Thursday, May 5, 2011

Europe is running a giant Ponzi scheme

by Mario Blejer

Financial Times

May 5, 2011

One of the pillars upon which the euro was established was the principle of “no bail-out”. When the sovereign debt crisis hit the eurozone this principle was ditched. As Greece, Ireland and Portugal were unable to service their unsustainable levels of debt, a mechanism was instituted to supply them with the financing necessary to service their obligations. This financing was provided, supposedly, in exchange for their implementing measures that would make their, now higher, debt burdens sustainable in the future. Yet the mode adopted to resolve the debt problems of countries in peripheral Europe is, apparently, to increase their level of debt. A case in point is the €78bn ($116bn) loan to Portugal. It is equivalent to more than 47 per cent of its gross domestic product in 2010, possibly increasing Portugal’s public debt to about 120 per cent of GDP.

It could be claimed that this mechanism is helping the countries involved since the official loans, although onerous, carry better conditions than the ones that need to be serviced. But the countries’ debts will increase (as a percentage of GDP the debts of Greece, Ireland, Portugal and Spain are expected to be higher by the end of 2012 than at the start of the crisis). The share of debt owed to the official sector will also increase (in addition to the bond purchases by the European Central Bank, which reportedly owns 17 per cent of these countries’ bonds with
a much higher percentage held as collateral).

Is this ongoing piling of debt an indication of imminent defaults? Probably, but not necessarily. An immediate default could result in major market commotion, given the high exposure of European banks to peripheral debt. Therefore, European governments are finding it more convenient to postpone the day of reckoning and continue throwing money into the peripheral countries, rather than face domestic financial disruption. Consequently, as long as European and international money (through the International Monetary Fund’s generous financing) is available, the game could go on.

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