Portugal Debt Success Not Light At the End of the Tunnel

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There are two major sources of fear (and hence instability) in today’s markets – credit tightening caused by rising inflation in China, and debt woes caused by bank and sovereign insolvency in the Euro-zone.

Both have the effect of causing risk aversion when they come to the market with bad news, and exchange rates and metal prices have been particularly sensitive to both over the last few months. China, inflation and Asian credit markets were the subject of a separate blog a few days ago and we might be excused for thinking this week’s Euro strength signals the end of European debt worries; particularly following Portugal’s successful floating of €1.25 billion of bonds maturing in 2014 and 2020 last week, followed by Spain selling $3 billion of five year debt, covered in an Economist article. Even though rates were a little below levels the week before, they are still — by historic standards — punitive rates of 6.7 percent in the case of Portugal and 4.54 percent in the case of Spain.

But to assume the storm has passed would be to take too simplistic a view. Portugal in particular cannot afford to pay 6.7 percent when its public debt is high and rising. In a country that has seen a steady loss of wage competitiveness since the 1990s and has had no better than feeble GDP during much of that time, it has suffered a persistent budget deficit that these rates of interest will prove unsustainable to finance. The country’s banks have been relying on the ECB for funding since last spring and with net foreign debts of more than 100 percent of GDP, those banks are horribly exposed to default. Greece had a fiscal problem it spent more than it earned; Ireland had a property crisis putting its entire banking system at risk; but both countries were capable of rapid growth in good times — Portugal has been on a long-term decline sustained only by EU largess.

A Telegraph report suggests some of the success for the Portuguese and Spanish bond auctions must go to buying by China. Chinese vice-premier Li Keqiang promised to buy Spanish debt during a visit to Madrid last week, reportedly up to €6 billion ($8bn). China was also rumored to be the secret buyer in a recent private placement of €1.1 billion of Portuguese debt, according to the paper. Although how much China’s buying impacted rates compared to the ECB, who was widely credited with buying through up to 20 brokers behind the scenes, is debatable. Their actions, though, have not passed without typical European paranoia, the paper explained, as Herman Van Rompuy, the European Council’s president, said during a visit to London that the Chinese may have “political” thoughts in the back of their minds for coming to Europe’s help, and gave a strong hint that they are also engaging in currency manipulation. “When they buy euros, the euro becomes stronger and their currency a little bit weaker. That is not neutral in regard to their competitive position. Yes, well, Herman, a measly $8 billion isn’t going to shift the exchange rate for very long, is it, but still we take your point: China’s purpose is certainly not altruistic. A more likely suggestion for ingratiating itself with Europe ahead of a review of the arms embargo imposed after Tienanmen Square massacre in 1989 is a desire for relaxation of that embargo and access to European technology.

What Portugal needs more than Chinese purchase of its bonds is adoption of Chinese working practices. The reality is Portugal (and Greece and Spain) will never work their way out of this situation without a massive and profound improvement in productivity, including working longer hours and demanding fewer taxpayer-funded comforts. This won’t happen though; cultural attitudes have become deeply entrenched (just witness the riots that attended the initial wave of fiscal changes proposed in Greece last year; only the Irish have grasped the nettle and seem willing to take the pain.) The southern Med states are relying on Germany to bail them (and the bankers who have lent them the money) out and while that story plays out, Euro-zone instability will continue — and with it, significant volatility. We could easily see the Euro drop back to its 2010 lows of $1.1873 during 2011 and goodness only knows what the effect of a ‘twin-track Europe’ is going to be this year and next. The Club Med contracting and northern Europe led by Germany powering ahead: the strains can only get worse.

–Stuart Burns

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Comment (1)

  1. Lee says:

    I’m notsure it was just due to China/India saying they would support peripheral debt.

    See here..

    http://marketsandculture.blogspot.com/2011/01/european-sovereign-debt-crisis-spain-to.html

    action over the Spanish banking sector

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