Fears of a sovereign default are “manifest” in Europe and will soon spread to Japan and the U.S. as governments struggle to control deficits, according to Citigroup Inc. economists led by former Bank of England policy maker Willem Buiter.
“Despite the recent drama, we believe we have only seen the opening and second act, with the rest of the plot still evolving,” London-based Buiter and colleagues wrote in a research note published today. “There is absolutely no safe” sovereign.
The warning comes after the threat of default forced Greece and Ireland to seek bailouts and as borrowing costs for Portugal this week surged at a six-month bill sale as investors speculate it will be next to seek aid. Elsewhere, U.S. lawmakers last month extended tax cuts and are now wrangling over whether to raise the nation’s debt limit, while Japan’s public debt is set to exceed twice the size of the economy this year.
“The U.S. and Japan likely cannot continue to ignore the issues of fiscal sustainability,” said the Citigroup economists, who added that it’s “only a matter of time” before the U.S. government can only fund itself through debt issuance at “significantly higher interest rates.”
Concern of default will spread especially if the definition is extended beyond violating legal contracts to include the infliction of losses on bondholders by deliberately engineering inflation or currency depreciation, the economists said.
Several debt restructurings will occur in the euro area in the next few years and the current system of providing liquidity won’t be enough to prevent them, the economists said. Greece’s government is “manifestly insolvent,” they said.
Western European government bonds are now riskier than emerging-market debt for the first time as investors brace for $1.1 trillion of borrowing from euro-region nations this year.
For a lasting solution, the sovereign-debt crisis must be addressed at the same time as weaknesses in the region’s banking system, the report said. In Ireland, for example, the recent aid package will “buy time,” yet fails to address fault lines in the country’s banking system and highlights the need for a continent-wide regime to deal with them, it said.
Portugal is likely to be the next country to access the regional rescue fund soon, yet the almost $1 trillion system of support “looks insufficient” to prevent a speculative attack on Spain or to fund it completely for three years, the economists said.
In a separate report also published today, JPMorgan Chase & Co. economist David Mackie said there is concern that if Spain seeks help “the current arrangements will not be able to contain the crisis” and that doubts about whether debt sustainability can be achieved without restructuring would linger and contagion could spread to Italy and Belgium.
“If that were to happen, euro-area policy makers would need to enlarge the current facilities,” said Mackie, noting that could involve moving to a system of debt guarantees and reducing the borrowing costs on the emergency cash.
The chance of the 17-nation euro area breaking up is nevertheless “extremely unlikely and would be an economic disaster,” said Buiter’s team, adding that exiting the region would be “irrational” for fiscally weak countries such as Greece.