Thursday, 29 April 2010

A Little Common Sense

In the last few days, we witnessed dramatic reactions to the downgrade of the rating of the Portuguese public debt and to the volatility in the financial markets. Some analysts and politicians went as far to alert us that we were pretty much on the edge of an abyss and that the country has no future. Some have even argued that the spreads are increasing so much that soon enough we will not be able to repay our debts and we will have to declare bankruptcy. They might as well be right (although I suspect, and I hope, that they are not). Still, in spite of all the hype and drama, shall we have a little common sense here? How can anyone honestly say that 6%-7% interest rates are unprecedented and that will make the repayment of our public debt unsustainable? Really? It might worthwhile remembering some things from our recent past then. When the IMF came to Portugal in 1983, Portuguese public finances were also in very bad shape, and thus the IMF imposed some draconian measures in order to put things back in shape. A couple of years after, the IMF was praising Portugal for being so successful in correcting its fiscal imbalances (there are important lessons to learn from this period, in fact). It is also interesting to remember that, at the time, the government was paying more than 20% interest rates in order to finance its debts (see table below). In fact, we don’t even have to go that far in time. In the 1990s, before we started the process of nominal convergence on the way to the euro, the interest rates on government bonds were still hovering around 10%.
What has changed since then? Well, we stopped growing (our biggest problem) and the country’s external indebtedness increased substantially. Thus, the risks associated with our debt are now greater. Still, this does not mean necessarily that we are on the edge of the abyss. As long as the government is responsible enough to follow some good policies (i.e., cut expenditure, suspend the large public works projected, and stops increasing future public debt through the PPPs), we will certainly be a lot more prepared to convince the markets that we don’t deserve their wrath. The big question is thus whether this government can, for once, stop behaving irresponsibly. After the latest news, I am not so sure.

Interest rates, government bonds, 1974-1995

Mercado primário (primary market)
Mercado secundário (secondary market)
Ano
Obrigações do Tesouro
Empréstimo Amortizáveis
Conjunto de Dívida
Obrigações do

Dív. Interna Amortizável
com Aval do Estado
Pública (2)
Tesouro (3)
1974
7.500
-
-
-
1975
8.474
-
-
-
1976
10.000
-
5.92
5.44
1977
-
-
7.18
6.76
1978
-
-
17.72
17.94
1979
-
-
26.03
26.78
1980
-
-
16.59
16.74
1981
-
-
23.57
23.81
1982
-
20.000
25.32
25.49
1983
-
-
-
-
1984
-
28.000
-
-
1985
-
24.646
-
-
1986
-
23.500
14.85
-
1987
-
15.200
14.82
-
1988
-
-
13.95
-
1989
-
-
15.18
-
1990
-
-
15.33
-
1991
16.000
-
13.63
-
1992
13.000
15.548
11.70
-
1993
11.461
-
7.54
9.19
1994
9.078
-
8.94
11.60
1995
11.788
-
7.67
10.03
Banco de Portugal
 

4 comments:

  1. A question - these interest rates are about debt denominated in escudos or in foregn currency?

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  2. There is substantial difference between paying interests rates of 20% on government debt when the inflation rat is even higher, as was the case of Portugal or Spain in the 80s, and paying an interest rate of 6% when the inflation rate is around 1-2%. In the first case the real long-term interest rate implicit in the debt could even be negative, actually a good deal for the government. In the second case the real interest rate is extremely high, a ruinous outcome for the government and for the economy.

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  3. A little common sense is welcome...

    First, once you don't have money, it gets surprisingly easy to distinguish between nice to have and need to have. You get your common sense back.
    Large public works will be stopped, more than suspended. And we will remain surprisingly close to Europe, despite fears that with no TGV or no new airport we would plunge deep into isolation.
    With no crisis, there would be no way to stop them. Governments would always fight for them, opositioners would always fight them, but Governments are always in majority and would eventually win.
    A crisis can be worthwhile.

    Second, common sense tells non-Eeconomicists that the only sustainable budget deficit value is zero.
    But Economicists seem to accept peacefully a consensus that says that a value of, say, 3% is suitable, even virtuous, and non-Economicists don't dare to disclose their ignorance by asking them "why?".
    With no money available, a zero budget deficit will appear, not only suitable, but the only possible value.
    And we will remain surprisingly alive, despite fears that with no budget deficit nothing would work.
    If we learn this lesson, we will be able to saved the value many airports and trains in the future.
    A crisis can be realy worthwhile.

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  4. Its an interesting point. I would add the following.

    i) If we run recurrent fiscal deficits and have an on balance sheet debt of 80% over GDP (much higher than Argentina in 2002 and Russia in 1998 even if we dont take into account the huge off balance sheet vehicles the government has created) we are on the edge of the abyss always and whenever our creditors decide to.

    ii) In line with TST comment more than the lack of real growth our biggest problem today is the lack of nominal growth, furthermore the lack of instruments to create inflation or deflate our economy (currency) to make it more competitive to export therefore boosting growth. We dont have monetary policy anymore and we dont have fiscal policy flexibility.
    iii) Our savings rate is and has been quite low in recent years adding to an already horror movie.

    Bottom line I dont think there is way out unless the ECB starts monetizing our debt through QE and Portugal deflates its economy like Greece is being forced to do and Ireland has done earlier. I think that will occur shortly. Of course by using that route the ECB will be socializing the irresponsibility of southern europe countries, Belgium, France and Austria at the cost of responsible countries, Germany and Nederlands. This will lead to obvious tensions in the eurozone.

    Super interesting times we live in. Not good ones unfortunately.

    http://montyhallparadox.blogspot.com/

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