After Greece, the piranhas are circling Portugal
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MoneyWeek Editor
John Stepek Feb 04, 2010
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The piranhas are swarming in the waters around Europe.
Greece has been saved. Well, that was the message you were meant to take away from the European Commission yesterday. The EU gave its broad backing to Greece's plans to cut its deficits.
And sure enough, Greek bond yields eased a little (in other words, investors stopped demanding quite as large a return to lend their money to the Greek government). There's still plenty of scope for another surge as the government actually tries to put its plans into action, of course.
But for now, investors have eased up on the country. Trouble is, that's only because they've found another juicy target – Portugal...
Why Portugal is the next target for investors
My colleague David Stevenson has more on the problems facing Greece. As he points out, there are several reasons to doubt its ability to push through its deficit-cutting plans. So expect more turmoil from that direction.
But more importantly, just because the EU has given the nod to the country's spending plans doesn't mean the entire eurozone is saved. Quite the opposite in fact.
Now the markets are looking to call the EU's bluff. Portugal is the next target. Yields on its debt spiked yesterday. It's as if investors were saying: "OK, so you might bail out Greece. But will you bail out Portugal too? Can you even afford to bail out Spain? And we haven't even started on Italy."
As one source quoted in the FT put it: "After the Greeks came out with new, tougher plans, the markets started to look for the next weakest economy in the eurozone to sell. Portugal's recent budget was not that impressive."
You have to feel sorry for Portugal. As Ian Campbell put it recently on Breakingviews.com, the country has suffered a bust without ever really having a boom. It didn't take much of a part in the European property bubble for example. Well before the ‘fly-to-let' psychosis was gripping property investors in Britain, the Algarve was a well-established, luxury property market.
And in dodgy debt terms, Portugal isn't Greece. In fact, Portugal isn't even Britain. Its fiscal deficit for 2009 looks like coming in at 9.3%, worse than the 8% expected, but hardly the worst offender in the world. Portugal's real problem is long-term weak growth. Real GDP per head was actually lower in 2007 than in 2000, as Campbell points out. "Over the same period, Spain's standard of living had gone up 8%, Greece's by 10%, Ireland's by 13%." Now of course, you could argue that Spain, Greece and Ireland are likely to lose all those cheap-credit-fuelled gains over the next few years.
But the real takeaway from Portugal's situation is that the living standards of the population won't improve until the system works better. "Growth has simply been too low to make the country's population better off. The challenge now is to make this round of austerity useful for future growth. Pruning Portugal's cumbersome state and excessive bureaucracy and trimming labour laws are priorities."
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How the eurozone crisis could be good news for weaker countries
In short, this isn't a problem that can be solved with cheap interest rates, or tons of printed money, or a bail-out from Europe. The whole system needs overhauling. It's the old story - government needs to be smaller, and entrepreneurship needs to be allowed to thrive.
But of course, that's a tough message politically. It's a lot easier to leave things the way they are and to hope for something to come along to paper over the cracks for a while. That's why countries don't tend to push through major reforms until their backs are really up against the wall.
So in a way, the current crisis could be good news in the long run for the peripheral eurozone countries. No matter which route they take, getting out of this fix is going to be painful. A bail-out from other European countries won't be cost-free. German taxpayers won't be happy about funding Greek voters to maintain the status quo. Meanwhile, quitting the eurozone would see their debts (still priced in euros) soar. It's possible that voters will realise that embracing painful reform now is better than having it thrust upon them by the EU or the IMF or grim circumstance. But I wouldn't bet on it.
That's why, even although Moody's has started warning about the US's budget deficit as well, we suspect the euro is in for a very hard time in the coming year, particularly against the dollar. We looked at ways to profit from this in Money Morning earlier this week.
Is now the time to exchange your holiday money?
But what about British holidaymakers? If you're planning to head off to the continent this year, should you be swapping your pounds for euros now, as a friend asked me yesterday? Or should you wait?
That's a tough call. And if you're that worried about the value of your spending money, maybe you should be reconsidering whether you can afford to go on holiday at all. But bearing in mind it's a gamble whatever you do, then if you can wait until after the election (most likely 6 May) then my instinct would be to hang on. I suspect the result will be decisive one way or another, and as long as we don't get a hung parliament, the pound will probably bounce.
Before that though, there's a good chance that economic data will disappoint in the months ahead and weigh on the pound. In January, the services sector saw its weakest growth since August, which doesn't bode well for an economy dependent on consumption. We might even see the Bank of England decide to pump a little bit more money (say another £25bn) into the system – perhaps not today, but it could well come in March or April. So if you're flying off at Easter, and you're the type to get your currency in advance, the potential for more bad news for sterling means I'd be tempted to buy now.
Our recommended article for today
The prospects for property are grim across the board, says Tom Bulford. Don’t be fooled by recent optimism in the sector – this bear market will be long and painful. Here's why.
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