It ain’t over until it’s over ...
The yield on the 10-year Portuguese government bond closed above 14.80 percent yesterday, a new record for the euro-era. According to the FT,
“The markets are pricing in a Portuguese default with 10-year bonds trading at about 50 percent of par, a deeply distressed level in the eyes of many investors.”
Friday the 13th may be an unlucky omen for Portugal. On that day, almost two weeks ago, Standard & Poor’s became the last rating agency to downgrade Lisbon to junk, marking the moment for many investors when default looked inevitable for Portugal as well as Greece.”
For more on this see my January 16 post “Credit Downgrades and Europe”.
The downward spiral in defaults will continue as long as Europe fails to honestly face its problems. (See my Jan. 25 post How Long Will Europe Continue to Lie to Itself.)
In the past, analysts, including myself, tried to explain what officials in Europe were doing by casually remarking that their actions amounted to “kicking the can down the road.” Basically, the actions of the European officials were an effort to postpone dealing with the real issues, hoping that by delaying what was needed to be done the situation would eventually correct itself.
Now, it seems that the days of “kicking the can down the road” are reaching a climax.
European officials hope to reach a deal on the Greek debt situation by the end of this month. The current write down seems to be somewhere around 50 percent of face value, but there still remain issues to be decided like whether or not the European Central Bank will have to write down the Greek debt it has on its books.
Bond markets have responded to this reality by dumping Portuguese debt. Note that the yield on the ten-year government bond was about 10.40 percent (compared with 14.80 percent yesterday) around the middle of November, a time when it still seemed that maybe the European Union might be able to pull things together and avoid a Greek default.
As the officials of Europe finally seriously traveled down the path to restructure Greed debt, the price of Portuguese debt started to weaken. The price declines accelerated, as the possibility of a Greek write-down became more of a reality. Today, the yield on the 10-year bond was around 15.00 percent.
I know that governmental officials hate to give in on these write-downs because they hate to concede to the “bond markets” and “speculators”.
It is hard for governmental officials to admit that maybe the bond markets and the speculators might be right.
It is a very difficult lesson for governmental officials to accept the fact that they cannot continue to cater to their constituencies with jobs and other benefits ad infinitum. Over the longer run, either taxes have to be raised or money has to be printed because the bond markets will not continue to underwrite debt that will be repaid, both principal and interest, by the issuance of more debt.
The economist Hy Minsky referred to this kind of debt financing as a Ponzi scheme.
Ponzi schemes come to an end and the end cannot just be blamed on the bond markets and the speculators. In fact, the governments just line the pockets of the bond markets and the speculators by extending their uncontrolled spending until the collapse of the market becomes a sure thing.
So the charade continues and Portugal seems to be next. Who will follow Portugal? Spain ... or Italy ... who knows?
Yet this is not the only concern that many of these officials are facing. The austerity programs enacted by governments throughout Europe are not setting well with the people. There is discontent and upheaval arising in many countries.
From yesterday's New York Times:
“The only consistent messages seem to be that leaders around the world are failing to deliver on their citizens’ expectations and that Facebook, Twitter, and other social media tools allow crowds to coalesce at will to let them know it. That is not a comforting picture for the 40 heads of state or leaders of governments who are attending the World Economic Forum (in Davos, Switzerland) ...”
The situation is quite uncomfortable. But this is what happens when you fail to deal with a problem -- when you continually try to kick the can down the road. The situation does not go away and the delay in dealing with the situation often turns out messier than if the situation had been dealt with earlier.
The only way for the officials to resolve a condition like this is to get in front of it. I don’t see anyone around in a position to do this. The only real possibility is Merkel but the resentment that already exists against Germany makes it that much more difficult for her to achieve what is needed.
If no leader arises then the defaults will continue, and the austerity will grow, as will the discontent and the upheaval.
The Times article ends with this thought-provoking quote from Kenneth Roth of Human Rights Watch:
“Europe risks being handicapped if it doesn’t deal decisively with this challenge to democracy.”