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Fitch Ratings Inc. yesterday (Wednesday) cut Portugal's sovereign credit rating for the first time, fueling concern that the problems plaguing debt-laden Greece will spread to other Eurozone countries.
The credit ratings agency cut Portugal's credit grade by one notch to AA-, citing budgetary underperformance in 2009. Fitch warned that if the country doesn't enforce stricter fiscal discipline this year, another downgrade is possible.
"A sizeable fiscal shock against a backdrop of relative macroeconomic and structural weaknesses has reduced Portugal's creditworthiness," said Douglas Renwick, associate director at Fitch.
The news punished the euro, as traders placed bets that a European Union summit later this week won't be able to reach consensus on how or whether to help troubled Greece. The currency hit a 10-month low against the dollar.
Stock markets around the world have struggled in recent months as investors worried whether the trouble in Portugal, Greece, and other Eurozone countries would hamper the global economic recovery.
Portugal's deficit is 9.3% of gross domestic product, more than triple the European Union's 3% limit. The EU's failure to agree on a mechanism to help countries shore up their finances has hurt the euro, putting it on course for its worst quarter against the dollar since 2008.
Worse, investors now are debating whether Greece's troubles could mark the beginning of an epidemic, a contagion that could spread quickly throughout the rest of Europe and on to the United States.
Money Morning Contributing Editor Martin Hutchinson says that horse has already left the barn.
"It already has spread to the U.S. — the workforce is overpaid, the country runs persistent payments deficits, savings are abysmally low and government spending is out of control," says Hutchinson who runs his own trading service, The Permanent Wealth Investor. "Same problem in Britain."
EU leaders will meet in Brussels tomorrow to discuss how to fund any rescue for Greece, which says it will struggle to pay its debts at current market interest rates. A split between Germany and France over whether the International Monetary Fund (IMF) should pay for a bailout so far has dominated that debate.
Germany's Chancellor Angela Merkel has taken an adamant stance against a Greek bailout, refusing to saddle her taxpayers with the bill. French President Nicolas Sarkozy says Europe needs to show it can solve its own crises.
Greek Prime Minister George Papandreou said March 19 that his country is a step away from not being able to borrow and may need to turn to the IMF if Eurozone officials don't offer aid soon. Greece needs to sell about $13.4 billion (10 billion euros) of bonds in coming weeks to avoid default.
While saying it's not "inevitable" that Greece will default, Columbia University Professor Charles Calomiris told Bloomberg it faces the daunting challenge of cutting government spending by 25%.
"A 25% reduction is something I've never seen in any country," Calomiris said. "It would require a huge lift."
Europe's fiscal crisis shows the need for the euro region to create a common fiscal policy, former U.K. Chancellor of the Exchequer Norman Lamont told Bloomberg in an interview in London.
"That would be the logical step," Lamont said. "I don't think they are prepared to do that, and without doing that I think the euro is a contradiction, a currency without a state."
Some analysts are saying it's just a matter of time before the European currency goes the way of the dinosaurs.
Paul Donovan, deputy head of global economics at UBS Investment Bank said the euro region's failure to deal with its first major economic crisis shows Greece will default on its bonds "at some point."
"I think it's in an impossible situation," Donovan, who is based in London, said in an interview with Bloomberg Radio. "Europe has failed to clear its first serious hurdle. If Europe can't solve a small problem like this, how on earth is it going to solve the larger problem, which is the euro doesn't work. It's a bad idea."
Meanwhile, Hutchinson contends the European Union and its currency are viable, despite being fooled by the deceitful tactics of their fiscally irresponsible members, including Portugal, Italy, Greece and Spain, which have come to be known as the "PIGS."
"The PIGS were let into the euro without being forced to clean up their act in budget deficits and feather-bedded workforces mostly through over-early retirement and short work hours," Hutchinson said. "Any bailouts should be accompanied by as much pain as possible, so they straighten up and fly right. Other PIGS will probably be downgraded, especially Spain, but if they can be scared straight, won't default."
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