It has long appeared unavoidable. Portugal needs foreign aid or they risk collapse. At 7.7% their borrowing rates are simply unsustainable. The flawed single currency system continues to wreak havoc on the region. So what happens next? It’s likely that the EFSF is utilized as it was in the case of Ireland and Greece, Portugal eventually accepts the austerity measures, gets forced into continuing recession and the core continues to pretend that they’re not screwing over the periphery. All the while we muddle towards some form of increased unity.
The core nations have made it abundantly clear that they will not allow the Euro to fall apart and that means they cannot risk the potential fallout of a sovereign default. Once Portugal is out of the way Spain will place its head squarely on the chopping block and the EFSF will gladly respond with a larger bailout. The inevitable outcome here appears to be a move ever closer to a United States of Europe. But not before further depression is imposed on the periphery nations. Although I still believe defection is in the best interest of some countries it looks like full unity is the endgame. As I said in January:
“If one thing has become abundantly clear over the course of the Euro crisis it is that the Euro is not going to be allowed to collapse. While I believe it is in the best interest of some of the periphery nations to leave the Euro it’s now obvious that they have been convinced that this is not in their best interest. The core is very concerned about the ramifications of defaults and defections as their banks remain the largest lenders to the periphery. So, while the periphery bails out the core (and vice versa) we will continue to see this union held together with increasing attempts to create a truly unified Europe.”
But the longer this plays out the longer we risk sinking back into recession. Austerity has already proven a failure for these nations. And an already disgruntled citizenry is unlikely to accept imposed depression for long. The risk in this environment is that Europe does not move quickly towards greater unification. The hope is that Europe can muddle through and eventually piece together some semblance of a working monetary system. But the risks remain enormous.
Revolts would be the likely worst case scenario in the region. While I see the odds of a full blown revolt in one of these nations as relatively low we cannot entirely discount it. But one thing is certain by this point – there is no middle ground. Europe must either move towards a more unified region (US of E) or they must allow some form of debt restructuring and defection from the Euro. I still think the prospects of a Lehman 2.0 will drive the region closer to a United States of Europe as opposed to a complete collapse, but the muddling along is only adding to the uncertainty and increasing likelihood of unrest.
Personally, I don’t know if I have ever been more uncertain as to a particular outcome. Part of me is certain that the core will move towards greater unity (and avoid any banking system trauma), but the other part of me says that the periphery nations will wake up to the injustice that is being imposed on them. For now, the periphery appears to be willing to go along with the core’s playbook. Is that sustainable? I don’t think anyone can predict the outcome here. And while I think we’re likely to see some form of a United States of Europe (with a common tax and common bonds) in the coming decades I think it’s unwise to entirely discount the potential of a defection and the fallout that would ensue.
While there is much uncertainty regarding the potential outcome I believe the biggest takeaway from all of this is crystal clear – there are better regions of the world in which to invest your money.