PIGS Might Fly

29/06/2012 at 4:03 pm

That, at least, is one prevalent view: whatever summits are convened and decisions made, Portugal, Italy, Greece and Spain will leave the eurozone. There are many who think that this is a great idea. In the long run, so they say, devaluation will improve competitiveness and thereby increase growth and employment.

Of course we know what happens to all of us in the long run. And the short run consequences are not likely to be pleasant – indeed, can be terrifying. In Iceland only four years ago, for example, the currency became unsaleable for a period and panic set in over the availability of (mostly imported) food.

There are reasons not to be quite so enthusiastic about the idea closer to home too. In the economic sense at least, Britain is not an island. There are real concerns about the effect on our own prospects that deeper uncertainty on the Continent would have.

Furthermore, there is no reason to suppose that bond markets – the most likely mechanism for triggering another sovereign bailout – would stop at chasing away the PIGS. When financing for Italy looked in greatest jeopardy last November, bond yields in France came under pressure too: ten year French bonds rose from a spread of 0.3% above their German equivalents to almost 2%. To many at the time this seemed the natural way for the crisis to spread.

The problem is that while Greece is a relatively small economy, France and Italy are giants. In absolute terms, the national debt of Greece is substantial, having risen to over €350bn by the end of last year. But for Italy and France, the numbers are over ten times bigger at more than €3.6trn. Writing down the value of debt on that scale – along the lines that Greece did this year – could really lead to “contagion”. To put the number into context, it is (on Bloomberg tracking) hundreds of billions bigger than the total writedowns suffered and capital injections required as a result of the financial crisis by all financial institutions, worldwide.

Sticking with the numbers for now, many seem not to realise that it would be nigh impossible to bail such large economies out. Between them they have around €420bn of bond and money market debt to refinance by the end of the year – and that doesn’t include the amount required to fund their budget deficits or support existing bailouts. Add in 2013 and that number almost doubles.

At the present time there isn’t much in the way of €800bn hanging off the world’s trees. The IMF’s entire gold reserves, for example, would cover payments until about the end of October – assuming that they could sell the full 2,800 tonnes at the current price. Couple this with the whole of the Fund’s emergency lending capacity – US$750bn – and you still wouldn’t quite make it to the end of next year, even assuming they would be able to raise all this from their member countries (including the $178bn supposed to be provided by various members of the European Union).

Alternatively, there are a couple of countries that have foreign currency reserve assets big enough to cover the amount – literally a couple: China and Japan. Even if the Chinese were willing to help it’s likely that they would insist on unwelcome lending criteria (they have previously insisted on more competitive trading terms with Europe and security over infrastructure, for example). And in Japan the cash isn’t really spare. They have their own debt problems, having run budget deficits every year since 1992 – in fact, a bill approved this week will see the nation’s sales tax double to 10% in an effort to contain the problem.

Which brings us from the PIGS to the elephant in the room: sovereign debt problems are not confined to Europe. In Britain our banks have about US$300bn of exposure to France – over 12% of UK GDP. We could well become another domino to fall. And as the city of Stockton, California’s decision to file for bankruptcy protection this week reminded us (the tenth municipal bankruptcy in the last four years), the US is not immune either.

So, while it must be possible that the PIGS might fly – anything is possible – it is not desirable, no matter what some say. Not least because, when it comes to sovereign debt, there are plenty of pigs beyond the Mediterranean.


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