New year, new crisis. No sooner had Europe’s bond traders, politicians and central bankers gotten back to their desks than it was time to begin tussling over the fate of a small economy on the periphery of Europe.
This time around, it’s Portugal. And yet the script seems very similar to the one played out already in Greece and Ireland. Bond yields surge. The government denies furiously there is any need for a bailout. French and German leaders rehash some of their lines about the importance of European solidarity. And the guys at the International Monetary Fund and the European Union pack their bags and check flight schedules.
Before you know it, the defiant words have vanished, and the bailout has begun.
And yet so far, most of the discussion has been about when Portugal gets rescued. There has been very little talk about a far more important question ― whether it should be.
In reality, it’s a terrible idea. It won’t stop the euro crisis spreading to the next country; the rescue mechanism is a mess; there’s no plan for getting countries out of the clutches of the EU and the IMF; and the obvious flaws in the packages are making the breakup of the euro area more likely. It would be better to admit that the EU made a huge mistake in bailing out Greece, and simply restructure Portuguese debt.
No one can say how long the Portuguese government will hold out against pressure from the bond market. Yields soared at the start of last week. They have fallen slightly since then. Yesterday, 10-year Portuguese debt was yielding 6.6 percent. As a rule of thumb, 7 percent seems to be the tipping point. Maybe they can keep bond yields below that crucial level, but you wouldn’t bet your last bottle of port on it.
The real issue is whether it makes sense to assemble yet another rescue package, the third for a euro member in less than a year.
The answer is no.
First, it won’t stop the contagion. Bailing out Greece didn’t stop the markets moving on to Ireland. Bailing out Ireland didn’t stop Portugal being attacked next. There’s no reason to think a Portuguese rescue will stop the markets moving on to Spain. The markets attack one country at a time because that is the easiest way to make some quick profits ― not because it is the only country at risk. As soon as one bailout is finished, the whole show just moves on to the next one.
Second, the rescue mechanism is a mess. The interest rate charged to countries is punitive, making it harder for them to dig their way out of their financial hole. Ireland is paying 5.51 percent interest on the first tranche of money it received from the bailout package. The Greek government is paying about 5 percent on the money it is getting from the rest of Europe. That’s a lot more than the funds usually cost the lenders. The reason countries need rescuing is because they can’t afford to pay the interest on all the money they have borrowed. How can it make sense to charge them premium rates for yet more debt?
Third, there’s no plan for getting countries out of the rescue mechanism. Greek and Irish bond yields are still way above the euro-area averages, even after the bailouts. There is no sign of yields coming down. Nor is there any sign of their economies recovering. So how are they meant to get back to normal growth again? You shouldn’t start a war without an exit strategy. Likewise, you shouldn’t rescue a country without any idea how to get the markets back to functioning properly.
Finally, all the flaws in the rescue mechanism make a breakup of the euro more likely. Investors aren’t stupid. They can see quite clearly that the EU and IMF medicine isn’t working. Only last week, Fitch Ratings downgraded Greek debt to junk. Greece’s economy shrank 4 percent in 2010, and will probably contract 3 percent this year, according to Fitch.
The rest of the world is recovering, but Greece is stuck in what could be a 10- or 20-year recession. How is the country supposed to bring its debts under control when it gets poorer every year? If that is what a “rescue” amounts to, it is hardly surprising investors keep betting against the euro.
It is already clear the EU made a mistake in bailing out Greece. It would have been better to simply let it default. As the old maxim has it: When you are in a hole, the first thing to do is stop digging. It would be better to let Portugal default, if necessary, then deal with the consequences of that.
The last thing the euro area needs is another failed rescue package that only ends up making the whole crisis even worse.
By Matthew Lynn
Matthew Lynn is a Bloomberg News columnist and the author of “Bust,” a book on the Greek debt crisis. The opinions expressed are his own. ― Ed.