November 26, 2010
Oh-dear. The ‘confidence’ in sovereign debt levels that I have written about recently seems to be in full-on retreat for eurozone members this week.
This must be galling for Portugal. They are clearly trying to pass a tough austerity package at the political level (yes, it probably needed to happen sooner) but it seems as though the financial world will not give them time to even try and put it into action.
The thinking seems to be that Spain cannot be allowed to fail despite the obvious weaknesses in it’s economy. The consequences would simply be too great for the euro and for most other eurozone members.
The story of Spain’s economic woes are well known. An economy with too much reliance on the residential property and tourism sectors, lots of borrowing at every level and not much industrial output. Worse, those sectors (property and tourism at least) depend to a very large degree upon the spending power of other nationalities in their country. In case you aren’t aware of the level of the property retreat in Spain, click here for some examples.
Since Spain is a ‘big’ country, the political theory says that it must be saved. If the Spanish default, or confidence in their ability to service their debts is lost – which sounds like it is starting to happen – the eurozone could be torn apart.
That would be an economic solution to economic problems created by a political decision.
Since Spain has leant heavily to Portugal, sacrificing Portugal may save Spain. Just to confirm, it may save Spain. There is no guarantee here. The Spanish economy is in such troubled condition that a bailout for Portugal may only postpone the default of Spain.
But must Portugal be sacrificed to save Spain? This seems akin to amputating a foot to save a leg. The options are not particularly palatable. Palatable or not, other eurozone members are pushing Portugal to accept financial help.
The real problem – to my mind at least – is that Portugal could receive a bailout, and the total cost to other EU members and the IMF to step in (and in Greece and Ireland) could use up enough of the funds that there simply isn’t the money to save Spain if and when the time comes.
The money could eventually run out.
Nation states are not ‘too big to fail’. The US government, for example, recognised in 2008 that it could not help everyone – hence the collapse of Lehman Brothers and others.
It is clear that this is a very complex situation and there are no easy answers.
A couple of issues seem to stand out though. Estonians must currently be terrified at the risks that will soon be pointed at their own economy when they join the euro. And British politicians and bankers must be heaving a sigh of relief that Britain has not joined the single currency. All of the pressures inside the eurozone are taking the focus of attention off non-members, allowing them to do something about their own economies away from the spotlight.financialguy