Friday, March 25, 2011

Portugal Refuses to Be Held Hostage

Portugal has consistently iterated that it has no desire for any EU and/or IMF bailout.  Portugal has consistently railed against the international market pressures betting on bailout which have forced up bond and CDS prices and has fought back with private placements and short term borrowing to avoid locking in high interest rates for long periods.  Portugal refuses to be held for ransom by an international market which is playing the historical incompetence (original Spanish text here) of the eurozone countries, the ECB, and the EU, which has consistently waited until it is too late to respond to the fiscal union needs of the eurozone members resulting from the structural deficiencies of the euro and its eurozone exchange rates.

While Portugal has committed to austerity to please the eurozone rules, its sincere attempts have meet with increasing political opposition, public protests, and little eurozone help.  If Portugal had its own fiat currency, would the international bond market be as concerned about its ability to grow?  What the international bond market recognizes is the dependence of eurozone members upon the willingness of other eurozone members to act together for mutual self-interest within a monetary union which has no functional fiscal union mechanisms of fiscal support.  The willingness to support each other has been perverted (original Spanish text here) by a fear of debt, by a fear of sharing debt, by a fear that union means not just taking but giving, and this fear is so great that the body stench of fear is overpowering in its pervasiveness, in its intellectual panic and dreading, and in its crowding out of rational, critical analysis and consistent, collective resolution.

While the ECB has stepped in to buy Portuguese bonds to marginally keep interest rates down, they did not do so in a manner which did not influence the market rate as a market maker would have done and the market has broken down consistently in Greece, Ireland, and now Portugal.  The ECB is a central bank with no sovereign funding base relying on contribution assessments which must be ratified.  The good faith credit of a sovereign nation with a fiat currency depends on its perceived ability to tax and collect revenue, promote output, and create fiscal policy.  The eurozone has created the euro as if it were based on a gold standard, which it is not, while failing to provide for fiscal transfers, fiscal account balance adjustments, the fiscal means to promote growth, and a unified debt issuance facility, preferring to leave each member to issue euro denominated debt which is at least, if not more, as dangerous as if it were a sovereign nation with a fiat currency issuing foreign denominated debt.

While the German and the Austrians were trying to convince each other the EFSF was big enough for improved conditions and the Germans were trying to find ways to evade the upcoming European bank stress tests, Portuguese bonds were setting off alarms and moving up towards crisis levels in February despite, almost as if independently driven, Portugal's strong efforts to find alternatives to debt auctions, such as syndication.  When that happens then sovereign related corporate debt also begins to hike and become broken.  Still, Portugal continued to raise money but at higher rates and with lower credit ratings.  ECB liquidity operations were helpful but not significant given Portugal's banks may not have been able to issue debt to foreign investors for at least a year.  With falling tax collections and revenue in Greece, Ireland challenging why its bailout interest rate is higher, a cold reception to EU finance ministers permanent EU bailout fund, and the market saying Portugal will have to ask for a bailout, Portugal remained adamant it would not ask for a bailout, despite an austerity driven contracting economy, as bond interest rates rose for all three.

It was as if no matter what Portugal did financially or economically or politically, the Gods of Debt were orchestrating its fate without regard to human effort or purpose.  A new, more severe austerity budget was being proposed against strong popular and political opposition by the Portuguese government of Prime Minister Jose Socrates and the market could smell the spoils of political defeat.  The austerity budget was overwhelming defeated with only the Prime Minister's party members voting for it.  This left Portugal with the need to raise 20 billion euro this year, a Prime Minister resigning, and the EU Council meeting convening.  Portugal's deficit may be revised up to 8% for 2010 and analysts woke up to the effect of the rising Irish bond rates, which exploded in September, had on other eurozone countries like Portugal, at the same time Germany is throwing the whole permanent bailout fund proposal back on the table for renewed debate.

Still, Portugal remained defiant it would never ask or accept a bailout having seen what happened to Greece and Ireland, but the market just shrugged it off as what they all say before it happens.  All of the warnings have been essentially ignored by the eurozone and the ECB until Portugal is on the brink and facing elections with no credible government to ratify any bailout, even if one is forced upon them.  The failure of the eurozone to proactively support member nations and promote growth with fiscal policy leaves Portugal's bonds heading towards 8% and no real government and a EU council which has continually kicked the can down the road.  The Pact of the Euro basically proposed a mechanism for future crises, has been solidly criticized as too punishment oriented and not enough resolution oriented, and exposes the currency as unstable.  With early estimates of a Portuguese bailout at 70 billion euro ($99 billion), creditor countries are scrambling for cover.  Any actual bailout may cost 80 billion euro with another 37 billion euro in maturing private Portuguese bank debt up in the air, as if the Portuguese central bank and government could come up with it without the help of the ECB.  The whole agenda of the European Council has been thrown in disarray with the likelihood that nothing of substance will be accomplished: no permanent bailout fund, no action on Irish interest rates, no competitiveness pact, no current or future crisis resolution, and no reform and extension of the stability pact.  The Finns are not prepared to support anything with elections in April.  The Germans have intensified their internal political squabbling and are demanding that their ESM capital injections be delayed until after the German 2013 elections as well as an insistence in providing financial assistance only when it is too late to prevent bailout and just prior to financial collapse.

What remains beyond the grasp of the eurozone countries with the predominant preoccupation with debt and transfers to debtor nations is the root problem is one of low growth (original Spanish text here) and an inability to recognize that growth requires not austerity and government debt reduction but economic stimulation through fiscal policy with government spending efficiently concentrated on the creation of output and jobs.  With the turmoil of German politics, the rise of nationalist parties in France, Finland, and the Netherlands, and popular anti-austerity protests growing in Greece, Ireland, Portugal, and the UK, the eurozone is converging fast towards a showdown between those creditors who preach the sins of debt while raking the money in and those who realize their only hope is growth.   Spain is a trillion dollar economy, the fourth largest in the eurozone, and has a smaller debt to GDP ratio than Germany.  If Portugal is made hostage to a bailout and forced to continue to pay ransom to the bond vigilantes, then the pressure will turn to Spain.  Without growth Spain cannot survive.  The consequences to European banks are horrendous, particularly for German and French banks.  One-third of the assets of Spain's banks are composed of private and government sector exposure to Portugal (original Spanish text here).  German banks have three times more activity in Portuguese banks than Spanish banks do.  French banks have twice the exposure to Portuguese public debt compared to Spanish banks.  One could go on with individual countries banking exposure to Greece and Ireland which can be found in the Bank of International Settlements data.

The root problems are not new, but the major players are flying blind in their sleep, trembling in fear of growth for all.

On very directly related subjects, we have recently written:

German Economists & Eurozone Insolvency
The Eurozone's Murder-Suicide Pact
Ireland's Indentured Servitude

and more past:

Ireland Betrayed
Germany's Irish Hair Shirt
On the Road Out of Ireland
Ireland's Bad Bank
Denial and the Pan-European Debt Crisis
The Unfolding Pan-European Debt Crisis
Greece, Spain, and the Euro Trojan Horse

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