Thursday, April 15, 2010

More Eurozone Trouble - Will Portugal or Ireland Be Next?


(h/T Economix (NYT), The Baseline Scenario,
The BoomBust Blog
and Zero Hedge)


As we noted in our last post, Greece is saved for now.

All that remains there is for the Greek Government
to "activate" the package and the aid Euros will begin
flowing.

Despite some lingering grumbling from Germany,
the deal will ultimately go through. The markets,
though, are not convinced.

As of today, the yield on Greek debt on the London
markets was 6.86% - down from 7.83% last week,
when it really looked as if a Greek default was going
to happen. Even though the CDS (default insurance)
rate is now up to a staggering 453 bp, the ECB and IMF
have bought Greece at least a year or two's time to
straighten matters out.

Attention will now turn to the next two basket cases
in the EU infirmary - Portugal and Ireland.

And of the two, Portugal looks to be the more immediate
problem.

Like Greece, Portugal's two main industries are
agriculture and tourism - trades that are principally
carried on with other members of the EU. Industry
is practically nonexistent, and Portugal lacks
Greece's foreign-exchange-earning Merchant
Marine. And, also like Greece, the principal reason
Portugal is in trouble is that the Government spent
far beyond its means on social services and transfer
payments, resulting in a fiscal deficit of 78% of GDP
(compared with Greece's 114%).

This deficit, like Greece's, has been financed with
foreign borrowing (mostly from other EU countries).
And, again like Greece, the additional borrowing has
gone to finance interest payments on current debt.
As a result, Portugal's deficit as a percent of GDP will
reach Greek levels by 2012 - at which point the money
tap may well dry up.

And making this even more difficult is that all three
countries are saddled with the Euro, which prevents
the far-reaching fiscal adjustments necessary to cure
the problem.

To use The Baseline Scenario's example, Portugal
this year forecasts a primary deficit of 5.2% of GDP
(all budget items less interest). Assuming
that the ECB/IMF consortium offers them the same
terms as Greece, Portugal will have to run a 10.4%
primary budget surplus almost immediately - which
could only be done with drastic budget cuts and
massive unemployment.

And thus far, with a total deficit of 8.3% for the
current year and 8%+ forecast for 2011, 2012 and
beyond, the Portuguese government's policy thus far
has been to hope and pray for a global economic
miracle - which everyone except the Portuguese
recognizes is not about to happen.

And Ireland is in even worse shape. Thanks to a
record fall in GDP last year of 7.5% (the highest
in the Eurozone), Ireland's budget deficit for
the current year is 11.3%, with 12.5% forecast
for 2011 and 13.3%+ for 2012 and beyond.

However, the Irish government at least took action.
It imposed layoffs and wage and pension cuts on its
public employees, and raised taxes on everyone else.
As a result, despite its problems, the interest rate
on Irish government debt is only 1% higher than
that of rock-solid Germany.

But in Ireland's case, it was the private sector, not
the public, that caused the problem. As a result of
Ireland's positioning as the "Celtic Tiger" - the
low-cost, low-tax, low-regulation alternative
to mainland Europe - Ireland quickly developed
an outsize financial sector relative to the size of
its economy. As of 2008, the assets of Ireland's
banking system were two and a half times its GDP.

And then the fun began. Taking a leaf from the
American savings and loan playbook, Ireland's
property developers began buying up banks, which
led to an orgy of speculation and overbuilding.
Property prices more than doubled between 2002
and 2008. When the crash hit, property prices fell
by half, private sector unemployment doubled, and
the number of non-performing residential and
commercial real estate loans skyrocketed - all in
less than a year.

And like their American cousins, Ireland's
politically well-connected bankers were bailed out.
Result - the banks kept the upside, and almost all of
the defaulted loans were transferred to the public
sector, more than tripling Ireland's total public debt
as a percent of GDP to 87%. Today, over one-third
of all property loans in Ireland are either already
defaulted or "under surveillance" (i.e. underwater) -
an astounding 80% of GDP.

Translation - had the Irish government made their
banksters suffer , they would today be one of the
strongest economies in Europe.

And that's the biggest issue - in both Europe
and the U.S. When you create moral hazard, you
don't get a fix - just more of the same problem,
whether the guilty parties are bloated banksters or
a bloated public sector. And at some point,
someone in a position of power somewhere
is going to wake up and say: "Enough!"

Judging from the way things are going just about
everywhere, The Thinking Nationalist thinks
that that long-delayed moment of truth will come
sooner rather than later.

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