Here we go again

Well here we are again. Not that it wasn’t obvious, I have previously talked about why, and also about the Greek mess, this is no different.

Europe’s wealthy countries looked to Portugal to resolve the year-old euro debt crisis by coming up with “sustainable” deficit cuts to pave the way to an 80 billion-euro ($116 billion) bailout.

Confident that Portugal will be the last aid seeker, German Finance Minister Wolfgang Schaeuble pushed the feuding political parties in Lisbon to unite behind an austerity package in the thick of an election campaign.

“It’s up to Portugal to decide,” Schaeuble told reporters today at a meeting of European finance officials in Godollo, Hungary. Portugal “has to deliver sustainable measures for reducing the deficit.”

Bond markets reflected optimism that Spain will escape the turmoil, bringing Europe closer to extinguishing the crisis that started with Greece and Ireland last year and threatened the survival of the euro, postwar Europe’s signal economic achievement.

Finance ministers agreed yesterday to send European Commission, European Central Bank and International Monetary Fund officials to Lisbon next week to start negotiations over the package, with the goal of wrapping it up on May 16, three weeks before Portugal’s June 5 election.

Portugal’s bond yields surged to euro-era highs after the opposition party balked on March 23 at a program of additional savings of 4.5 percent of gross domestic product over three years, leading Prime Minister Jose Socrates to step down and prompting downgrades in the country’s credit rating.

I am not confident Spain will miss anything. When Greece was in the same boat we were all being told that Portugal wasn’t Greece.

Portugal is a “totally different situation” than Greece, Ricardo Salgado, chairman of Espirito Santo Financial Group [ESFG], a financial services holding company that does business primarily in Portugal, told CNBC on Tuesday.

“Greece is much more oriented to the Eastern part of Europe, to the Balkans,” said Salgado, who also serves as director at NYSE Euronext. “Portugal is in the crossroads of the southern emerging countries.”

While Portugal is exposed to new markets like Morocco, Algeria and Tunisia, said Salgado, the Iberian country also enjoys close economic relationships with Brazil and Sub-Saharan Africa.

“Our exporters move rapidly into those regions, and today, we have an increase in exports of over 14 percent,” he said. “We are exporting very well— engineering services, construction service, software service— and goods from machinery and agriculture.”

Unlike Greece, Portugal plans to allocate billions of dollars into public projects including a national airport and high-speed rail linking it to Spain. And, at 77 percent of GDP, Portugal’s debt is less than many other European countries, said Salgado.

I know that everyone thinks they are different, we have the same issue in Australia with the credit driven housing market, but the fundamental facts are they are not.  Here is the private debt to GDP chart for the EMU periphary

and here is the balance of trade charts for both Greece and Portugal.

These countries suffer from the same issues. They have allowed themselves to take on too much debt caused by a lack of monetary control by being a member of the EMU and a lack of fiscal control caused by political ineptitude, economic stupidity and greed. As I have said previously

…  the PIIGS will flounder from bail out to bail out but ultimately it will make little difference because they are currently tied to an economic model that neither supports them or allows them to make the necessary changes to alter their economic course.  That is not to say that they are not to blame for many of their own woes, they certainly are, but it is by no means as clear cut as you will read in the mainstream media.  The PIIGS were always going to be in trouble as soon as there was an economic downturn because they are trapped between the domestic policies of Germany and the inflexibility of the monetary system they signed up to when they joined the Euro.

All of the PIIGS are in the same boat, they simply allowed debt levels to get to a unsustainably high level because the monetary and fiscal environment did not provide the non-bank markets with a correct measure of the underlying nations real economic value. As I said before in reference to the EU macro-economic settings.

National governments kept issuing bonds to cover the ever growing debt while the backing of the ECB was giving the false impression to foreign investors that Greece was as safe a Germany. So while Germany kept exporting into Europe other national governments kept spending to cover the difference. Those countries appeared safe and relatively cheap to foreigners so in rolled the capital causing asset driven speculation.

The whole framework is an economic trap that requires prudent economic management by national governments…..

As soon as the EU was formed the fuse was lit, it was inevitable that economic stupidity, political opportunistic behaviour and corruption was going to lead to a collapse. But the real problem was that no one seemed be aware that once it did collapse the EU had no mechanism to deal with the fall out.

The Euro-elite have quickly decided that the mechanism to deal with this fallout is to keep the banks alive at all costs. The previous bailout deals with Iceland, Ireland and Greece have all had a “bank bondholder comes first” approach by forcing the citizens of the countries to take the pain by socialising the debt and forcing austerity on the nation.

I am not 100% sure who convinced them this is the approach to take, but it smells like a bankers solution to a banker problem to me. I can see little reason to take this approach outside the fact that all the banks including the ECB  are themselves holding vast amounts of sovereign bonds as collateral on loans to each other. A recent EuroIntelligence article explains the interconnectivity issues of the EU banks. The banks all fear that any form of default will lead to a collapse of the entire system. They now seem to be playing a game of keeping the system afloat while trying to force the taxpayers of Europe to re-capitalise their balance sheets using whatever means possible. The only problem is that they are the same people who caused the problem by not completely understanding the system they had built, and they now falsely believe they have the ability to fix it.

But that is why you saw the EU step in early in Portugal back in January

Germany, France, and the IMF has recently put pressure on Portugal to accept financial aid from the EU. They are concerned that the bond market will turn on the small nation and drive yields on its sovereign debt so high that there will be a rush to bail Portugal out as was the case with Ireland and Greece.

A source told Reuters that “France and Germany have indicated in the context of the Euro group that Portugal should apply for help sooner rather than later.” All parties have denied the discussions to keep the international global markets from decisions that Portugal may default.

and you can be sure that they already had a plan to deal with the recalcitrant government of Portugal (more on that below ).

By late March Portugal’s government imploded.

Just as Portugal appeared to have dodged a bailout like those taken by Greece and Ireland, a domestic political spat was set Monday to worsen its financial troubles and possibly spoil Europe’s efforts to put the sovereign debt crisis behind it.

Portugal’s main opposition parties told the beleaguered minority government they won’t budge from their refusal to endorse a new set of austerity measures designed to ease a huge debt burden that is crippling the economy.

The next day the government fell.

The fall of Portugal’s government yesterday will add complexity to a regional policy approach that has failed to make much of a dent in solving the acute debt problems in the periphery of the euro zone. Portugal must now work with European partners to find a way to join Greece and Ireland in the EU/ECB/IMF intensive care unit. It will not be easy, and Portugal will engage only reluctantly given this ICU’s poor track record in returning patients to good health.

Portugal would need some pushing. “Luckily” the ratings agencies were there to provide the stick and the carrot.

Standard & Poor’s Ratings Services today lowered its long-term sovereign credit rating on the Republic of Portugal to ‘BBB’ from ‘A-‘.Moody’s

Conveniently, as noted by ZeroHedge, this meant that…

Following S&P’s lowering of its sovereign credit ratings on Portugal to BBB on Friday 25 March 2011, RepoClear participants are advised that with effect from Monday 27 March 2011 Portuguese Government bonds will no longer be eligible for delivery in any of the RepoClear €GC Baskets.

Until today’s downgrade Portugal had been eligible for the single A €GC Basket.

This is in line with LCH.Clearnet Ltd’s Regulations*, which state that while the criteria which define each of the eligible €GC baskets remains fixed, the countries’ debt meeting the defined criteria for inclusion in each basket may change from time to time. Where the combined credit rating of a country that falls within the definition of Euro zone countries changes, LCH.Clearnet Ltd will add or remove that country’s debt from each of the relevant eligible €GC baskets based on the new combined credit rating of that country.

All of a sudden Portugal’s banks found that their government’s debt was no longer ECB repo worthy and that meant that they no longer had any reason to purchase Portugal’s debt. After that Portugal had little choice but to ask for a bailout. Who said those credit rating agencies were good for nothing ?

So now that Portugal has no choice but to accept the bailout here comes the inevitable plan. Funnily enough it sounds just like the “plan” they had for everyone else.

Portugal has been served notice that it will need to endure years of unprecedented austerity, spending cuts, and tax rises if Europe is to rescue it from national insolvency to the tune of €80bn.

The daunting terms of the proposed three-year bailout were spelt out by EU finance ministers meeting in Hungary. It was clear that while the 17 countries of the eurozone are to bear the brunt of the bailout, Britain will also be liable for several billion euros in loans to Portugal through its participation in the emergency fund managed by the European commission.

Senior EU officials said the terms for the bailout were to be finalised by mid-May, a fortnight ahead of early elections in Portugal following the collapse of the centre-left government of José Sócrates, toppled last month when the opposition rejected his minority government’s austerity package aimed at fending off the need for a European rescue.

If the main political parties could not agree on Sócrates’s cuts package, they will now have to agree on a more savage programme dictated by the EU.

The Sócrates proposals will be merely a “starting point” for the austerity measures to be agreed with the European commission, the European Central Bank, and the International Monetary Fund, said Olli Rehn, the economic and monetary affairs commissioner.

The Finnish finance minister, Jyrki Katainen, went further.

“The package must be harder and more comprehensive than the one the parliament voted against,” he said. “The package must be really strict because otherwise it doesn’t make any sense.”

Actually it doesn’t make sense at all. Telling a country that has large public and private debt, a trade imbalance and no control over its monetary policy to cut spending will have the same effect it has had in every other country in the same situation. It will cause a sharp rise in unemployment and sharp fall in GDP. This will inevitably lead to further falls in government revenue which will make the problem worse not better. As this happens the EU and the IMF will tell the country that it isn’t trying hard enough and tell it to sell public assets and anything else that could actually help it get back on its economic feet and actually be able to pay the money back.

I can’t for the life of me work out why anyone thinks this plan will secure payment on loans past and present (Remembering these “bailouts” are just more loans). But that is simply what a “bankers” plan for an economy looks like. Take a look at Ireland, the first to be given this “plan” years ago.

Dublin released official data showing that gross domestic product fell by 1.6% in the final three months of 2010 and by 1% in the year as a whole.

Irish GDP has contracted by 12% in the three years starting in 2008, one of deepest contractions of any industrialised country after the financial crisis led to the collapse of its housing bubble and took its banks to the brink of insolvency.

And what does the future hold for Ireland under this plan?

Ireland’s GDP will shrink by 2.3pc this year, according to a forecast out this morning from a accountants Ernst and Young.

The firms’ latest Euro Zone Economic Forecast blames the fall on fiscal tightening, as well as ongoing weakness in the banking sector and the housing market.

It also expects unemployment this year to be 15pc, 50pc greater than the euro zone average.

The firm forecasts that consumption in Ireland in 2011 will fall by around 4.5pc – putting Ireland only ahead of Greece in terms of the lowest consumption levels across the euro zone. The forecasts are among the gloomiest yet for the Irish economy this year.

The 2.3pc drop in GDP compares with a decline of 0.8pc in 2010, the forecast says, adding that there will be a return to growth of 1.1pc in 2012.

The Euro-elite are their own worst enemies. They built a broken macro-economic model for their region and now have broken plans to fix the issues that have arisen from it.  If you don’t think Spain suffers from the same issues then I advise you to check out their balance of trade chart below and their debt levels above. Look familiar ? Expect the oil price to make that worse in coming months.

Comments

  1. I think we are about to have an austerity budget of our own, no doubt, to prepare for the day when we have to bail out our banksters. 🙁

  2. Deus Forex Machina

    This is a brilliant and important post…nice work DE

    BTW – Over the weekend in Iceland there was a second referendum on whether or not they would repay the British and Dutch Governments what they paid depositors in the failed Icesave version of one of their banks. The political class is out of step with then populice in in Europe and as Bloomberg quoted one Icelader the decision should be “a wakeup call for the citizens in other countries”.

    • All good and well but this really is a simple agreement and there is no way Iceland will be able to get out of this one. Well, not without breaking international laws, a number of treaties and facing loss of trust and reputation as a result. It would do heaps of damage to Iceland’s future.

      The only thing Iceland managed to do is postpone payments and maybe even get a worse deal after a future court decision…

      • who wrote “international laws”? who dominates IMF, WTO?
        what kind of “reputation” a debt slave has?

        threats, tariffs, embargo, exclusion- sure, usual playbook. But at least the only nation has the courage to stand up.

        “The great looks great because we are on our knees. Let us rise” (it was Irish national heroe, who said these words a century ago)

        each and every citizen has to pay for private banks failures?
        Be carefull what you wish for- Australia’s pending bailout bill per person will be much bigger.

  3. A question?. Do you think the Euro-elite do not have the foresight to understand their policy implementations?

    The level of austerity they are imposing, and it’s feedback loops into aggregate demand for at least the short term will be damaging to say the least.

    I can only see that they are trying to recalibrate prices for either labour or welfare. Both cases it will just see desperate people accepting less, but we know what desperate people can do.

    Perhaps this is Germany trying to impose the equivalent of Versailles treaty hardship on the rest of Europe.

    • >A question?. Do you think the Euro-elite do not have the foresight to understand their policy implementations?

      I am in two minds about this. One part of me says “no” they really have no idea what they are doing, the current state of the EU shows that. The other part of me say “Yes” in this case they know exactly what they are doing.

      But really it is a question about whether I think they are driven by stupidity or personal greed. I get the feeling it is both.

      >I can only see that they are trying to recalibrate prices for either labour or welfare.

      I would like to think that as well, at least that would give you some sense that there is at least a “plan”. I am not sure however exactly how they think they are going to get their money back on previous loans if this is the case.

      I doubt however they are going to get there. The rumblings in iceland are the start of the “wake up” by Euro citizens that they have been sold a lemon and are being screwed for the purchase of said lemon.

      I see little reason to believe that this isn’t all going to end in a hideous mess sometime after one of the member states pulls the pin on an “Austerity plan”. I get the feeling Ireland could be next.

      • > I am not sure however exactly how they think they are going to get their money back on previous loans if this is the case.

        Well I’ve thought of this in how this financial crisis had affected the real economy, thus becoming an economic crisis.

        By distressing everything else, it makes it cheaper. I wouldn’t be concerned too much about paying overs using fiat currency, it ain’t worth much.

        I don’t think they’re interested in the cash, I think it’s about owning everything.

        • “I don’t think they’re interested in the cash, I think it’s about owning everything.”

          Bingo.

    • No doubt European politicians listened to what all those economist from the various European universities had to say. Of course they were aware of the risk…

      However, politics is not just about economics. It would be “easy” if it was. Sometimes you have to seize the opportunity, advance something and deal with the fall out later. If European politicians had waited until every nation was ready to make the giant leap from sovereignty to single monetary union with strict monetary rules the Euro would have never happened. The EU is being build in small increments and so far we’ve had more than 65 years of peace and prosperity because they started with that first small step. I for one am glad someone had a vision and went for it.

      I personally think this can go two ways… Hopefully they will pull this of and it will be Europe’s finest moment. Europe will become stronger because of it, finally having the momentum to move toward a single monetary policy and imposing the same strict monetary rules across all Euro nations. Now is also the opportunity to address various issues in the affected economies (such as the pension age or massive tax fraud in Greece). It will be hard and maybe not very pretty, but in the long run it will pay off.
      Obviously we also have to be realistic and accept that it may not work and countries will have to leave the monetary union with the economic impact that will go along with it.

      I personally still believe they will pull this of. The Euro has so many advantages for the European economy that they just won’t let it slip easily. Don’t underestimate what an economic powerhouse the EU still is. Just because Australian media is focusing on the weak markets within the Union doesn’t mean it’s weak overall.

      Yes, I love the European Union and the Euro. 🙂

      • >However, politics is not just about economics. It would be “easy” if it was. Sometimes you have to seize the opportunity, advance something and deal with the fall out later. If European politicians had waited until every nation was ready to make the giant leap from sovereignty to single monetary union with strict monetary rules the Euro would have never happened. The EU is being build in small increments and so far we’ve had more than 65 years of peace and prosperity because they started with that first small step. I for one am glad someone had a vision and went for it.

        Actually I think the reverse is true. If politics was about just about politics then it would be easy, but it isn’t. It is about real things linked to the actual lives of real people.

        That means understanding the macroeconomic environment of not just one nation, but many nations and how they interact. If they had 17 german states then they would have little problem, but they don’t. They have a very diverse range of economic, political and social economies that all came together under the pretence that they were one homogenous society. But this is not the case.

        I get the feeling that your idea is somewhat a romantic belief of what could be, and I actually have some empathy for this ideal as I too hope that it could be true.

        However reality is quite different. Greece/ireland/spain/portugal are not Germany and it is quite unlikely they ever will be. Ask a Greek if they want to be German and I suspect the answer will be a resounding “No” and it is fairly likely you will be punched in the face for suggesting such as thing.

        The thought that Europe is a single nation is a “financial” concept made up by bankers hoping for ever increasing monetary profits. Reality is very different.

        • > Actually I think the reverse is true. If politics was about just about politics then it would be easy, but it isn’t. It is about real things linked to the actual lives of real people.

          Exactly my point, we agree on that one. There are so many facets to politics (or maybe we should call it ‘governing’). Economy is undoubtedly one of the most important as there will be no stability without a functioning economy. However, politics is just as much about values, social fabric, security, ideology, religion, identity and (unfortunately) the political game.

          My background is in Public Administration (focus on public management) and I just feel many do not appreciate the complexities faced in the public sector (which isn’t my way of saying it can’t/shouldn’t perform better than it does… quite the opposite).

          > I get the feeling that your idea is somewhat a romantic belief of what could be, and I actually have some empathy for this ideal as I too hope that it could be true.

          It very much is, guilty as charged. Consider though that no one considered a European Union with a single currency to be even a remote possibility when they first proposed to create a European Community for Coal and Steel, only 11 years after the end of WW2 and the horrors of the holocaust…
          Many do not know or appreciate just how integrated Europe already is. More than 30% of legislation in The Netherlands has its roots either directly or indirectly in decisions taken in Brussels. In that regard my romantic belief is already reality.

          Right now we see a situation which can either break the experiment (the Euro, I doubt the EU will collapse even in a worst case scenario) or provide another political opportunity… this time to move to a more integrated monetary union. Member states have already agreed to show their national budgets to the Commission before they show them to national parliaments. Formally this will only have informative purposes but member states will take whatever the Commission says very seriously and as such it has huge implications. This obviously would have been unheard of just two years ago and shows how this situation is used to advance European integration.

          I see the austerity measures in the same light. Countries such as Germany and The Netherlands seize the political opportunity to make happen what they already knew had to be done before the Euro was introduced. Portugal, Greece and Ireland are in a tough spot which gives the other nations the possibility to have those nations finally push the economic reforms necessary. I’m pretty sure the result won’t be perfect, but the status quo had to give at some point. Hence, I’m hopeful this will become one of Europe’s finest moments.

          > The thought that Europe is a single nation is a “financial” concept made up by bankers hoping for ever increasing monetary profits. Reality is very different.

          Again I agree and I’m pretty sure politicians where aware of this when they decided to introduce the Euro. It is widely accepted the Euro was a political wish, rather than an economic one. Many academics with an economic background had the same concerns back in 1991… but see, that’s exactly my point. Sometimes politicians have to weigh the benefits versus the risks, catch the momentum and opportunity of public opinion and go for it*. It’s what leaders are supposed to do and I am very glad they had a vision and went for it. No way would anything have ever happened if they would have tried to negotiate a giant leap from sovereignty to full-blown single monetary policy. Even Australian states are still not keen to transfer powers to the Commonwealth and they are nowhere near as diverse as the European member states.

          You are right that there are huge differences in the economies of the various member states. Also true that this poses difficulties along the way and that the ride will be a bumpy one. The EU is founded on the idea that each and every memberstate will eventually catch up and will receive help to get there. Obviously this doesn’t go without the occasional set-back but so far the EU has come a long way. I know I may be naive but I think there’s enough integration and European identity to make it through this one. The whole stabilization pact is testament to how far the member states have integrated into the EU. Member states cannot stand by and watch another go under without feeling the negative effects themselves.

          Finally, consider this. Australia is a single nation with a single currency and a single monetary policy. Should we start a second currency now that we have a two speed economy, or do we try and fix the Dutch Disease?

          * Play it save and you end up with Adelaide 😛

  4. Tony Soprano once said: “I knew you can’t repay all your debts, but your wife owned a nice sport club…”

    We (EU,IMF, ECB) know those countries can’t repay their debts, but they have nice public airports, railways, tollroads…”

    Australia- you have nice mines also 🙂

    • Bit harshly put but I think you are right.

      This is an educated guess, but I think you only have to look at the increase of trading with emerging countries such as Poland to see clear benefits for countries such as The Netherlands and Germany.

      I know I saw a huge increase in the amount of trucks from Poland after they joined the EU. I also noticed those trucks went from old and crappy to modern and shiny very, very quickly!

  5. I don’t what to add to the gloom and desp, but The Economist recently estimated by how much house prices were overvalued in a selection of developed countries. It estimated fair value as price against 10-year average rental values. France came third on the list, with prices 48% overvalued, even more than in Spain. The French seem to believe that their banks are safe as, uhh, well, houses actually. We nmust just hope they are NOT right!

  6. the EU is deaddddd..bank on it.
    socialism doesnt work, only a freedom produces prosperity, the banks and corps who are bankrput, yes mc donalds took loans from the fed, should close stores and restructure, nothing lasts forever and these big businesses need to go down if thy need “bailouts”. The countries should declare bankruptcy also, cut the bullshit out its more than a joke.