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The Bar of Cadiz

Two dramatic events unfolded in Europe yesterday. The first was when Gordon Brown drove a stake through his own political heart on the campaign stump. Brown was pressing flesh among supporters when an old lady asked about “all these Eastern Europeans what are coming in, where are they flocking from?” Brown answered with what the Online Times called his "fixed smile" with ill but feigned grace; moments later he savaged the lady as a "bigot" in the imagined privacy of his limousine. He forgot to turn his radio mike off. It was a Jekyll and Hyde performance, Brown's own gun and Bible-clinging fiasco, and will probably be fatal to his campaign.

The second event was the spread of the Greek contagion through the Eurozone as Spain's credit rating was downgraded. Although some leaders blamed the ratings companies.

Ratings agencies have been strongly criticized for their role in the U.S. financial crisis, in particular over conflicts of interest and their failure to recognize the high risks inherent in complex structured products. They have also been panned for throwing fuel onto the fire of crises by belatedly ratcheting down ratings, stirring many investors to scramble to sell securities.

But unless the ratings companies are completely off, the problem facing European authorities now is how to stop the cascade. The Southern European economies are weak and are being punished by higher rates of interest.

The crisis affecting the Eurozone worsened yesterday when Spain’s credit rating was downgraded less than 24 hours after Greece was sent into financial meltdown.

Fear of contagion gripped Europe’s financial markets when the debt rating agency Standard & Poor’s cut the rating on Spain’s sovereign bonds. The decision — coming after the agency downgraded Portugal’s rating and cast Greek bonds into the scrapyard, designating them junk — sent the euro plunging against the dollar.

The risk that weak eurozone economies might be infected by a Greek financial virus added pressure to an emergency meeting in Berlin, where the heads of the International Monetary Fund and the European Central Bank considered a proposal to triple the size of a bailout for Greece.

The Guardian says there are fears that Portugal might be next. "Portugal's Socialist prime minister José Sócrates called in opposition leader Pedro Passos Coelho, of the centre-right Social Democrat party, for an emergency meeting ... Portugal shares Greece's explosive cocktail of a high budget deficit, a large and growing debt mountain and poor growth prospects."  Peter Boone and Simon Johnson of the NYT blogs predicted on April 15 that Portugal might be in trouble.

Next on the radar will be Portugal. This nation has largely missed the spotlight, if only because Greece spiraled downward. But both are economically on the verge of bankruptcy, and they each look far riskier than Argentina did back in 2001 when it succumbed to default.

Portugal spent too much over the last several years, building its debt up to 78 percent of G.D.P. at the end of 2009 (compared with Greece’s 114 percent of G.D.P. and Argentina’s 62 percent of G.D.P. at default). The debt has been largely financed by foreigners, and as with Greece, the country has not paid interest outright, but instead refinances its interest payments each year by issuing new debt. By 2012 Portugal’s debt-to-G.D.P. ratio should reach 108 percent of G.D.P. if the country meets its planned budget deficit targets. At some point financial markets will simply refuse to finance this Ponzi game.

The problem is that the conflagration threatens not only to move north into the core EU economies but to jump the channel. Another article from the Guardian reported that "UK banks sitting on £100bn exposure to Greece, Spain and Portugal". That will add to Britains already weakening credit ratings. Labor's impending loss in Britain will do little to slow the growth of its debt. The reductions proposed by all the major British parties to spending are far too small to have any major impact on the situation. While they agreed that the RMS Titanic is leaking, all they have between them are a bunch of 5 gallon pails.

Vermont Public Radio says that unless the problem is firewalled it will cross the Atlantic to the US. First, American institutions have exposure to Portugal and Spain. Second, the dollar will rise with the decline of the Euro, killing US export prospects. Third, it will "derail" the recovery. It's safe to say that the next few weeks in Europe will be interesting ones. They will put pressure on the Euro, the Pound and ultimately the Dollar.

Like the Brown campaign, the world financial system is entering a critical period. Some really fundamental changes and not just government stimulus and band-aids are necessary to fix the underlying problems. Greece and Portugal are extreme examples of fundamental shortcomings: bad demographics, inefficient economies and a declining human capital base. The problem is way beyond the capability of Green Jobs, carbon trading or other shambolic nostrums to fix.

Farewell and adieu unto you Spanish ladies,

Farewell and adieu to you ladies of Spain;

For we're bound beyond the bar of Cadiz,

But we hope very soon we shall see you again.