More Risk From Portugal

The euro area has had a rough few weeks: Cyprus agreed a bailout program that will decimate its economy, Italy’s Pier Luigi Bersani, the Democratic Party leader, failed to put together a government, borrowing costs for businesses in the peripheral countries continue to rise, unemployment reached record highs, and purchasing manager indices across the region greatly underperformed expectations.

There may be one more piece of bad news to add to the pile before the week is out: Portugal’s budget for 2013 may fall apart, and with it the Portuguese government. Read more of this post

Fancy Footwear and Austerity Won’t Save Portugal

Anyone still in need of proof that austerity isn’t fixing the euro area’s debt crisis should visit Portugal. Read more of this post

4 reasons the recent EU summit agreement will fail

I was planted firmly on a beach chair on holiday during the EU summit on July 21st and was worried I might be missing a piece of European history-in-the-making. As it turns out, I didn’t miss much at all. Upon my return a few days later, analysts were just as confused about the outcome of the EU summit as they had been immediately following its conclusion. Digging into the details of what was agreed at the EU summit, there are four main problems that will preclude the agreement from drawing a line under this crisis.

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The euro is dying a slow death

The euro is dying a slow death. Political leaders are unlikely to take the steps necessary to address the underlying factors creating the current euro crisis, and the eurozone will eventually break up as a result.

To highlight the severity of the euro crisis, one only needs to glance at credit default swap (CDS) spreads for the peripheral euro area countries. CDS is a form of insurance against default or restructuring. The higher the CDS spread, the more likely investors think a sovereign default is.

In the first week of June, five-year CDS spreads for Greece were a whopping 1495 basis points, for Portugal 708, for Ireland 650 and for Spain 255. This compares with only around 200 for Iceland, a country that underwent a private default only two and a half years ago.

The euro crisis is just as much underpinned by politics as it is by unbalanced economies, rigid labour and product markets, burst property bubbles and unsustainable public and private debt levels. This has been particularly evident in recent weeks, as a cacophony of voices has emerged at the EU level on how to handle Greece.

Ultimately, it is politics, more than unsustainable debt, that will threaten the very existence of the euro.

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What happens to Portugal and Ireland if Greece reprofiles/restructures?

There is currently a debate raging about how exactly private investors will be involved in a Greek debt reprofiling in order to secure a second bail-out for the government. I wrote in a blog post last week that I think Greek debt will probably be rolled over as demanded by the European Central Bank (ECB). If Greece reprofiles or restructures its debt, would the same be inevitable in the other two insolvent euro area countries, Portugal and Ireland?

I do not think a Greek debt reprofiling or restructuring would necessarily lead to one in Portugal and Ireland, though it might if either country were to opt for a strategic default.

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DSK scandal won’t seriously impact euro area bailouts

The news that Dominique Strauss-Kahn, IMF chief and frontrunner in opinion polls for the upcoming French elections, was arrested on allegations of rape yesterday was a bombshell. Mr Strauss-Kahn is innocent until proven guilty, but whatever the outcome of his trial, it is likely this will be a game changer for French politics. It is unlikely, however, that this development will impact the future of the eurozone bailout packages.

Mr Strauss-Kahn was widely expected to announce his candidacy for the French presidency. According to opinion polls, Mr Strauss-Kahn would have easily won the Socialist Party nomination and very likely could have defeated the current president, Nicolas Sarkozy. The Socialist Party has demanded candidates for the primaries apply between June 28th and July 13th. It seems unlikely that the Mr Strauss-Kahn’s trial will be wrapped up by then, in which case he will not be able to run for president.

While this may well change the course of French politics, the short- and medium-term future of the eurozone bailout packages is not likely to be in question. Mr Strauss-Kahn was on his way to Berlin for a meeting with German chancellor Angela Merkel yesterday and then onward to Brussels for a meeting with the EU finance ministers. There are two big items on the agenda for this meeting in Brussels: a new bailout package for Greece and approval for a €78bn bailout package for Portugal. Yesterday’s arrest of Mr Strauss-Kahn is unlikely to significantly impact either of these. First, the IMF is not a one-man show, and another representative will be present in Mr Strauss-Kahn’s absence. Secondly, EU leaders seem committed to a new bailout package for Greece and a lending facility for Portugal. This is not affected by Mr Strauss-Kahn’s arrest. The lending facility for Portugal has largely already been agreed, and this scandal could at most delay agreement on a new bailout package for Greece. A short delay on a Greek bailout is fairly irrelevant; Greece does not need more funding until 2012, when it is currently expected to return to the markets.

The United States has historically prioritised leading the World Bank. If Mr Strauss-Kahn were to resign from his position at the helm of the IMF, therefore, it seems likely another European would be chosen to replace him. If this is the case, the medium-term outlook for the European bailout programmes would not change. I expect that European leaders will continue to support the bailout programmes until 2013, when the European Stability Mechanism (ESM) is implemented to allow for orderly debt restructuring.

Media round-up: Jan 3rd-9th

Find below some of my media appearances relating to the euro area debt crisis for this week:

On the euro area debt crisis:
BBC World Today, January 8th (available here and here)


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