Goldman Sachs Economist Erik Nielsen: Portugal is in Deep Trouble

Goldman Sachs (NYSE:GS) Chief European Economist Erik Nielsen appeared on Bloomberg TV to discuss the sovereign debt crisis in Europe. Nielsen said that Portugal’s borrowing costs are “unsustainable” after the interest paid on an auction of 1 billion euros of government bonds surged. ┬áHe also said that “good growth in Germany (NYSE:EWG), low unemployment, is sort of a very important requisite for the help of peripheral” nations.


On the Portugal bond auction:
“There is a concern in Portugal for sure. The fact they have been able to raise a bit of money, it is still at rates that are clearly unsustainable. The fact of the matter is that in Portugal right now we are in a stalemate with the elections coming up in some months and the inability of them to do very much about drawing up a program with the EU and the IMF. It is day-by-day, getting the money in to get through these difficult months.”

On Europe’s sentiment towards Portugal:
“I think the key issue is there is a lot of frustration in Europe with Portugal. We know quite certainly that there was pressure on them all the way back before the Irish deal was done, and certainly when Ireland got their program, there was a lot of pressure to get Portugal to come along and do the same thing. I think we understand certainly that it was pure politics in Portugal, maybe in Brussels, that led them to think they could tough it out. Officially, they said the rate we have to pay on the European and IMF loans are not that different from what we pay in the market. We have the shadow program with 90% to 95% of the conditionality. I think the latter one is probably a bit of a stretch. They need more conditionality. They need more structural reforms. Clearly, the market knows these rates are not sustainable and rates never stay at sustainable levels. Either they come down because something fantastic happens, or they shoot up and eventually they have to get the program.”

On Europe doing well away from the peripheral trauma:
“This is a very important point to make. Probably 75% of the eurozone measured as GDP are growing still well above the long-run trend, which is normal, because you had a very sharp decline in output through the crisis and then a nice recovery out for the mentally-sound economies. Many of them, like the Netherlands, and also Germany, were surely doing their work with the exchange rate when Euro Dollar was down 1.30-1.35. These are numbers for sure which are undervalued for the strong economies so they were nice for recoveries for those types of economies. Now, they are shifting to domestic demand. They are in pretty good shape.”

On Germany after the elections and cleaning up peripheral Europe:
“The first thing is that surely the better Germany (NYSE:EWG) does, the more generous they will be to other people. That is normal. If you have your own trouble domestically you are focused more on the domestic problem than the external one. Good growth in Germany and low unemployment in Germany is sort of a very important prerequisite for the help of the peripheral. The second thing that I think is very interesting, and a lot of people miss, if you read the German press, and you go to Germany and talk to people, you will see a lot of skepticism about giving money to the periphery in the sense. However, the outcome of the elections all swayed very strongly to parties, namely the social democratic party, and the green party, which are much more pro-European and actually the Social Democrats have advocated a so called Euro bond which the present government opposes. The toughest party, the Free Democrats had a terrible election outcome. The Germans, like everybody else, do not like to give money away or lend money away, but it is not top priority when they go to the polls.”

On the tipping point when looking at Euro Dollar:
I cannot give you a number, and the reason is them a lot of the increase in the Euro Dollar is due to dollar weakness, and only 15% of European exports go to America (NYSE:SPY). Your dollar is not that important. At a time that we have oil commodity prices shooting up, it is helpful for Europe to have a stronger euro. There is not a simple number. I would suspect where you think of it in trade rated terms, I think you are at a stage where the strong ones like Germany, the Netherlands, Finland, Belgium, France to some extent, are still in pretty good shape, but we are obviously in a stage where the peripheral is going to hurt a little bit..

On which set of players need to give way:
“Let me start by saying that remember when they raised money by 5% or 8%, that is the marginal cost. The average cost of debt in Portugal is about 3.7%, or 3.8%, it’s still too high and with these rates it will go up further. Who will give the debt relief? I don’t know the answer to that, but I would say that the commitment in core Europe, so Germany, France, Italy and northern Europe, that there will not be a debt restructuring of bonded debt to private creditors, it is, in my opinion, clear. They will do all lot more to avoid that scenario. That means if the countries need debt relief, they will need to do it from the official creditors through much longer maturities and interest rates lower than what the market price is.”

On the strong Swiss franc:
“The interesting observation here is really that Switzerland has done phenomenally well in terms of growth in spite of the very strong Swiss franc and stronger than we had thought. This is a testament to the fact that in Europe and many other places you have countries with very high value-added companies — the famous watchmakers in Switzerland is 8% of exports. As they say in Switzerland, the more expensive the watches get, the more the Chinese want to buy them. So you can sometimes do quite well with a strong currency. The other lesson is, as you know the Swiss national bank has intervened very heavily for a long time and built up an enormous balance sheet that has cost them money. This discussion that we have occasionally about the quality of the balance sheets after qe2 and one and what have you, is probably worthwhile taking a look at the Swiss experience.”

On what the US can learn from the Swiss that can be applied to the debate of QE2:
“The key messages that in Switzerland they have not been shy of boosting the central bank’s balance sheet very significantly for the overall objective of macroeconomic stability and growth. We have something in the order of this 40% or 42% of GDP in FX now on the balance sheet and I think they lost about $10 billion on that last year. But as they say in the central bank, this is a central bank and not a commercial bank, and we can if we want operate with negative capital if we have to. Do not like to do it. The message here you have to remember is that the the central bank is part of governance, not government, but governance. They need to take an overall view like the Fed does of the economy and not operating monetary policy or its overall policies with too strict a view on the balance sheet itself.”