European sovereign debt crisis

With yield on 2 year Portugal government bond spiked 3.2% over friday and 7% over last month, Portugal is heading toward insolvency at an ever accelerating rate. The scale of any potential bailout to counter and push down the sovereign debt yields will need to be massive and truely historical.

Standalone Greece sovereign debt (EUR 236 billion) has limited contagion effect as major debtholders: France EUR 75 billion, and Germany EUR 45 billion, still fiscally sound at this point to weather the potential impact. Portugal on the other hand with her close financial tie to Spain could potentially trigger an unprecedent shock wave through the global economy. One-third of Portugal sovereign debt (EUR 286 billion) is with Spain (EUR 86 billion). Spain with persistent high unemployment rate at 20% and economy that is likely to contract over next few years is not fiscally strong enough to withstand the potential impact from Portugal insolvency. At this very critical juncture, EU has every bit of interest (or self-interest) to safeguard Portugal from faltering. If the effort fails then the debt yield for Spain will surely accelerate and ultimately force Spain into insolvency as well. Compare to the size of debt for Greece and Portugal, the size of sovereign debt for Spain is whopping EUR 1.1 trillion. The potential impact of insolvency from Spain is almost.... too lethal to imagine

The stake is indeed extremely high not only for EU but also for the US and China. For the US, the central bankers are painstakingly trying to chart the course to offload the bloated balance sheet accumulated during the subprime crisis. The process of offloading is only feasible when the financial markets are operating in a "normal" environment, meaning healthy and liquid with many buyers stood ready and able to absorb the portfolio from the central bank. With the unfolding of sovereign debt crisis, the financial markets are anything but "normal." Crippled with bloated balance sheet, the ability of US central bank to deal with any further crisis is seriously questionable.

For China, advanced economies should pay more gratitude to China politburo for deciding to do the heavy lifting during the subprime crisis. China faced with strengthening dollar could very well allowed renminbi to devalue to remain competitive in the international trade. However such policy of competitive devaluation will invariably force many other export powerhouses notably emerging Asian countries like Singapore, South Korea and etc. onto their knee. Instead Chinese government injected unprecedent amount of liquidity into the domestic markets to artificially create "domestic demand." With banking sector still immature, the poor control and oversight invariably allowed sizeable amount of liquidity flown into speculative investment like real estate. Although the amount of loans that eventually went into speculative investment is not known, the figure so far from the central government is massive and still ringing up. Good portion of these loans will surely turn sour as central bank soaks up the liquidity to contain the real estate bubble from inflate ever larger. But if the European sovereign debt crisis deteriorates further we could expect to see the acceleration of bad loans in China banking sector.

The European sovereign debt crisis is deteriorating and spiraling out of control. The stake is so high that boil down to "save you... save me" scenario but with central banks around the globe still crippling from the subprime crisis any chance of averting this crisis will not be from ECB alone rather from a concerted effort of central banks from advanced economies. Although political meddling could complicate this much needed action.