The Prime Minister of Portugal Jose Socrates the head of the Socialist party has tendered his resignation to the President of Portugal, after receiving a vote of no confidence today for his mixture of tax rises, and spending cuts.Portugal’s benchmark 10-year bond yield had risen to 7.77% before the debate on Wednesday, while five-year bonds hit a euro lifetime high of 8.2%.
Interest rates at these levels are unsustainable, and the uncertainty of the caretaker government that will be in charge until elections are called in 55 days will push Portugal over the brink. This scenario is eerily similar to that of Greece and Ireland where the leaders deny need for a bailout then the bond interest rates and credit default swaps ( cost of insuring bonds) spike, shortly to be followed by news of a bailout. Belgium and Spain will be more exposed to bond vigilantes and credit raing agencies. Spain which has a much larger economy and 20% unemployment, luckily owes most of its money to Spanish banks, and its deficit is more mangeable.
The woes in the PIIGS countries of the EU stemmed from flow of cheap credit mostly from Germany, as EU had onew low common interest rate. The money was used in real estate developments that went bust after the so called property “boom”. Investor were caught up in the trap of believeing that real estate “always increases” and the equity gained in the property will keep pace of mortgage payments. Bundled mortgages that mixed prime and subprime loans and mortgage backed securities that were traded by the bankers did not help either.
Ireland, UK, and other EU countries bailed out the banks using public funds for private mistakes. Milton Friedman, Ayn Rand and even Adam Smith would be aghast at government “intereference” in the almighty markets. Despite making losses and bad bets the bankers were able to keep their bonuses, even bailed out RBS which is 83% owned by UK taxpayer paid out nearly a billion in bonuses despite a 1.1 Billion £ loss.
The austerity plans in Ireland, Portugal and UK are counterproductive as tax receipts drop when workers are laid off, increasing welfare payments, decreasing spending power, which in turn leads private sector to lay off more workers, thus killing growth. Unlike the UK which declined in GDP by 0.6%, the USA under Obama’s stimulus grew by 3.2% in the last quarter of 2010, UK, Portuguese and Irish unemployment rolls are increasing, while USA is decreasing. It seems that Junior Senator from Illinois was right after all in a bad economy stimulus is the cure not austerity.