Just when you thought it was safe, up rears the eurozone crisis again.
Portugal and Greece have unnerved investors once more. Portugal’s government is on the verge of collapse, and the Greeks seem incapable of the reforms they promised to do in return for a eurozone bailout.
Bond yields jumped again, with Portugal’s leaping back above the 7% mark.
But does any of this actually matter, or is it just another false alarm?
Portugal’s problems are long-term
Portugal’s problems demonstrate why politicians in every other country are doing their best to avoid putting any genuine austerity into place.
Finance minister Vitor Gaspar has resigned, followed rapidly by the foreign minister, Paulo Portas. Portas is also the leader of the government’s junior coalition partner.
To cut a long story short, the resignations are about growing opposition to austerity reforms. Portugal has been a ‘good’ eurozone member. It has pushed through some tough measures.
The trouble is, it hasn’t returned to the promised land. The recession has been more drawn-out than expected, and unemployment is “already set to rise above 18%”, notes the FT.
Financially, Portugal is actually OK in the short-term. The country doesn’t need to borrow any more money from markets this year. The big risk is that the fragile government falls, and backing for reforms falls apart.
That’s a problem. Because Portugal needs a lot of reform. As we’ve noted before here, Portugal never really had a boom during the ‘good’ times. Its consumers took on a lot of debt of course, but the economy has been stagnant. The labour force is low-skilled and uncompetitive.
The whole economy needs to be shaken up and rebuilt from the ground up. That’s a process that takes political will, a period of stability, and more than anything else – time. This stuff won’t happen overnight. And it certainly won’t happen in time to turn Portugal into a growth dynamo capable of paying off its national debt without any help.
This of course, all goes back to the basic problem with the eurozone. If you’re going to strap an economy like Portugal’s to one like Germany’s, then Germany has to be prepared to nurture and fund Portugal’s through hard times. And – in turn – the Portuguese have to be prepared to take a bit of guidance from the Germans.
The ‘big lie’ at the heart of the eurozone, if you like, is that neither German nor Portuguese citizens were told this when they signed up for the euro.
Portugal will not bring down the eurozone
But that’s a long-term problem. How much does it really matter for investors?
Being blunt about it, if Portugal chucked out the current government and got in a bunch of people who said: “Let’s leave the euro”, then it would start to matter. But that’s not going to happen.
Even if the current government fell, it would be replaced by another – to all intents and purposes for outsiders – just the same as the last.
So the Portuguese stock market will wobble, bond prices will fall a bit, but for most UK investors, I don’t see this as critical.
Europe’s real problem lies with America’s threat to stop printing as much money. At one level, it’s actually quite good news for the European Central Bank (ECB). Less money printing means a stronger dollar. That takes some pressure off the euro.
ECB governor Mario Draghi would like to see a weaker euro – it’s one of the few ways to provide some help to the troubled southern countries by the backdoor – he just can’t tell the Germans that.
Unfortunately, the threat of less money-printing also has a couple of other less beneficial impacts. Firstly, it has effectively pushed up the cost of borrowing for every government in the world.
The US Treasury is the benchmark ‘risk-free’ rate. Whether you agree or not, almost every other asset in the world is seen as being riskier than a US government IOU.
So if the yield on a US Treasury goes up (in other words, the price goes down), then – speaking very broadly here – the yield on every other asset in the world has to go up too.
That’s bad news if you’re the central bank in charge of a group of heavily indebted countries, and you can’t actively intervene to buy that government debt and keep a lid on their borrowing costs.
Secondly, if the Federal Reserve decides to stop printing money, then markets are going to be less forgiving, and more discerning. You’ll have fewer investors with cash burning holes in their pockets. That means fewer takers for Rwandan debt, or Bolivian government bonds – or crazy punts on near-bankrupt southern European nations.
The ECB will have to print money
There’s not much Draghi can do about any of this yet. There’s a big ECB meeting today – same with our own Bank of England – but no one expects him to do much more than talk.
Interest rates are at 0.5%, so there’s not much to be done there. (People have talked of negative interest rates, but as far as I can work out, the potential downsides outweigh any gains). And the current pitch of the crisis is not high enough yet to justify another panicky summit designed to find a new way to fend off the markets.
But in the longer run, it’s not just Portugal that will see its borrowing costs rise to unsustainable levels. It’s going to get tougher for all the eurozone economies. And if a systemically important one like Spain or Italy ends up needing a bail-out, the only solution will be to print money.
Ultimately, this is why we like the cheap eurozone stock markets, Italy in particular. Italy has suffered a bit in the latest correction, so now could be a good time to pick up some exposure if you haven’t already.
For more on why the ECB is going to have to print money in the longer run, see Matthew Lynn’s column in this week’s of MoneyWeek magazine, out tomorrow. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
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