On Wednesday 6 April, Portuguese Prime Minister  José Socrates asked a bail-out from Europe to the President of European Commission Manuel Barroso. The day before Portuguese banks refused to buy more government bonds, so that Socrates, who had resisted to pressures from his Finance Minister Fernando Texeira dos Santos, decided to ask a help from the European financial stability facility (EFSF).

 This happens few days after the European Council (24-25 March), so that one may wonder if there is any connection between the two events. The Council decide that from June 2013 the European Stability Mechanism (ESM) will succeed to EFSF. ESM amount will reach 700 euro billions, with a loan capacity of 500 , but the most important point is that there is an explicit prevision of a debt restructuring. That this debt restructuring is defined as a an “orderly restructuring” doesn’t change very much  the real content: reduction of debt and extension of payment terms, that is a bondholder haircut. And who are the holders of those bonds? Mainly German, France, British and Spanish banks.

 Is it surprising that the financial markets are so nervous? In the last two months spreads over German bonds and CDS of Greece, Irish and Portuguese sovereign debts are continuing creeping, while Spanish and Italian spreads and CDS are bending . It is also interesting to note that the greatest spread between Portugal and Germany is not that of ten years bonds (384 basic points), but that of two years bonds (583 basic points). Financial operators would prefer either a clear statement that euro countries do not allow a default of a member country , or an immediate debt restructuring. More than one commentator noted that  the policy of “buying time” gives room to speculative attacks.

 Germany and the other “AAA” countries aim at obtaining the maximum effort in debt reduction by the countries in need, and EFSF has financed Greece and Ireland with a spread greater than two hundred basic points, in order to show  that “irresponsible” countries are not rewarded for their behaviour . As a consequence Eurostat forecasts that two countries will have a negative rate of growth of GDP, Greece (-3%) and Portugal (-1%), but also Ireland’ rate of growth will be a slim +0,8%. Unemployment is rising and in Greece the central bank is forecasting a rate of 16,5%; it is not surprising that a recent poll shows that the support to George Papandreu is lowering to a 35 per cent.

 As a matter of fact, the three countries have different stories behind them. Looking at the end of 2007, when the financial crisis was already creeping, and focusing on three variables we get:
 
                                                      Greece                Ireland                         Portugal

1997-2007 rate of growth              high                         very high                  low

2007 public debt                             high                        very low                   very low

2007 private debt                            very low                 very high                  medium

 The financial crisis acted like a kind of Hegelian night, where all the public debts are high. Now it is enough clear that the debt-GDP ratio (both public and private) cannot go up for ever, but the point is how to realize a rate of growth for all the European countries, and in particular for those under scrutiny, sufficient enough to establish a realistic timing for stopping the debt increase. The official answer by EU is that each country has to cut public spending (and if necessary rise taxation) in order to restore confidence, and, with confidence, stimulate consumption by families and investment by firms. But the other way around is the more probable outcome: a general slowing down of economic activity, and a negative loop for countries like Greece, where we already see the process: deficit cut → decrease in rate of growth → new deficit cut, and so on…

 But let us suppose, for sake of argument, that all European countries, at least those of the Eurozone , became like Germany, that is an export-led economy. If Eurozone comes up with China, Japan and other rapidly developing countries, the global unbalance vis à vis United States will blow up, preparing the route for the next worldwide financial crisis. 
 

[1]Temporary Prime Minister until next elections which will happen in a couple of months.

[2]The rest will take the form of guarantees and callable capital, like the EFSF.

(3) ]Mohamed El-Erian, Ceo of Pacific Investment Management Company (Pimco), one among the greatest investment funds, said (6 April) that Greece, Ireland and Portugal (in this order) are under scrutiny, and he thinks that at least one of the three will restructure before 2013.

(4) After all the percentage of sovereign debt of the three countries is a small fraction of the euro public debt.

(5) To the respective public opinions and, in the case of Germany , to obtain the consensus of the Parliament and of the Constitutional Court.

(6) Strangely enough this “moral hazard” argument holds in the case of public debt, not in  that of banks debt.

[7)]See on this problem J. Felipe – U. Kumar “Do some countries in the Eurozone need an internal devaluation? A reassessment of what unit labour costs really mean”, vox eu 31 March.