May 8, 2011

IRWIN STELZER predicts a coming Euro-zone crackup: it’s a fine, short, and brisk analysis of the political economy of the EU.  The cold facts, says Stelzer, are these:

  • Greece, Ireland, and Portugal are now frozen out of credit markets. The yield on Greek two-year bonds is 24 percent and on both Irish and Portuguese bonds of similar maturity around 12 percent. No country can afford to borrow at those rates. Of interest to the White House and Congress might be the speed with which the markets move: Interest rates charged on Greek debt increased by 10 percentage points in the past month.
  • The debt burden on these countries is in excess of the 90 percent of GDP that scholars now agree stifles growth. Portugal’s debt is at 90 percent of its GDP and rising, Greece’s is approaching 150 percent, and “Ireland’s debt now appears to be bigger, in relation to its economy, than the reparations imposed on Germany after the First World War,” according to economist Anatole Kaletsky.
  • These economies cannot grow their way out of the problem. The Greek economy shrank at an annual rate of 4.5 percent last year and is forecast to decline this year at 3.2 percent. Portugal’s will shrink at an annual rate of 1.5 percent, guesses the International Monetary Fund. And Ireland, despite a robust export industry and a corporate tax rate of 12.5 percent that, at half the EU average, remains attractive to foreign investment, might eke out growth of 1 percent. No way these growth rates produce enough tax revenues to meet debt obligations.

One of the many problems of the risk models used in the run-up to the debt crisis was the assumption of smooth, continuous rises and falls in the price of debt.  But institutions, whether firms or sovereigns, tend to grow incrementally, financial instrument by financial instrument – and crash by institution.

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