Contagion Concerns Resurface In Europe

While the eyes of the financial world are fixed on the U.S. budget debate and refinancing of Greece, Moody’s has put Spain’s sovereign debt on credit watch and the country set new elections. The contagion was supposed to be fire-walled by the EU and IMF restructuring of Greek paper, but the measures have not served their purpose. Sovereign debt vigilantes will push up Spain’s interest rates, and many smart investors will begin to short its debt.

Moody’s wrote in its report it has placed Spain’s Aa2 debt under review for a possible downgrade.

The reasons were two-fold:

1.) The continued funding pressures facing the Spanish government, which the precedent set for future euro area support arrangements by the official package for Greece is likely to exacerbate, and the resulting increase in risks to bondholders. 2.) The challenges posed to the government’s fiscal consolidation efforts by the weak growth environment and the continued fiscal slippage among several regional governments.

The Spanish government has not been able to bring unemployment down below 20%. The economic drag caused by so many people out of work is enormous. Spending cuts by the government are considered insufficient by Moody’s. Economist argue in many cases that austerity, same as that being contemplated by the U.S. Congress, saps federal investment from the market. This makes a recovery impossible. A victory by cost cutters ruins any chance of recovery, these experts argue.

The parties that have bailed out Greece warned that such an arrangement will not be offered to any other EU nation — ever. But the period over which that pledge will be honored may only last a few months. The yield that Portugal, Spain, and even Italy have paid recently on debt issues is at historically high levels. So many nations in the region have debt and deficit problems that there is an extreme view that Germany, the only nation that has an unquestionably robust economy, will have to rescue the entire region. That, of course, will not happen. German taxpayers will not support such a program. Europe’s financial problems will worsen, as bond yields have already shown.

Greece, it turns out, did not create a firewall at all. The bailout of the southern European nation may actually encourage those who hold to the idea that only serial bailouts will save the EU economy. The trouble with that idea is that there is no money to make it viable.

Douglas A. McIntyre