Experts warn of danger to the euro as Portugal debt doubts increase

News - Banking

Written by Ray Clancy

Wednesday, 24 November 2010 09:08

Expectations that Portugal will follow Ireland and need a financial bailout are intensifying as some expert predict it is also the beginning of the end for the euro.

The gloomy predictions come as the world’s biggest bond investor suggested depositors should take their money out of Ireland’s stricken banks. Mohamed El-Erian, chief investment officer of the powerful bond manager Pimco, described Ireland’s banks as ‘bleeding deposits’ but his views were denied by Ireland’s central bank which said there was no need for concern.

But the central bank admitted that major international companies had been withdrawing their funds from Ireland highlighted the increasingly anxious mood of the markets.

It is a sign that Ireland is not going to be a fire break for the eurozone crisis which now risks enveloping Portugal and even Spain. The cost of borrowing for both countries rose yesterday. Spain did not manage to raise as much money as it had hoped in its regular bond auction and was forced to pay more to raise the funds.

Jim O’Neill, chairman of Goldman Sachs Asset Management, said that the Irish rescue package did not solve the problems at the heart of the single currency. ‘Unless there’s an underlying solution to not just the debt challenge, but also to how European monetary union sits together involving all these domestic political partners, how can we forget about the problems lurking with Portugal and Spain,’ O'Neill said in a TV interview.

Other market experts were also concerned about the eurozone. Graham Turner of GFC Economics said the solution for weak members might be for Germany to walk away from the single currency.

He suggested that Austria, Finland, the Netherlands and Germany could form a new deutschemark bloc which would allow the other 12 members of the eurozone to devalue and reflate their way out of the crisis. ‘It has to be a better option than the present straitjacket of a single currency,’ said Turner.

Lawrence Galitz, chief executive officer of ACF Consultants, which has developed an accurate simulation of how the markets are likely to be affected by the Irish bailout, believes that it is only a matter of time before Portugal calls for an Irish styled bailout with Spain following suit, leaving a larger economy to flirt with collapse.
‘The euro was founded on the ability of eurozone countries to keep their economies in sync, but the events of the last few years have revealed this to be flawed. Portugal and Spain are almost certain to go next, hand in hand, and the threat of default to a larger economy, such as Italy, will be the last straw for a financial powerhouse such as Germany or France,’ he said.

Galitz believes that following the German chancellor, Angela Merkel’s calls for European treaty changes, the German people, government and economy are tired of bailing out incapable European Union neighbours and may decide to pull out of the euro.

‘Germany set the tone for bailouts when they came to Greece’s aid, but it’s been a slippery slope since. Were fear to spread, and with it a reluctance to hold euro denominated debt, this would be disastrous for the future of the eurozone and of the euro itself. Unless deficits can be curbed, a fracture in the structure of the eurozone could bring the whole project down and see the re-introduction of legacy currencies, like the Deutschmark,’ he explained.

Despite the €90 billion bail out package for Ireland’s stricken banks, the derivatives expert warns that this may not be enough to calm the markets and the fear of the debt crisis could damage a third economy.

Read the latest Eurozone Crisis report from Investment International.