The EU elite are patting themselves on the back right now after Portugal was able to sell some debt. They all follow the party line that all is well and that Portugal is financially healthy. Portugal is certainly not Greece or Ireland. To anyone with a brain, these are, of course, preposterous notions similar to Hank Paulson’s statements back in early 2008 promising that the US economy was still sound or Bernanke’s comment that sub-prime was contained. Whenever you get these kinds of false assurances by politicians, the smart money knows something big is going to happen. In this case, it is almost a guarantee that Portugal will soon be feeding on the EU bailout fund in order to survive.
But don’t listen to me. Take a look at what the markets are saying. After today’s “successful” debt auction, Portuguese 5 – year CDS is currently trading at 513 bps. Yes, it was down 4 percent for the day, but the number is telling us the market does not believe Portugal is going to make it without EU assistance. If you remember, back before Ireland collapsed, I mentioned that when you see sovereign CDS rise above 400 bps, bankruptcy is not far off. Portugal is well above this critical threshold, which already means the die has been cast—the only question is:When will Portugal be forced to beg for financial aid from the EU? Personally, I think it will occur within the next 3 months despite Portugal’s recent bond offering.
Below is a chart of Portuguese CDS. How can you tell me everything is okay?
One thing to keep in mind is the news from the WSJ that Portugal was forced to initiate a 1.1 billion Euro private placement of debt with China last week. Does this sound like a economically viable and strong country? A private placement of government debt is what soon-to-be bankrupt countries do when the market loses confidence in their ability to repay their debts. Instead of holding an auction where people bid for your debt, in a private placement, the government goes out (with the help of a few investment banks) and actively looks for gullible fools to purchase their debt. The insinuation is that the Portuguese government had to take this action because they feared a failed bond auction.
So even though Portugal was able to see 1.25 billion Euros worth of debt today, it is more of a temporary stop-gap measure because it is a slap in the bucket to the 20 or so billion Euros that Portugal needs to finance itself in 2011. And don’t forget there is 2012,2013, and so on. It is true that Portugal has a little more breathing room than the perennial basket case Greece because it starts with a lower debt-to-GDP ratio of around 80%. The problem for Portugal is an uncompetitive economy which lacks any real catalysts for growth. About the only hope for Portugal is to grow its way out of its problems (along with ECB induced inflation). But this is next to impossible for a country that is implementing harsh austerity measures to placate EU demands. This, along with a inefficient labor market and over regulation, leaves the Portuguese economy with no hope of strong growth. The Central Bank of Portugal was forced recently to cut its 2011 growth forecast from 0% to -1.3%, as a result of the austerity measures. Considering that this number comes from a government, we can expect it to be overly optimistic. The real number is likely to be much worse. So we have an economy, which is contracting, and yet at the same time continues to run chronic budget deficits (9% in 2009, and somewhere around 7% for 2010). It is a recipe for disaster as Greece and Ireland have already discovered. More, importantly for Portugal, 2011 does not look very promising either, with current forecasts predicting a 4.6% budget deficit. So much for Portugal taking tough measures.
The combination of a permanently weakened economy with rising debts is exactly like what happened to Greece. Oh, the game continues as long as the country is able to constantly roll over its debts and issue new debt. But when the day comes when the bond market wakes up and pulls back the punch bowl, it is lights out for that insolvent country. The only question is: How long can the bond market continue to finance Portugal? In reality, the market has already abandoned Portugal and rates on Portuguese debt confirm this fact. 10-year government debt is trading around 7%, hardly a vote of confidence by the market–and this is with continual ECB monetization! Imagine if the ECB stepped away and let the market function freely. Do you think rates would be lower or higher? So as long as the ECB keeps up its purchases of EU peripheral debt, the ponzi game can continue indefinitely, saving Portugal from officially tapping the EU stabilization fund. But is this a real victory when it is predicated on an ECB stealth bailout financed with money printing? I don’t think so.
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