Portugal to be first to default

The so-called Keynesian consensus that seemed to emerge following Obama’s stimulus package, was a short-lived one. Governments, mainly in the eurozone shatter belt, are dropping the same public policies they had put forth a year ago. It is not that unemployment has decreased – on the contrary. Nonetheless, “special social measures” and “job creating” public investment is being curtailed.

This should be sufficient evidence that the Keynesian answer to the crisis has failed. The Keynesian stimulus plans ignored the very low saving rates. In particular, Greece and Portugal had the lowest internal liquid savings rates (when public and private savings are added, and replacement investment deducted) of the last decade. Indeed, both countries had negative saving rates in 2008, with Portugal hitting a low of -5.8% of GDP against an EU average of 6%! It is no surprise that such highly indebted countries are now paying heavily for such leveraging.

Added to this, the Portuguese socialist government failed to understand that it should cut spending drastically. Instead, it has decided to increase taxes to respond to market worries about government borrowing. Taking into account the deep level of leveraging, both in the public and the private sector, the tax rise simply added to the risk of a banking failure, as it passed on debt from the government to households and firms, leaving the size of government untouched.

As such default probabilities on credit derivatives based on Portuguese sovereign debt remain very high; interest rates spreads are increasing; and bank refinancing is more expensive, leading to added costs for indebted firms and households, as well as to another increase in the budget deficit.

The question is: how is the government going to avoid default? Raising taxes again will be suicidal, and reducing the public sector wage bubble is anathema. Public sector wages have never been frozen in Portugal, and they are still growing. If the government does not lower them, there is no way Portugal will get out of its debt trap. I would bet on Portugal being the first eurozone country to default.

It is not surprising the Keynesian approach needs high savings rates, as from where else can the wealth be syphoned off after diluting? It is like watering the beer and carting off the extra barrels.

Dear Tim,From my point of view, any sort of demand management policy will always fail, as accurate forecasts are impossible: individual knowledge is specific to each of us, as Hayek has pointed out, and no model can aggregate all of that information, nor can it account for the bits and pieces of tacit knowledge. In any event, you are clearly right, if Keynes was to have a chance we would need to have had a budget surplus for a number of years. Portugal never had a balanced budget in 36 years of democracy. It is simply not feasible for such a country to share the same currency with Germany.
Unemployement in the US is another great example of failed policy forecasts. Best, Carlos

“This should be sufficient evidence that the Keynesian answer to the crisis has failed.”Absurd sir. Euro Zone govts have obviously not taxed and borrowed enough. They fell into the same trap as japan in the 1990’s/2000’s. We desperately need another tranche of quantitive easing across Western and Midle Europe. 10 trillion might do it. As the saying goes “The only thing we have to fear is fear itself”.

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