European Deadpool Part 1: Government Debt
Today the Fed announced that it is raising its federal funds rate by 25 basis points to between 0.50% – 0.75% and also signaled that it will add another 75 basis points next year. These increases make it harder for debtors to pay back their loans—especially if they are non-US entities with US denominated debt.
Much of the debt throughout Europe is Euro-denominated, so the Fed’s actions may not have a direct and/or immediate impact on those debts, but nonetheless, I am using the occasion to kick off everyone’s favorite game: European Deadpool.
This is the first of a four-part series covering seven at-risk European nations. Today’s posting is on government debt. Parts 2, 3, and 4 will examine the implications of high debt levels to those nations’ banks, companies, and consumers.
So let’s get started!
You might be surprised to learn that government default (also called “sovereign default”) is not uncommon. It has happened dozens and dozens of times. Even the mighty US of A defaulted on its national debt four times (1790, 1862, 1934, and 1979). Therefore, sovereign default isn’t the end of the world. But in today’s interwoven world of finance, a default by a large nation will be felt around the globe.
Do you remember the 2008 financial crisis and how it hit several European countries especially hard. Those were the “PIIGS”- Portugal, Ireland, Italy, Greece, and Spain. The PIIGS’ governments (not to mention its citizens) suffered mightily with heavy debt burdens and weak economies. They could not grow their way out of the debt problem, so their neighbors and the International Monetary Fund (IMF) decided to help out by giving them even more debt.
We haven’t heard much about PIIGS of late (except for recent rumblings in Greece), so everything must be hunky dory, right? Actually, no. Those countries simply kicked the can down the road far enough so that the general media lost interest. In the mean time, each of their debt burdens have exploded.
And, so we have the first deadpool question: which of the above could/will fall first?
(Note: I added Netherlands because it will play a role in subsequent chapters of this 4-part series…not because it is in jeopardy of sovereign default. I’ve also added Cyprus when I could find the data.)
The smart money is on Greece. Government debt is a ridiculous 174% of GDP and there’s a bunch of debt–nearly €7 Billion–coming due between now and April 2017. Athens urgently needs money (it is asking for $92B!) from the IMF and European Central Bank (ECB) but the terms of a new loan may prove too onerous because Germany and Netherlands are sticklers for austerity, especially when it comes to their “lazy” southern European neighbors. The Germans and Dutch claim they will only approve the loan If Greece if it maintains a 10-year budget surplus (before the loan payback) of 3.5% GDP.
To Greece’s credit, it has run a budget surplus this year from January through November of €7.4 Billion, but in today’s macroeconomy, it is virtually impossible for any country to maintain 3.5% surplus for a decade. So, we are left with a game of chicken for the solvency of Greece —will Athens give in to Northern Europe’s impossible demands or will Merkel risk political suicide by acquiescing? (Sounds like a case for Trump and his “talent” for deal-making, huh?)
Anyway, Ireland is a really just a dark horse in the Deadpool. It has vastly improved its situation post-2008. It’s debt-to-GDP is now just over 100% and the economy is growing like gangbusters at 3.7%…although that is expected to slow next year. Still, there is a troubling statistic I uncovered in which I haven’t heard anyone mention: its short-term debt (due in less than 1 year) is 147% of its foreign reserves!
In 2017, Ireland will need to find over $1.5B behind the sofa cushion to keep its debts current. Admittedly, that is less than 1% GDP, but the money must come from somewhere and debt financing is getting harder and harder these days.
Italy is a global concern because it’s big– $1.8 trillion GDP—and debt-to-GDP is a jaw-dropping 160%. To make matters worse, its GDP is growing at an anemic 0.8%. None of this bodes well for the government’s coffers. The most pressing matter in Italy isn’t sovereign default though. That distinction goes to Italy’s possible banking sector collapse early next year (more on this in Part 2).
Rounding out the other deadpool comptetitors:
Spain is at risk because of its high levels of short-term debt (100% of foreign reserves) and because it continues to run a 4.5% annual deficit. Oh, and its 117% debt-to-GDP is a bit much.
I don’t have much to say about Portugal other than it is carrying an awful lot of debt, though it doesn’t appear to be in imminent danger.
Cyprus has made good strides since 2008 and is in far less danger than Greece, Spain, or Italy. I list it here because its small enough to get the cold shoulder from the Eurozone if it needs help and because the Greek-Turkish dynamic that could pull Cypriots apart.
So, there you have it. Which government do you think will default first?