It is so ugly that Portugal drew polite applause Wednesday for completing the euro zone’s first sale of government debt in the New Year – even though it had to pay six times the going rate at this time last year.

Adding to the heady atmosphere of a stayed trip to the guillotine, the euro dropped against the dollar, though not too much. And stocks in France and Germany dropped 1%, but that did come after two days of solid gains. Hey, why set the bar too high?

“No panic is good news,” explains Lena Komileva of Tullett Prebon in a note to clients.

Portugal sold 500 million euros ($662 million) of short-term bills. Bids rose 11% from the last auction in September, in a sign that bond buyers are still willing to buy the country’s debt given the right price.

But what a price. The government had to pay almost 3.7% to sell the debt – up from 2% in September and more than 3 percentage points above the going rate a year ago.

“Not a great result, but better than expected,” writes Komileva.

Still, she adds, the surge in the government’s borrowing costs at the start of a year in which Portugal is expected to sell 20 billion euros of existing debt sets up “an unsustainable dynamic.” No one can afford to pay 3.7% for six-month money for long, particularly when the economy is stagnant. Six-month U.S. Treasury bills yield 0.19%, by contrast.

Like so many other trends in the euro zone, Portugal’s fiscal situation appears to point toward a deeper crisis later this year – a fact that isn’t changed by the sale Wednesday of 5 billion euros of European Financial Stabilization Mechanism bonds.

The fact that neither bonds, nor equities, nor currencies have been fazed by today’s Portuguese auction is a small victory for the Eurozone’s periphery. … Yet, the worrisome reality behind the rise in government bond yields and behind Portugal’s relatively good market liquidity conditions outside Europe’s safety net is that the market does not see the European Financial Stability Fund (a solid and superbly run structure in its own right) as a political safety net and a borrower credit support mechanism but as a liquidity vehicle towards potential future organized peripheral government default.

The question for 2011 is how long it will be till those defaults will start rolling in.