Timetable of the euro-showdown
Barely has the non-drop Nordic Pine been dragged, threadbare, to the door, but the euro sovereign debt crisis revs up again - this time with Portugal and Spain in the firing line.
This is how I expect it to pan out.
First a primer: governments have to borrow to a) finance their overspend (aka deficit) and b) to roll-over old loans from years past, known as redemption. They borrow by issuing bonds. Those who buy the bonds are banks and investment funds, sometimes also other governments who are flush with cash - most notably in the Middle East and China. Usually these bonds last for 5, 10 or 20 years until maturity - but there are also short-term loans called Treasury Bills, which are repayable after one year.
Right. Overall Euro area governments are expected to issue €750bn this year. Of this, the markets expect Spain and Portugal alone to be borrowing €225bn.
The only Geiger Counter we have to judge whether it's going to be hard or easy for them to borrow is the effective cost. This is called the bond yield: it's the official interest rate on the bond divided by its current price as traded on the bond market. Here is what's been happening to Portugal's bond yield over the past 12 months (from Bloomberg.com):
Portugal gets caught in the general panic around the Greek crisis and then hit again as confidence wanes over Ireland in November/December.
This year Portugal is on course to reduce its budget deficit from 9.3% of GDP to 7.3% - according to its finance minister. But its cost of borrowing is rising and is not far off the trigger point where investors will start refusing to buy. There are already reports today that the Swiss National Bank is refusing to take Portuguese bonds as collateral in short term financing deals.
Portugal got downgraded by the ratings agency Fitch before Christmas, and Moody's issued a downgrade warning. They were worried about a) the size of the overall debt and b) the possibility that Portugal will fall back into recession this year. The effect of the downgrade is to make some investment managers less likely to hold onto these bonds - because their investors, which could be your pension fund, demand they only hold ultra-safe debt.
In this crisis timing is important. Portugal needs to borrow €20bn this year, but €10bn falls in Q2. This rising cost of borrowing plus the short timescale is what made JP Morgan analysts last night warn their clients:
"In Portugal, €10bn of redemptions in Q2 do not leave the country much room for manoeuvre: we expect external aid to be requested."
So this is the market - not speculators but your pension fund guys - beginning to back off Portuguese debt and predict what no Euro politician is prepared to talk about: a final massive bailout process for the stricken periphery of the Eurozone.
The good news is Portugal can be sorted: there is plenty left in the pot of the two Euro bailout funds created in May 2010 to cover the €20bn, plus what it might need next year. But now look at Spain.
There are two Spanish bond auctions coming up, on 13 and 20 January. Spain needs to borrow about €38bn in new money this year, plus another €47bn to roll over. If you add in the Treasury Bills coming up for repayment (the short term loans) this rises to €225bn over 12 months (not three months as I mistakenly said in my report last night).
Now the T-bills should be less challenging, although there is an anecdote circulating of a big US investor deciding it will not roll-over Spanish T-bills. Likewise, market people estimate it should be able to renew €15bn plus €10bn in new borrowing this quarter.
The problem is the banks. The banks hover over this crisis as a constant wildcard.
The Spanish and Portuguese banks were largely given a clean bill of health by the very same tests that said the now busted Irish banks were OK. That's the problem. If the Spanish and Portuguese regulators decide to make their banks as safe as the Irish banks have been made, raising their requirement to hold capital to about 12%, then - because the government has guaranteed certain banks - that would add another €80bn to the borrowing requirement for both countries, bringing it to 300bn. (See Spain's current borrowing cost here, again, on Bloomberg).
The problem is the main Euro bailout fund, the EFSF, stands at 440bn. But in order to gain its own AAA credit rating, that fund has used the 440bn to guarantee only about - says BarCap analysts - 255bn of actual rescue funds. So the answer to those who've emailed me to ask: is there enough money to bail out Spain - the answer is, just about.
So the difference in this phase of the crisis is that what is driving the problem is not economic collapse and abject political mis-accounting (as per Greece) nor the collapse of a kleptocratic banking and property elite (as per Ireland), but collapsing confidence in the Eurozone's authorities.
I will blog - and report - separately on the deeper roots of this but basically they could - but will not - combine their sovereign debt issuance into a "Eurobond". Or they could double the size of the bailout fund - but have so far refused.
Or they could bite the bullet and impose losses on investors - ie when a country cannot borrow, it partially defaults, making the bondholders take a "haircut" - ie they get less money back, or get the same money back over a much longer timescale. But they will not countenance this. In fact, as our interview with Christine Lagarde last night showed, they will not countenance anything. Nor will they admit the possibility of the Euro breaking apart.
There is some support for the Euro authorities' view in the market. David Bloom - the forex wizard at HSBC's investment bank - has pinned his colours to the mast of Euro survival, and even to the pressure moving onto the dollar by the end of the year.
But in the end all these upward-moving graphs demonstrate a divergence between the relative safety of lending to Germany and the relative riskiness of lending to Spain and Portugal, despite the fact that they are part of a single currency. Meanwhile the whole crisis takes its toll on Euro credibility in the wider world.
Right now the Chinese deputy PM is touring the stricken countries offering to lend 5bn here, 6bn there. That's fine - but if it came to much more we would be well and truly in the realms of "political economy": 5bn is a lot of money for Portugal - a quarter of its borrowing. It would give China a massive economic lever over Portuguese policy - on for example acquisition of transport and infrastructure assets and, as is the way of the world, all kinds of personal lines of communication might then open up, some of which might lead to what the French are currently calling, with disarming frankness, "economic war".
Before Christmas, Lord James told the British parliament that a mysterious group called Foundation X was prepared to lend Britain £22bn to get it out of its difficulties. The Treasury "decided not to pursue the matter further". For the same reasons it is unlikely that Europe is going to accept being bailed out by China.
So it's the good ol' capitalist bond market, the big gorilla whose strings are pulled by self-effacing men and women who manage the pension funds of coupon-clippers in the coastal retirement resorts of Europe and America who will have to lend the money.
And it's the unelected eurocracy around the Commission, the ECB and the EFSF that is going to have to get its act together and come up with a credible plan: to meet the eventuality of a Spanish crisis and the near-certainty of a Portuguese one - and then work out what to do about Greece, which is not improving.