Sovereign debt bubble thread

[Valmy]

I think the US defence budget's ridiculous - and I imagine a lot of it's corrupt.  It reminds me of Churchill's diary of a pre-war cabinet meeting.  The Admiralty wanted six dreadnoughts, the Treasury suggested four, the cabinet decided to build eight.

Oh yeah it is the safest way to spread pork out to the constituencies.

[MadImmortalMan]

http://www.bloomberg.com/news/2011-03-28/portuguese-bailout-costs-more-than-money-alone-commentary-by-matthew-lynn.html

Portuguese Bailout Costs More Than Money Alone

Is it 50 billion euros? Or perhaps 70 billion euros? The cost of bailing out Portugal varies according to who makes the calculation. No one will know the real price until officials from the International Monetary Fund and the European Central Bank tell us.

But it isn't the actual amount that counts. It is the price the euro area is paying for having a single currency.

And on that measure, a rescue package for the beleaguered Portuguese economy comes with far too high a price tag attached. It will raise too many questions about whether the euro can ever be made to work; it will mean there is no longer a firewall that stops the crisis from spreading to Europe's core; and the Portuguese don't seem willing to accept the same type of austerity package that Greece and Ireland got.

For all three reasons, the last thing the euro area can deal with right now is a Portuguese rescue.

It now seems inevitable that Portugal will be forced to accept a bailout from the rest of the euro area. Last week, the country's parliament rejected the package of budget cuts proposed by Prime Minister Jose Socrates, prompting him to offer his resignation. Fitch Ratings and Standard & Poor's both lowered the country's debt rating, and bond yields soared.
Debt Payments

The country needs money. It faces redemptions valued at about 9 billion euros ($12.7 billion) in total on April 15 and June 15, perhaps around the time of early elections to choose a new government. Portugal intends to sell as much as 20 billion euros of bonds this year to finance its budget and cover maturing debt. Right now, it doesn't look as if the markets are willing to come up with that kind of cash. That leaves the euro area and the IMF as the only viable alternative -- the same way it was for Ireland and Greece.

The money can be found if it has to be. A bill for 70 billion euros won't bankrupt Germany or France. But just because you can afford something financially doesn't mean you can afford it in other ways. The euro area can't take the cost of bailing out Portugal. Here's why.

First, there's no easy explanation for why Portugal needs a rescue. Greece got into trouble because it fiddled its way into the single currency. It never really met the entry criteria in the first place, and its first application was quite rightly turned down. Ireland had a huge property and banking bubble, which then popped, plunging the economy into a deep recession. In both cases, you could argue that some external event created the crisis. It wasn't the single currency as such.
No Bubble

But Portugal? It didn't fiddle any figures or have any kind of bubble. Ever since joining the euro, the country has had low growth, and that has worsened its debt position.

It is hard to conclude that the problem was anything other than the currency itself -- and the way it affects countries that aren't able to stay competitive with Germany. After this bailout, it will be impossible to claim that the euro represents a functioning monetary system with just a couple of rogue members. Its flaws will be impossible to ignore.

Second, once Portugal is bailed out, the hard questions are raised. For the last three months, the markets have been focusing all their firepower on this one tiny country on the western edge of Europe. Whether it is bust or not has never been a huge deal. It is the questions that come next that matter.
Bank Stability

Once Portugal is out of the way, the markets will start looking hard at Spain and Italy. And they will probe the stability of the euro area's banking system. The answers may well turn out to be explosive. Portugal has been a kind of shield -- and without it, the euro will look a lot more exposed.

Third, the Portuguese don't look willing to play by the rules -- at least as they are written in Frankfurt and Brussels. The indebted, peripheral countries are meant to accept massive austerity programs, and to allow the ECB and IMF to effectively run their economies. But the results elsewhere haven't been encouraging. Greece is still stuck in a recession, and bond yields remain high. Ireland's economy sinks further into the mud. It is no surprise the Portuguese have looked at the results of the medicine and wondered if it is a treatment they need.

But if the Portuguese refuse to accept the austerity measures, what is Plan B? So far there hasn't been any sign that anyone has thought of one.

The euro area can pay for a Portuguese bailout. The 70 billion euros won't matter much. But the final bill will end up being much costlier.

[Sheilbh]

I thought the Portuguese had already had a big bout of austerity over the last year, but the economy shrank so that the deficit wasn't cut as much as was projected? 

It's also worth saying that no-one wants to deal with Portugal now because they have to have an election, as the government's fallen, and no one in the EU/IMF wants to repeat the Irish experience of making a deal with the Fianna Fail government and then having Fine Gael and Labour try and renegotiate.  The EU will keep Portugal going until after an election at least.

[Admiral Yi]

Plan B is to default.  Duh.

[Alcibiades]

If there were a US political party that advocated cuts across the board (including a deep cut in defense) and sensible tax increases to return to sustainable deficits, I'd vote for that party.  There is no such party, however.  I think the current US political system is destined to implement another train wreck.

I am as hawkish as they come (mostly) when it comes to defense spending.

I would very much like to see a SERIOUS cut in defense spending.

Same

[Sheilbh]

Weirdly the Brazilians are looking into supporting Portugal by buying government debt.  I think it's Lusophone solidarity and a left-wing Latin American nation's fear of the IMF.

[The Minsky Moment]

Weirdly the Brazilians are looking into supporting Portugal by buying government debt.  I think it's Lusophone solidarity and a left-wing Latin American nation's fear of the IMF.

Solution: merger.  The Empress Dilma shall rule the reconstituted empire.

[Hansmeister]

Currently about 70 percent of newly issued federal debt is being bought by the federal reserve.  When QE2 ends this summer who will by all that debt?  And at what interest rate?  And how will the necessary increase in interest rates impact the financing of that massive debt?  Or if the fed decides to go with QE3 to prevent interest rates from rising how long will it be until investors bail on the dollar because we're willing to inflate away our debt?

Throw in a President who is AWOL on that issue, and a Senate Majority leader whose cries that defunding the "Cowboy Poetry Festival" would be an extremist act and you're looking at a massive crisis in the making.

In early April the House GOP is supposed to unveil a budget that will address all spending, including entitlement programs, and is supposed to balance the budget.  I predict the Obamateur, Pelosi and Reid will turn hysteric, claim that there is no problem and shut down the gov't in the hope that it will bring the public on their side of staying the course on the deficit.

And in europe the question is ow long will the North Europeans be willing to continue to bail out the irresponsible South Europeans?  It is pretty clear that the SE are incorrigible, so the only question is how much will the NE waste on bailouts before quitting on the SE, killing the EMU in the process.

We are starting to see the collapse of the bismarckian system of gov't that has dominated western civ for the last 100 years.  The question now is what will replace it?

[Admiral Yi]

Hans, explain to me how default of a member state would kill the EMU.

[Sheilbh]

Hans, explain to me how default of a member state would kill the EMU.

If default's not possible then it's screwed.  I mean Greece and Ireland will almost certainly have to default and I think it's just working out how.  I don't think Portugal will, hopefully.

[MadImmortalMan]

I hear the cowboy poetry festival is kinda nice. They also have camel racing.

[Hansmeister]

Hans, explain to me how default of a member state would kill the EMU.

Whom would they default on?  Northern European banks. The EMU has not only failed to achieve it's objective, it has had the opposite effect that was promised. The inefficient SE economies can't devalue their currency to stay competitive, while the NE economies are forced to subsidize their profligacy while crippling their own economies. The Euro has proven to be bad for both the north and the south.  The only reason not to abandon the euro now is that would cause an immediate default of the exposed states. Once they start to default anyway there will be no reason to keep it around.

[Hansmeister]

Hans, explain to me how default of a member state would kill the EMU.

If default's not possible then it's screwed.  I mean Greece and Ireland will almost certainly have to default and I think it's just working out how.  I don't think Portugal will, hopefully.

Greece, Ireland and Portugal will certainly defaultin the near future.  The question is when spain and Italy will. Italy can probably limp on for a while, they are masters at limping along, but Spain will be fucked due to its heavy exposure in the housing bubble.

[MadImmortalMan]

Peoples' optimism in sovereign debt is astounding in its insanity and its irrationality. Look at the fictional nation of Poyais for example. They floated 200k worth of bonds on the London exchange, and the damn country didn't exist. People think that shit is safe.

So, I wouldn't be too eager to predict defaults in big nations so easily, but it's certainly a lot more likely now than it was before the Euro.

[Sheilbh]

Greece, Ireland and Portugal will certainly defaultin the near future.  The question is when spain and Italy will. Italy can probably limp on for a while, they are masters at limping along, but Spain will be fucked due to its heavy exposure in the housing bubble.

I don't think Spain or Portugal will default. 

I'd also say that this crisis has, in a perverse way, helped the strong Northern European recovery.  It combined with Euro-fumbling has kept the Euro very low which has helped their export led recovery.  I imagine they'd be moaning far more about China if the Euro membership was Finland, Germany and the Netherlands.