7 Apr 2011

Portgual bail-out: eurozone tectonic stress rises

So we now have a full PIG. But the detail of Portugal’s political and economic pickle¬† and today’s likely news from Frankfurt show up the real danger.

The Eurozone is like two tectonic plates sliding up against each other, reaching a stress point. On one are the donors, Germany mainly, but also Finland, facing a backlash against the euro turing into a “transfer union”. On the other plate are the recipients, Ireland, Greece and now Portugal, increasingly fed-up with the Austerity roughing up they are getting from Frankfurt and to a lesser degree Berlin. So in Ireland there is talk of a referendum on the bailout, and in Portugal the Parliament votes down self-imposed austerity in order to accept being enforced by Frankfurt.

And with consumate awful timing, at this very moment, the European Central Bank in Frankfurt seems highly likely to raise interest rates, on the back of a booming Germany (this morning it was announced that German industrial production was nearly 20% up on the year, yesterday  factory orders were up over 20 per cent year-on-year). It is an argument that is the reverse of the argument from the birth of the euro where the Club Med countries (and Ireland) were booming and Germany was the sick man.

So some nations trapped in an austerity cycle of low growth, low confidence, low tax revenues, and no option to devalue face higher interest rates, even as they face deflation. Deflation is of course an utter disaster for countries with high debts as you have the prospect of debt deflation where your stock of debts grow in real terms. This is why many feel multiple default is inevitable. And why the euro bailout mechanism really seems like a route for small scale controlled shutdown of these debts.

Portugal’s political hiatus is another serious flashpoint. It needs the money possibly by April 15th, certainly by June 15th. If it is to access the European Financial Stability Facility or indeed the Mechanism (to which UK will be exposed) then proper EU/ IMF conditionality is required and needs to be negotiated with a sovereign government. To the extent that Portugal is accommodated, that will clearly annoy the voters in Germany and Finalnd who have been giving their governments a kicking. To the extent that Portugal is treated “leniently” its people might choose to aggressively reject a package in its June election. This is happening already with Ireland. I have already heard suggestions that the much hoped for reduction in Ireland’s aid package interest rate has become a hostage to President Sarkozy’s presidential election hopes. Sarko hopes to appear tough not just against Laurent Gbagbo and Colonel Gaddafi, but Enda Kenny’s 12.5% corporation tax rate too.

So what is the problem in Germany? It’s booming, partly because of the captive market for its industrial exports created in the eurozone. Germans scarcely believe when you prove statistically that the eurozone has delivered better price stability than the Bundesbank. If I could boil it down to one thing, one fact, one set of tables, it isn’t actually the signing of cheques and guarantees for its European neighbours. It’s all about unit labour costs. More on that in another post.