubled monetary zone, highlighting the same economic flaw that brought Greece to the verge of insolvency: a chronically low savings rate that forces a reliance on the now-diminishing appetite of foreign investors to finance persistent deficits.

Just as investors are turning their attention to the next vulnerable country, Greece moved a step closer on Thursday to activating a $61 billion rescue package, as Prime Minister George A. Papandreou asked the European Union and the International Monetary Fund to meet in Athens next week.

The aid package agreed on last weekend — aimed at calming fears of a Greek default — has not yet had its desired effect. The yield on Greek 10-year bonds briefly topped 7.3 percent Thursday, not far from the 7.5 percent it was at before the rescue package was announced. Interest rates on 10-year government bonds for Portugal have also been rising, hitting a high of 4.5 percent on Thursday.

Though Greece’s finance ministry said its request for talks did not necessarily mean it would draw from the funds, it contributed to anxiety that helped push down the value of the euro by 0.008, to 1.3576 against the dollar.

It all raises the prospect that the loan package for Greece, the result of months of political haggling, may be nothing more than a bandage on a wound that shows little sign of healing.

Some analysts think the Greek bailout may have an opposite, more harmful long-term effect. Instead of ushering in a period of lower rates and market calm, it could prompt investors to test Europe’s — and in particular Germany’s — stomach for a rescue of other troubled European economies, beginning with Portugal.

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