She watched it all crumble away
Is this the end of yesterday?
“Lord, I hope so” is all he said
– Endgame – “Rise Against”
The Next Greek Tragedy
European leaders are falling all over themselves to tell us that the Greek default does not in any way suggest that it is possible for another country to default.
Kiron Sarkar makes the following points, with which I agree, so let’s jump to him:
“Spain unilaterally set its 2012 budget deficit at 5.8% of GDP, much higher than the 4.4% previously agreed with the EU. The budget deficit came in at 8.5% last year, once again higher than the target of 6.0%. A ‘discussion’ between Spain and the EU is inevitable, especially as (to date) the EU has insisted that Spain stick to its prior commitment. Quite an interesting development, particularly as it has come on the same day that 25 out of 27 EU countries (excluding the UK and the Czech Republic) signed up to the ‘fiscal compact’ which, once approved by each country’s national Parliament (Ireland will need a referendum), will introduce the German-inspired ‘debt brake’ into their constitutions – basically commits the 25 EU countries to reduce borrowings and, indeed, balance their budget deficits.
“Spanish unemployment rose by a massive +2.4% MoM in February, with youth (under 25) unemployment over 50%, yep that’s 50%. The EU has a tough task. If it offers concessions to Spain, expect Portugal, Ireland, etc., etc. to submit their own ‘requests.’ However, I just can’t see how Spain can meet its prior commitment. Officially, GDP is forecast to be -1.0% to -1.7% this year, though in reality the actual outcome will be closer to (indeed may exceed) the more pessimistic forecasts.”
And the report from Portugal is not much better. This from Lew Rockwell (Feb. 3, 2012):
“Things are also unraveling very quickly in Portugal. Now there is talk that private investors will be required to take a ‘haircut’ on Portuguese debt as well.
“The following is from a recent article in the Telegraph…
“‘A report for the Kiel Institute for the World Economy said Portugal would have to run a primary budget surplus of over 11pct of GDP a year to prevent debt dynamics spiralling out of control, even in a benign scenario of 2pct annual growth.
“‘Portugal’s debt is unsustainable. That is the only possible conclusion,’ said David Bencek, the co-author, warning that no country can achieve a primary budget surplus above 5pct for long. ‘We won’t know what the trigger will be, but once there is a decision on Greece, people are going to start looking closely and realize that Portugal is the same position as Greece was a year ago.'”
“Sadly, that article is exactly right. Portugal is marching down the exact same road that Greece went down. The yield on 5-year Portuguese bonds is now up to an all-time record 19.8 percent. A year ago, the yield on those bonds was only about 6 percent. This is the same thing that happened to Greece. A year ago, the yield on 5-year Greek bonds was about 12 percent. Now the yield on those bonds is more than 50 percent.”
The world is facing a debt crisis unlike anything ever seen before, and Europe is right at the center of it.
Italy can pull out of its tailspin, but it will need help from the ECB in the form of debt issued at lower than current market rates. But if you give it to Italy, must not you do the same for Spain and Portugal? And while their economies are markedly worse, their government debt-to-GDP ratios are nowhere near as bad. And don’t even get me started about France, which becomes a crisis of biblical proportions by the middle of the decade. Let me note that France is not Greece. It actually is too big to save. France will make a difference when it enters its problem period. And the probable election of Hollande does nothing to alleviate any concerns.
There are only two ways that countries in Europe can get their deficits under control and begin to shrink their debt-to-GDP ratios. They can either grow GDP faster than the growth of their debt, or reduce their debt. How can Spain, with 20% unemployment and a projected 6% deficit, grow enough? Certainly not in the next few years. Portugal has the same problems. Austerity at the levels they will need will soon make growth even less likely, but borrowing more money is going to mean ever higher interest rates, unless the ECB is willing to print or Europe is willing to tax northern European countries to bail out the southerners. Try selling that one in an election campaign, or for that matter, anytime.
Because of the current willingness of European leaders to tap their taxpayers and of the European Central Bank to print money, a crisis has been averted, at least for the moment. For that, the US and the world can be grateful. The probability of a recession this year in the US is falling, as a crisis in the EU could have been the trigger that pushed a slow economy into recession.
But let’s make no mistake. The sovereign debt crisis is not over. Not in Europe, not in Japan, and not in the US. It is in a lull period. And don’t give me that old shibboleth, “The market is telling us that the crisis is over.” The market knows a lot less than many pundits believe. What did the market know in mid-2007? Not very much, although the warning signs were clear, at least to some of us.
Sadly, the focus of the crisis will now move on to other countries in Europe. The economic arithmetic of the peripheral countries is not much better than that of Greece only a few years ago. The pronouncements and assurances from European leaders are about the same as they were a few years ago. Total European debt is at 443%, well above US debt of 350%. European banks are leveraged over 30 to 1, at least double that of US banks, which are nerve-wracking enough.
It is the time of the Endgame. There will be contagion.