About three years ago, the world started referring to Portugal, Italy, Ireland, Greece and Spain as the PIIGS. These four countries had such terrible debt to GDP problems that there was SPECULATION it could become problematic for Europe as a whole. Three years later, the situation is worse than anyone could have imagined with the solvency of all of Europe being called into question. Below is a chart showing the official Debt to GDP ratios for most of Europe.
The strong economies such as Germany have very debilitating debt to GDP loads on their own, but sport enough economic growth to keep the bond vigilantes at bay, at-least for the time being. It is interesting that it took three years for the problems in the PIIGS to really hammer the economy. I believe the catalyst was the high degree of debt that had to be rolled over during the last 24 months (see below).
So far, the European Union has responded as predicted, with massive money printing and a huge leverage up in the ECB’s balance sheet (see below). These strategies have been very effective in buying time, but, unfortunately, policy makers have yet to come up with any long-term fixes. The most recent agreement, as of today, buys Spain a little bit of time (don’t forget this is Spain, now Greece has been temporarily replaced by a new red-headed stepchild) to reduce its budget deficits with a huge catch. Spain recently agreed to a 21% value added tax, which is a tax on everything you buy, as well as a 25% cut to unemployment benefits, cuts to civil servant pensions, higher property taxes and new taxes on energy. So there you have the solution? Without a mention of growth, or how massively burdensome this will be.
It seems that European leaders have met on a weekly basis, yet little resolution has come from this. Many have become disillusioned into believing that a feasible solution is attainable, but upon a closer look at the numbers, you quickly realize that these hopes are unrealistic. With the “club-med” economies struggling to produce much of any economic growth, it is likely that debt-GDP ratio‘s will jump. It will be interesting to see how long the European leaders can continue borrowing at the current rate of increase in bond yields.
Given these economic realities it is not a surprise that market uncertainty is running high and many, including myself, see a clear end to the Euro as it is currently known. To be fair to Europe, almost every industrialized economy has run up ridiculous debts, with Japan and the United States making most of the world look downright responsible. For more on this subject keep an eye out for a follow-up post entitled PIIGS R US (a title I shamelessly stole from one of my personal heroes, Niall Ferguson).