Portugal is the recent flashpoint, but Spain and Belgium are on deck. Note too that sovereign spreads in Ireland and Greece are at record highs in spite of the alleged bailouts.
In response to the clearly not-contained crisis, Germany is considering expanding the bailout fund from 750 billion-euro ($966 billion) by as much as 25%. Meanwhile, it’s time to look beyond Portugal to Belgium and Italy, and of course Spain.
Why stop there? Interest rates are soaring in European countries outside the Eurozone, notably Poland.
Looking Beyond Portugal
The Financial Times says Europe must look beyond Portugal.
Like the rival warring sides on a battlefield, European policymakers and financial markets left each other alone over the Christmas holiday. The new year, sadly, holds little prospect that peace will soon break out in Europe’s sovereign debt crisis. Eurozone leaders must ensure that 2011 does not become a repeat – only worse – of 2010.
The imminent flashpoint is Portugal. Long mentioned in the same breath as Greece and Ireland – which have both accepted rescue packages from the European Union and the International Monetary Fund – Portugal has now taken their place as the most exposed eurozone state still reliant on market funding. The yield on 10-year Portuguese sovereign debt remains near euro-era highs, above 7 per cent. There are rumours of German pressure – denied by Berlin and Lisbon alike – for Portugal to take money from the European financial stability facility.
Portugal’s problem is similar to Spain’s. Stagnant productivity alleviated with excessive private sector borrowing resulted in a decade of huge current account deficits that were squandered instead of assisting reforms to increase growth. But private debts quickly turn into public ones when the alternative is a depression brought on by a private funding drought.
The costs of the financial crisis are being born by everyone from citizens to shareholders – with one exception: senior creditors to private banks, treated as sacrosanct. The sovereign crisis will not end until this false religion is unmasked. That means Europe’s leaders must open a new front. If they want financial peace, they must prepare for war.
Bundesbank President Says “Optimism Seems Premature”
Please consider Weber Says ‘Premature’ to Be Optimistic on Containing Crisis
European Central Bank council member Axel Weber said it’s too soon to assume Europe’s debt crisis has been contained as the ECB steps up its purchases of government bonds to ease market tensions.
“The optimism of some observers seems premature to me,” Weber, who heads Germany’s Bundesbank, said in a speech in Frankfurt late yesterday. “There are several good reasons to look into 2011 with cautious optimism, not least the economic outlook. At the same time there remain — also in Germany — important challenges in terms of cleaning up the financial system and getting state finances in order.”
Greek, Irish and Portuguese bonds rose yesterday as traders said the ECB bought the assets of the euro region’s most indebted nations amid mounting concern Portugal will be forced to seek a bailout. Portugal auctions 2014 and 2020 bonds today. The turmoil has prompted calls for Germany to soften its opposition to expanding the region’s 750 billion-euro ($966 billion) rescue facility.
“The outlook for 2011 depends on the extent to which the right lessons are drawn from the crisis,” Weber said. “The responsibility for the debt crisis in the euro area lies primarily with fiscal policy, not with the financial markets. The affected countries must themselves restore the confidence that’s been lost.”
The ECB purchased Portuguese debt yesterday, said two traders with knowledge of the transactions, who asked not to be identified because the deals are confidential. A spokesman for the central bank declined to comment. Portuguese 10-year yields fell 12 basis points to 7.08 per cent.
Polish 10-Year Yields Hit 6.18%, Highest in 16 Months
Bloomberg reports Poland Faces Highest Yields in 16 Months on Cuts to Pensions
The Finance Ministry faces yields of at least 6.18 per cent on 10-year bonds, the most since an auction in May 2009, according to analysts at PKO Bank Polski SA, ING Bank Slaski SA, Bank Handlowy SA and data compiled by Bloomberg. 20-year debt may yield the most since an auction in September 2009.
Yields on 10-year Polish bonds climbed 17 basis points to 6.227 per cent this month after the government said on Dec. 30 it plans to lower contributions to private pension funds, which as of November were the third-biggest holders of government debt, according to Finance Ministry data. The auction comes the same day as an offering of 10-year bonds from Portugal, the first from any of the euro region’s most indebted countries this year.
“Market sentiment has worsened as there is a lot of uncertainty whether Portugal will get a bailout,” Rafal Benecki, an economist at ING Bank Slaski, said by phone from Warsaw. “The long-end is risky because that’s where the pension funds were calling the shots and we don’t know what the market will look like after the reform takes effect.”
The extra yield investors demand to hold Polish 10-year debt in zloty over German bunds rose to 335 basis points this week, the highest since Nov. 30. The cost of insuring European sovereign debt climbed to a record on concern backstopping the region’s banks will overwhelm government finances. Portugal’s Prime Minister Jose Socrates said yesterday his country doesn’t need a bailout from the European Union and its 2010 budget deficit will be lower than forecast.
Crisis Will Escalate Until Haircuts Taken
This is not a matter of looking beyond Portugal, but rather of looking at the reason for the crisis itself: debts that cannot possibly be paid back. The market understands Greece and Ireland will default, otherwise yields and credit default swaps would not be at or near record levels.
Attempts to bailout country after country is itself destabilizing. Every increase in the bailout fund and every purchase by the ECB brings the crisis closer to the core – France and Germany. This is why Axel Weber is correct in voting against ECB bond purchases and Trichet is wrong.
Sovereign debt purchases do nothing but mask over the problem while loading up the ECB’s balance sheet with garbage. In the end, what cannot be paid back won’t.
In the meantime, Trichet has gone against everything he has ever stood for. His short-term efforts to “save the euro” are the very things that may cause the Eurozone to break apart or the Euro to collapse long-term.
Mike “Mish” Shedlock
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