Is Portugal the Next Greece?

PIMCO CEO, Mohamed El-Erian, his firm’s track record badly damaged last year, told German weekly Der Spiegel that Portugal is the next Greece. His point is buttressed by the current recession in Portugal, which mirrors that of other financially weak EU nations. The Portuguese economy probably will shrink by 3% this year. But El-Erian’s analysis does not take into account the firewalls built by the European Union, International Monetary Fund and, indirectly, the European Central Bank. These firewalls may work.

A number of nations in the region are the “next Greece.” First among these, alongside Portugal, are Spain and Italy. The worry about these economies has lessened, if bond yields are an indication. These yields could rise at any time, however, if global capital markets investors decide the sovereign paper becomes too risky to hold. A deeper recession could trigger that action. So could a failure of these countries to reach their austerity goals, or political changes that cause some of the countries to break covenants or deals with their neighbors.

The argument that Portugal will not move toward default is based not only on its ability to hold austerity in place and stage some GDP recovery in the next year or two. It also has a foundation in the size of the European Stability Mechanism. And the EU still remains committed to keeping the alliance in place, because, among other reasons, it is not clear how badly the European economy would be damaged if it dissolves.

The ESM has 500 billion euros committed, but because of efforts by the IMF and others, the fund could increase by 50% or 60% more than that. Some of the older Financial Stability Facility may be rolled into the new fund. Germany may be persuaded it should lead an effort to increase the size of the permanent fund.

Portugal does not have to become the next Greece. A new, larger firewall the region may well shield it from Greece’s fate. Predictions that it will not are nothing more than guesses.

Douglas A. McIntyre