0

The Euro at Mid-Crisis

CAMBRIDGE – Now that the European Union and the International Monetary Fund have committed €67.5 billion to rescue Ireland’s troubled banks, is the eurozone’s debt crisis finally nearing a conclusion?

Unfortunately, no. In fact, we are probably only at the mid-point of the crisis. To be sure, a huge, sustained burst of growth could still cure all of Europe’s debt problems – as it would anyone’s. But that halcyon scenario looks increasingly improbable. The endgame is far more likely to entail a wave of debt write-downs, similar to the one that finally wound up the Latin American debt crisis of the 1980’s.

For starters, there are more bailouts to come, with Portugal at the top of the list. With an average growth rate of less than 1% over the past decade, and arguably the most sclerotic labor market in Europe, it is hard to see how Portugal can grow out of its massive debt burden.

This burden includes both public debt (owed by the government) and external dent (owed by the country as a whole to foreigners). The Portuguese rightly argue that their situation is not as dire as that of Greece, which is already in the economic equivalent of intensive care. But Portugal’s debt levels are still highly problematic by historical benchmarks (based on my research with Carmen Reinhart). With a baseline scenario of recession or sluggish growth amid budget austerity for years ahead, Portugal will likely seek help sooner rather than later.