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The Hard Assets Alliance Blog

Portugal: A(nother) Central Bank Story

The Greenspan put, the Bernanke put, the Yellen put, the Draghi put?

Easy money causes people to take risks that they otherwise wouldn’t. And the result is always the same—a boom followed by a bust. Will the retail investor ever learn? Probably—but it won’t last because the emotions of greed and fear are too strong.

Yes, there have been improvements in the global economy since the financial crisis. That said, the devil is in the details. Artificially low interest rates have been okay for the global economy and great for asset prices. But structural problems such as youth unemployment, corruption and fraud, a high cost of living and high taxes, aging populations, and excess debt still remain.

We can’t paper over these problems. If they’re not dealt with, then they’ll persist—and they might get worse.

As a result of central bank policies, saving your money no longer pays off. Interest rates are so low that it’s hard to rationalize leaving your money in a bank. To compensate for this, investors are buying all kinds of junk securities, such as government bonds issued by the PIIGS.

Today we’re going to take a look at Portugal specifically.

If people are buying its bonds, does that mean they’re optimistic about its future potential? Not necessarily. What it means is that they’re confident they’ll get their money back—regardless of the fundamentals.


Debt and Rates

Portugal’s total government debt outstanding fell from 2011 to October 1, 2013; however, debt as a percentage of GDP is still rising and has now reached 129%.

Even though it seems that the government’s financial health is deteriorating, the chart below shows that demand for Portuguese bonds sent rates down from over 18% in late January 2012 to less than 4% on August 11, 2014.

 


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Investors want to buy Portuguese bonds, but it seems like a dangerous bet.

If economic conditions continue to deteriorate, then who’s to say that the government will be able to pay its debts when they come due?

The world monetary system is now dependent on debt for growth. As a result, when credit growth slows so does the economy.

Shown below, credit to households and nonprofit institutions serving households peaked in 2011, while credit to the private nonfinancial sector peaked in 2010.

 


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Economic Activity

Both the production of total industry and GDP per capita are in decline in Portugal. Falling output isn’t going to help it pay off its debts.

 


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Moreover, retail trade and building permits for construction have been falling since 1999 and 2008 respectively.

 


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Overall, it appears that economic activity is slowing down.


Employment

Part of the reason for the slowdown could be the weakening labor markets.

Here’s how Portugal’s is faring. The employed population for those aged 15-64 has been shrinking since 2008, and the number of unemployed is up by around 600,000 since 1999.

 


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That means fewer people earning and more people relying on the government for support.

In the next graph, we see that earnings peaked in 2010 and job vacancies rose from 2012 to 2013.

 


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The labor market looks bad, and that’s not good for workers and businesses.

Sentiment

In a recent Organisation for Economic Cooperation and Development (OECD) survey, respondents were asked, “How do you expect the general economic situation in Portugal to develop over the next 12 months?” The results showed that net 40% were negative about the economic situation.

The PSI 20—Portugal’s benchmark stock market index—is not doing so hot and is far off of its peak in 2007.

 


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Both the consumer opinion survey and the price action of the PSI 20 seem to indicate that many people aren’t confident in Portugal’s growth prospects.

Demographics

Finally, let's look at demographics. This last chart show that both the population and working-age population were contracting while the 65+ age group is growing.

Fewer workers and more dependents means that Portugal is facing headwinds that will only make progress more difficult.

 


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The Takeaway

Asset prices around the world may continue to rally, but it’s important to remember that nothing is risk-free. The statement “central banks have our back” relies on the assumption that they can and will be able to deal with serious problems that might arise. Unprecedented policies may very well lead to unprecedented consequences. No one can say what the results will be.

If you’re reaching for yield in PIIGS bonds, then good luck to you. Yes, you could make a lot of money if rates continue to fall. But know that the country you’re lending to may not have the money to pay you when it’s time to collect.

The outcome for Portugal's economy is uncertain at best. While the chosen path for Portugal now leaves the country facing its own unique issues, the economic uncertainty that lies ahead is something that’s shared by the global economy—and it’s this uncertainty that continues to drive investors to the safety of gold.

At current prices, now is an opportune time to add precious metals to your portfolio, and the Hard Assets Alliance can help. Our intuitive, online trading platform offers a better way to buy, store, and sell precious metals—all with the ease and liquidity of an ETF.

Whether it’s as an inflation hedge, portfolio insurance, or for diversification purposes, gold’s history for providing a trusted store of value is something investors today cannot afford to overlook.

 


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