THE BLOG

PIGGS Problems Could Pepper U.S.

05/12/2010 05:12 am ET | Updated May 25, 2011

A few months ago, if you read something that mentioned PIIGS, chances are you would probably mutter, hey, some goofball out there doesn't know how to spell pig.

No more. Now we all know what PIIGS stands for: Portugal, Italy, Ireland, Greece and Spain, five countries in the Euro-zone that foolishly did what a lot of big-time spenders do, borrow way too much during good times and then run into problems repaying their debt. That, of course, raises the specter of debt defaults, the kind of news that rattles investors and pounds world markets.

As we all know, the pounding has already begun, what with Greece wreaking international havoc with its sovereign debt woes, causing stock markets around the world to slide. The general Wall Street consensus is that if the PIIGS undergo more financial and economic pain--which a number of overseas economic trackers consider a foregone conclusion--markets around the globe will get slammed again.

So the $64,000 question is whose next, although some global market trackers insist Greece's problems, contrary to some expectations, are far from over.

Why, some might wonder, should any of us give a hoot, about the debt difficulties of such countries as Portugal, Italy, Spain, Ireland or Greece? The relevance, as investment adviser Michael Larson explains it, is the symptoms that provoked the financial difficulties of the PIIGS--too much debt, oversized federal deficits, shaky economies, politicians spending money like drunken sailors, and government lack of fiscal discipline--are all present in the U.S.

Wall Street, Larson says, is clinging to the misguided notion that the debt and deficit problems will stay bottled up in the PIIGS countries. "That's hogwash," he says. "Mark my words, the PIIGS problems are coming to American shores."

Larson, the associate editor of the Safe Money Report newsletter in Jupiter, Fla., says the U.K. and the U.S. face the very same dismal underlying fundamentals vexing the PIIGS. And that means, he says, they will suffer a similar fallout--a sharp decline in government bond prices, a drastic rise in long-term interest rates and tanking stock markets.

He's hardly alone in his sour view that that the U.S. could copycat the PIIGS. Bill Gross, the managing director of Pimco, the world's largest bond house, and Marc Faber, publisher of the Gloom, Boom & Doom report, recently expressed similar thoughts.

Gross, in fact, in a recent "ring of fire" commentary, lumped both the U.S. and U.K in with the PIIGS and took note of the negative implications--namely that hefty debt levels slow growth by 1%, or more, which, in turn, reduces returns on both investment and on financial assets.

In simple terms, observes Costa Rican money manager Felix Heligmann, "if the problems of the PIIGS expand to the point to where they embrace the U.S. and U.K. in a substantial way, "a lot of global investors will follow the PIIGS to the slaughterhouse."

To grasp it all, Larson gives us an insight into what he views as the most "blatantly obvious debt disasters," which are most conspicuous in the PIIGS. Greece, for example, is running a deficit equivalent to 12.7% of its GDP, more than four times the 3% cap mandated for the 27 countries in the European Union. Both Standard & Poor's and Fitch's have recently responded by slashing Greece's sovereign debt ratings and Moody's is also contemplating its own ratings cut. In reaction, Greek bonds have collapsed in value, with yields surging to a decade high.

Portugal's economy is in freefall, with last year's GDP shrinking to 2.7%, the worst showing in more than six decades. The unemployment rate there just surged to a 23-year high of 10.1%. In response, the rating agencies downgraded Portugal's credit outlook, sending its government bond prices down and their yields up. Ireland is even in worse shape, what with the collapse of its real estate bubble devastating its economy, which plunged 7.5% last year. What's more, the nation's budget deficit is closing in on 12% of GDP.

As for Spain, its economy has been shrinking for almost two years, while unemployment has ballooned to 19.5% and to 45% for the 25 and under age group. In addition, its deficit now stands at 11.4% of GDP. Making matters worse, instead of cutting back, the Spanish government has ramped up spending to reinvigorate the economy, a move that's starting to backfire as global investors rush for the exits.

Discussing Italy, Larson notes that its debt load this year should hit 117% of GDP, the second worst in the European Union, right behind Greece. Again, the common thread is too much debt, oversized deficits. And the market's response is also the same--plunging bond prices and surging interest rates. Typically, rates fall in a weak economy, but in this case they are rising despite severe recessions and declining inflation.

In another ominous note, Larson recently put together a table which shows the projected 2010 debt-to-GDP ratios and the projected budget deficit-to-GDP ratios for the PIIGS, the U.S. and the U.K. The key conclusion: The U.S. is not the least vulnerable. Quite the contrary, other than its shaky status as the world's dominant economic power, it is actually among the most vulnerable with the third worst debt-to-GDP ratio and the fourth worst deficit-to-GDP ratio.

The inference here is we, too, could face plunging bond prices and rising rates. The only reason, observes Larson, the U.S. has gotten away with relatively lower borrowing costs--so far at least--is its elite status as the center of a dollar-dominated global financial system.

"But that special privilege," he says, "does not give us a free pass to use and abuse the good-will of foreign creditors. Nor will it prevent us from an avalanche of bond selling similar to what struck Greece and the U.K. in recent weeks."

As Larson sees it, a sovereign debt crisis is unfolding before our eyes, what with government bond prices falling, long-term rates climbing and insurance against government defaults rising. He ends with an ominous warning: "A bond collapse is beginning, with massive losses now looming. If you're in long-term government notes and bonds (10 and 30-year durations), you're going to get crushed." Likewise, he sees a similar fate befalling investors in bond mutal funds and bond ETFs (exchange traded funds).

What do you think? E-mail me at Dandordan@aol.com.