Six months after the EU and IMF’s 110 billion EUR rescue package sailed out to save Greece, Ireland agreed to a bailout in order to keep its financial system afloat. With this debt contagion unfolding, how long will it be until Portugal and Spain call out for help?
Before we get ahead of ourselves, let me first explain what contagion is.
Simply put, contagion is when the loss of market confidence in one economy spreads to others. One way to see this is through credit yields. In recent weeks, we saw credit spreads between Ireland and Germany (considered the strongest economy in the euro zone, and therefore, the “safest”) rise.
And now, it appears that those concerns are spilling over onto Spain and Portugal. The public is now eyeing the two as the next possible recipients of bailouts because they have been dealing with financial headaches–nay, migraines!– themselves.
True, Portugal doesn’t have a budget deficit as large as Greece’s, and its banking sector isn’t doing quite as badly as Ireland’s. But it does still have the combined problems of high government debt, slow growth, and budget deficits hanging over its head.
As for Spain, investors are concerned that it may default on its debts. Since people are feeling antsy about holding onto Spanish debt, the prices of Spanish bonds have risen, causing yield spreads with German bunds to reach levels unseen since the euro was created back in 1999.
Another problem that Spain has to deal with is that it has large holdings in Portuguese banks. It can’t be completely isolated from Portugal because of its exposure to the Portuguese banking sector. Whether they like it or not, the two are practically joined at the hip! Ay caramba!
Spain’s situation is particularly alarming because of the size of its economy. How big are we talking? Well, its GDP is greater than the GDP of Greece, Ireland, and Portugal combined! Thus, bailing out Spain would require drawing out a huge sum of money from the European Financial Stability Facility (ESFS).
Of course, this crisis has weighed heavily on the euro. So far this week, EUR/USD has tumbled a good 400 pips. In fact, after hitting a high at 1.4279 earlier this month, the pair has fallen nearly 1000 pips!
Hmmm… this sounds eerily familiar. Late last year, EUR/USD topped out just above 1.5000. Then, when concerns over Greek debt emerged, the pair dropped off sharply. As European leaders debated on what to do, the euro tumbled 20% in value over six months before Greece finally got bailed out.
Could we see history repeat itself?
Yes, I know that the EU and IMF have put aside 750 billion EUR for the sole purpose of potential bailouts. However, I don’t really think they expected any other nations to actually request for a bailout. They had put up the fund to help ease tensions in the market before things spiraled out of control. They certainly didn’t expect euro zone members to form a line at the bailout counter.
And we’re not exactly talking about a small figure here. As I mentioned earlier, Spain’s problems are much larger than that of Greece, Ireland, or Portugal. Until we hear more news about whether or not Spain will formally ask for help, I think this European debt crisis could remain the major theme for the rest of the year.