When PIGS Can Fly
By: Shishir Nigam Wed, Feb 10, 2010
Note: See important disclaimers below article.
And so, as expected by most, the major Western European economies are talking about what they can do to resolve Greece’s fiscal problems. Contagion has already caused anxiety to spread to the fiscally “un-sound” European nations. Specifically, the PIGS – Portugal, Ireland, Greece and Spain. PIGS is an acronym that was first used by in 2008 by journalists to refer to Portugal, Italy, Greece and Spain. All these 4 economies suffer from similar problems such as fiscal indiscipline, current account deficits, and high unemployment. However, in Pat Buchanan’s view, Ireland deserved a spot in this demeaning group more than Italy did which apparently has a stronger balance sheet that its counterparts.
Contagion
This contagion has already caused the sovereign CDS spreads of these countries to rise with investors fearing that Greece is the just the first in a line of dominos that could fall across the EU. Greece has seen its yields on government debt sky-rocketing, with its latest 5-year bond issue having a coupon of 6.1%, as investors demand more compensation for the risk they are taking by purchasing those bonds. Very soon, the other countries in the PIGS acronym could see their own yields being elevated. The higher interest costs will be of help to any of these governments as it may start a vicious cycle of rising costs and an increasing inability to service the debt burden.
However, many are of the opinion that France and Germany will not let the Greece go down because that could be the first step on the path leading to dissolution of the European Union itself. Seen in fast forward, the scenario plays out something like this. Greece is not bailed out, and due to its inability to manage its debts, it defaults. Contagion leads to fear spreading through other weak economies and they start to experience higher interests costs and pressure, which could lead to more defaults. Those countries that have defaulted will likely have little incentive to continue being a part of the EU, with Brussels imposing constraints on what kind of monetary and fiscal policies those nations can utilize.
Why not me?
To avoid even starting down that path, Greece will be bailed out, but the question is what are the un-intended consequences? Once Greece is pulled up out of the hole with the help of French and German money, the other PIGS countries will have all the right to ask, why not me? The moral hazard that accompanies such action is very often glossed over in crisis situations that demand current situations be addressed immediately before deteriorating further.
But the real problem arises when the un-intendend consequences of those actions start becoming bigger than the problems those actions were supposed to solve in the first place.
Disclosure: Long Market
Image Credit: enggul under a Creative Commons license
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Last 3 posts by Shishir Nigam
- The Era Of Unintended Consequences - June 13th, 2010
- First Dose Of Moral Hazard Delivered - April 18th, 2010
- Two Big Issues - RIM’s Future Hangs in the Balance - April 3rd, 2010
You bring a up a good point "why not me", if the bigger EU powers are able to. I'm sure they will try and bail out fellow EU nations, but at what cost? Is the interesting question. I see the Euro dropping in the near future. I can't wait to see how this plays out. Considering its only France and Germany who have the economic clout to help, it will be interesting to see how far they will stretch their resources, considering they won't get much help from GB who has its own fiscal issues to sort out.
Although half-hearted and a little late, Ireland has already taken certain remedial actions to fix its fiscal situation. It's a dog at the moment but should slowly pull out. Greece seems a bit more anarchic; some unpleasant images of communist rallies and such. It could be a real problem child. The ticking time bombs are Spain and Portugal. Both rely heavily on happy economy scenarios such as booming tourism and property development. So for them a turnaround couldn't come soon enough. Italy, well, it's so corrupt (at least from the outside looking in – Burlusconi et al.) that how can a true economic analysis be put forward in the first place!
The interesting thing is that there are ticking time bombs all around the world…it's more a matter who can keep ticking longer and prolong the waiting period before the big explosion. The US for example, one could say, is in a worse position than many of the European countries…but the US also has the advantage of the having the world's biggest money printing press, and people willing to hold that money, hence allowing it to postpone the explosion much more than others.
If these gentlemen are serious persons on this debt meeting, who desire to maintain some shred of personal credibility, they will both respectfully decline to participate in this charade. Obviously, the President wants cover for any action on taxes and spending, and naming a commission is the opposite of showing leadership. Mr. Obama continues to want to avoid responsibility for anything. One wonders why he wanted to be President at all. McConnell and Boehner should also respectfully decline to name members to the President’s commission. The President is not serious about budget or spending issues, and no commission will make any substantive recommendations that the President could not address now. Paul Ryan has already done this work.
What I want to know is what the “professional investment managers” are telling their retired customers to do about their retirement income? What is being said to retirees that hold these bonds? What will the federal gov do if these start to fail? Bail them out through inflation?
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