I’ve written about the sovereign debt crisis numerous times already. See here, here, here, here, and here. But so far, I’ve only written about those “at-risk” countries such as Portugal, Greece, Spain, and Ireland or individual states such as Illinois. In other words, the sovereign debt crisis has so far been limited to “small” countries or states. Debt defaults among these countries or states certainly would cause problems and a sharp decline in financial markets, but likely wouldn’t break the bank. But if this crisis spreads to larger, more financially important countries, it would obviously have a much larger impact, possibly one similar to the stock market crash of 1929.
Marketwatch reports that the sovereign debt crisis may in fact be spreading to a first world nation:
There’s no ‘B’ in PIIGS, but Belgium could eventually cause headaches of its own for the euro zone if a bitter and protracted political fight prevents the country from hitting its deficit-reduction targets.
Belgium, in northern Europe, has seemed an unlikely candidate for sovereign-debt troublemaker. From a fiscal perspective, the country, whose capital Brussels is the home of the vast EU bureaucracy, has been associated more with the so-called core of the euro zone than the troubled “periphery.”
But an increasingly bitter political divide along linguistic lines has left Belgium without a government since April and is beginning to raise some concerns.
Belgium, which has enjoyed solid growth, appears on track to reduce its budget deficit to 4.8% of gross domestic product this year from 5.6% in 2009, economists said. The nation’s deficit is among the lowest in the euro zone and compares well with other core countries, including Germany at 4.5% of GDP, France at 8% and the Netherlands at 6%.
But if a government isn’t formed soon, the 2011 fiscal target of a reduction to 4.1% could be in jeopardy, said Philippe Ledent, an economist at ING Bank in Brussels. That in turn would make it all the more difficult for Belgium to meet its target of bringing its deficit down to 3% of GDP, the EU limit, in 2012.
In reality, a 4.1%, 4.8%, or 5.6% don’t seem too bad, especially considering the 10.6% deficit here in the US for 2010 and 8.3% deficit expected for 2011.
Belgium’s deficit figures raise few alarms, but government debt stands at around 100% of GDP, which compares more closely with Greece and Italy.
U.S. debt, by comparison, also stands at about 100% of GDP.
The financial markets are starting to notice Belgium’s problem:
Belgium has had no problems selling its government bonds. Borrowing costs have risen, however, with the yield premium demanded by investors to hold 10-year Belgian debt over benchmark German bunds standing at around 0.8 percentage point, up from around 0.4 percentage point around the same time last year.
But borrowing costs are far from problematic, Ledent said. Belgium’s premium remains nowhere near comparable to Spain’s, for example, which is at around 1.6 percentage points, much less Ireland’s at around 4 percentage points.
The cost of insuring Belgian debt against default is up sharply since the April elections, but well off the peak seen in mid-June. The spread on five-year sovereign credit-default swaps was at 119 basis points last Thursday, according to data provider CMA. That means it would cost $119,000 a year to insure $10 million of Belgian government debt against default for five years.
The spread stood at around 60 basis points in mid-April before the latest round of political turmoil and peaked at 149 basis points in late June.
“Up to now, there has been no strong impact [on borrowing costs], but I’m not sure it will continue like that,” Ledent said. “If in two, three, four months we still don’t have any government, financial markets will consider that we won’t reach the [budget] target and then there could be an impact on the spread.”
How long can countries like Belgium or the United States continue to borrow at low interest rates? These are countries with deficits exceeding 4% of GDP, in Belgium’s case, or 8-10%, in the United States, with debts equal to 100% of GDP. Logic tells us that in these countries, either taxes have to rise significantly or government spending has to fall sharply. Neither Belgium nor the U.S. is doing much to reduce their deficits and even less to cut government spending. Both countries, along with all other nations, are hoping for and relying on an economic recovery to lift their finances. What if we enter another recession? What if the recovery is slower than they expect, as it has been so far? All this talk of deficit reduction will be gone and we’ll be looking at even larger deficits and debt levels.
Worse yet, what happens when investors demand higher interest rates? As mentioned above, Belgium is already paying an extra 0.4% interest on its debt. That does not sound like much, but with government debt at 100% of GDP, the deficit increases by 0.4% just from the interest payment. This is an additional cost on government at a time when it needs to reduce its costs. It increases the deficit just as the country is trying to reduce it. Furthermore, this creates a self-fulfilling prophecy: worries of a debt crisis will cause a country’s interest payment to rise and deficit to increase, thus increasing the chances of a crisis.
So I will repeat what I’ve written many times: The sovereign debt crisis is far from over. In fact, it is just beginning.
Michael E. Newton 