The euro: fear returns
Over the New Year I read several references to an "easing" of the crisis in the eurozone. I was curious as to what this was based on, as none of the fundamentals had changed.
As the chief economist at Deutsche Bank observed, "the euro crisis had a Christmas break, but it's back".
White knuckles have re-emerged in Brussels and other vulnerable European capitals. Portugal is in the firing line. Last week the markets pushed the interest rates on Portuguese debt (10-year bonds) above 7%.
Nobody believes that is sustainable. Portugal has to raise 20bn euros (£17bn; $26bn) this year - but not at those rates. Officials in Lisbon were privately conceding that.
An early test will come this Wednesday when Portugal auctions its first bonds of the year - in an effort to raise 1.25bn euros. What will it have to pay to attract investors?
Wednesday will reveal whether Portugal has a realistic chance of raising the funds it needs in 2011. If the price is too steep then the markets are likely to conclude the country is heading for insolvency or the bail-out club. Some analysts, I noted, were saying already that Portugal was "quietly insolvent".
A clear majority of economists who were sounded out in a recent poll believe a rescue package is inevitable. "Portugal will have to access the stability fund," said Colin McLean of SVM Asset Management.
In the meantime a by now familiar routine is being played out. The Portuguese Prime Minister, Jose Socrates, declared his country . He insisted that Portugal could finance its debt.
Again - with echoes of what happened with Ireland - there are reports that Germany and France want Portugal to accept an international bail-out as soon as possible in order to limit contagion.
On Friday, as the bond markets showed chilling disdain for Portuguese debt, the European Central Bank - once again - tried to ride to the country's help by buying up Portuguese bonds.
What rattles investors is a diagnosis we have seen elsewhere. The Portuguese economy is spluttering with growth predicted at around 1%. Only this month it introduced a raft of austerity measures which will dampen down demand further. Its exports are uncompetitive. So where will the growth come from to pare down its debt? The markets don't see it. What it can't do, locked into monetary union, is devalue its currency. The alternative is years of brutal austerity combined, most probably, with a bail-out.
So many expect that Portugal will sooner or later have to draw on for around £85bn. (The IMF and EU's emergency fund could also be used.) The figure is not in itself a problem. So far 200bn euros has been earmarked to keep Greece and Ireland from going under. There are sufficient funds left to help out a relatively small economy like Portugal.
From there on it all becomes more perilous. Sometimes in Brussels I detect that the fight is less to save Portugal but more to ring-fence Spain. It's the fourth-largest economy in the eurozone. If it needed rescuing the funds currently are probably not there. And then awkward questions would have to be asked - including whether Germans, in those circumstances, would commit further treasure towards what would be a giant bail-out.
Spain has made progress in reducing its deficit. Its target for 2010 was to get its deficit down to 9.3%. It says it has done "somewhat better" than that. It also says it is on target to have the deficit down to 6% by 2011.
They are also hoping to benefit from the warm embrace of China. The Chinese have been buying up Spanish sovereign debt. They may well now hold 10% of Spain's national debt.
(In a future blog I will examine China's growing influence in Europe.) But even with Beijing's actions the cost of servicing Spanish debt is rising.
What the markets worry about is the debt held by Spanish banks. Many are heavily exposed to the property markets. Spain's property crisis has not fully run its course. There are a million properties unsold and prices are still falling. They may go down a further 8% this year. There are over four million jobless.
So both sovereign debt and bank debt still unsettle investors. Some hedge funds don't want to touch the debt of the so-called European periphery countries. They believe sooner or later debt restructuring is inevitable.
In all of this never underestimate the determination of Europe's leaders to defend the euro. There are two scenarios, however, that they fear most: if the German people tire of bailing out others or if one of the rescued countries says years of austerity are too high a price to pay for defending the single currency.
We are at Week Two in 2011 and European nerves are jangling again.
I'm 
Comments
or to comment.