Each proud in their great accomplishments, Portugal first
globalized the world through its trades, Ireland gave the world some of its
greatest poets, Italy shined as the center of the Roman Empire, Greece gave
birth to democracy , and Spain conquered half of the world. Yet, during the
past few years, they have been known as the “PIIGs.” This simple acronym is not
merely a coincidence and reflected to some degree, people’s pejorative
attitudes toward these countries’ governments.
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Since this is not a trivia game, we will not spend any time
guessing why these countries belong in the same group. All of these countries, Portugal,
Ireland, Italy, Greece, and Spain are the trouble makers in the sovereign debt
crisis. To simplify the term, it basically means that these countries have
spent more than they could make or borrow and are now asking for help. As we went over in “Greek Tragedy,” it is
common for countries to borrow money to spend, but it is less common for
countries to either make so little, or borrow so much, or a combination of
both, that they cannot sustain their spending. Let us also think about it this
way. It is good when a person chooses to spend within a budget. Some call it frugality,
financial responsibility, or simply, being an adult. On the contrary, it is bad
when a person spends more than the budget and asks for more money. Therefore, it
is easy to understand why investors would want to call them “PIIGS” when these
countries overspend so much that they need help.
While all of these countries are in trouble and are in need of bailout funds from the European Commission, do they deserve to be known as the “PIIGS?” Let us take a look at each country individually and give them a chance to speak for themselves.
Portugal, like the rest of the countries, not only spends
more than she makes, but also spends so much that she is unable to properly
find investors to lend her money. So what did she spend all that money on
anyways? For Portugal, the bloated government spending in public works and
services was one of the root causes. Portugal is essentially a restaurant owner
who owes a great amount of debt when customers stop coming because he or she pays
heftily to the chefs and constantly renovates. The Portuguese owner claims that
customers love the restaurant and for some reason (ie: the financial crisis of
2008), people just stopped coming. As a result, now the Portuguese owner has to
go around and ask for more money.
Going back to the restaurant owner example with Ireland, now
the Irish owner has to ask for more money because the owner promised to take
care of the chefs and six chefs have lost nearly their livelihoods gambling on
housing prices. In bailing out the six main banks in Ireland who financed and
lost money in the property bubble, the Irish government put itself in financial
danger. As a result, regardless of how good the restaurant is, the Irish owner
has to go and ask for money.
As for Italy, the Italian owner simply owns a bad restaurant. For years, the restaurant has become dated and less competitive. Times are changing and people just do not want to go to the restaurant anymore. Especially with the overall decline in the restaurant businesses in the area, as with Europe, the Italian owner faces tough choices. Yet stubbornly refusing to adapt the restaurant or cut down on spending, the owner sees the restaurant going the way it is. As a result, Italy, just like the Italian owner is struggling. The restaurant is losing money and the owner may need to go ask for money soon.
The Greece owner also has it pretty tough. Having a restaurant
in the beautiful Mediterranean Sea, the Greek owner used to be able to cash in
on all the tourists. During the heydays, the generous Greek owner paid the
chefs and workers handsomely and promised riches. But with the declining number
of tourists due to the bad economy (ie: the financial crisis of 2008), the
Greek owner is struggling to come up with ways to continue to pay the employees
like kings. As Greece’s tourism driven economy suffered hard blows in the
economic downturn, it finds itself in trouble having to fulfill its
obligations. As a result, the Greek owner has asked for money, and plenty of
it.
Lastly, the Spain owner has woes similar to the Portugal
owner. While both of them had their fair share of good businesses and took on renovations
and high paying chefs, their declining earning has different reasons. For
Spain, the owner used to be able to make a lot off of tips. When the tips are
good, there was no problem paying all the wages and expenses. But when the tips
go bad because people are overall poorer, the Spanish owner will start to have
sleepless nights. Similarly, when the housing bubble was brewing in Spain, the
government enjoyed strong revenues from the property taxes. Yet, when the
bubble burst and home prices went down, the government lost its luxury of the high
property tax revenues. As a result, the Spain owner has also asked for money.
After understanding each country’s individual predicament,
one may ask an interesting question, “why cannot these countries just borrow
more from its normal lenders? Are there no investors that are willing to lend
to them?” This is another topic that is essential in understanding the
sovereign debt crisis. The quick answer is that there almost always will be
investors willing to lend to them, but these investors will also ask for much
more in return. As a result, it may be a bad idea for these countries to
continue to borrow from these investors. As for the long answer, keep on
reading.
When a friend borrows money, a lot of times you will lend
the money based on your own financial situation, your friend’s reason for the
money, and your relationship with the friend. When a country borrows money
through government bonds (see “Greek Tragedy”), the investor goes through
similar considerations. One, when the economy is good and the investor is rich,
there may be more people to borrow money from. (One thing to note is that when
the economy is good and the investor is rich, it is not necessarily cheaper to
borrow money because of financial policies and the characteristics of interest
rates. That is a topic for another time.) Similarly, when the economy is good
and your friends are rich, it may be easier to borrow money from your friend. Two,
while people do care about what they money is for when the friend borrows the
money, most investors do not care as long as the country will repay the amount
based on the terms. Three, when a friend asks for money, your level of
friendship and your understanding of his character and background play a
factor. Furthermore, the public perception of the friend may also affect your
willingness to lend the money. As for countries, investors get to know the
country’s character and background through debt ratings. Rating companies such
as S&P and Moody’s rate a country’s credit as if rating a friend’s
trustworthiness. Instead of spending time on these countries, investors believe
in these ratings and make decisions off of these ratings. A higher rating means
a country is more likely to pay back and vice versa. This became a key factor
in the sovereign debt crisis.
During the crisis, rating companies downgraded many PIIGS countries’
debt ratings. As their ratings dropped, investors become more cautious about
their lending to these countries. Some back off completely and those willing to
stay will ask for more in return. For example, countries used to be able to
borrow from investors through bonds paying a low rate, yet after the rating
downgrade, they could only borrow with bonds paying a high rate. Furthermore,
the self-fulfilling prophecy of risk also plays a factor. Similar to vicious
rumors about a friend, concerns about a country makes it more expensive for
countries to borrow, which put them in even more financial ruin. As a result,
in a world inundated by information, these concerns turn into self-fulfilling
prophecies in the markets and make it harder for these restaurant owners to
make a comeback.
Fortunately, there is still hope for these countries.
Turning the disadvantage of these rating influenced and rumor prone investors
into advantages, governments have been able to pacify these antsy investors
with strong political and economic figures. Putting the Milgram experiment on obedience
to authority figures into good use, European Central Bank’s Mario Draghi,
Federal Reserve Bank’s Bernanke, and Germany’s
Angela Merkel have been authority figures for the world. While the extent of
their influence is arguable, we need and rely on their impact. It may worth
your time to listen to what they said the next time they speak and how the
market reacts.