As Greece goes on strike again , I’m reminded of just how long I’ve been covering the Eurozone crisis and how the underlying issues within the monetary union constantly bubble to the top, but are yet mostly unaddressed. For those who maybe new to the topic you can read my previous posts on the fundamental issues. Here and here for a start.
In short, the single monetary policy across the zone led to a situation in which interest rates for one set of nations, namely France and Germany, were incompatible with the economic stability requirements of many others. On top of this the lack of counter-balancing floating exchange rate under the single currency made the issue far worse. Free-flowing capital, cross border banking, lack of macro-prudential control and basic corruption and greed did the rest. The resulting financial and real asset price booms that this created eventually imploded leading to some countries with large overhanging debts, in main part, to the banking systems of other euro-using nations.
That has been the battle-ground of the Eurozone over the last few years with two major themes playing out. Firstly debtor nations have been forced, in most cases very unwillingly, to implement large adjustments in fiscal policy along with structural reforms in an attempt to make their economies more competitive relative to their neighbours. The aim was to create an export-led revival and allow them to slowly pay-down existing debts. Secondly, creditor nations have , again mostly unwillingly, provided promises of capital to support this re-balancing while attempting to hide the fact that their own banking systems were a major driver of the imbalance in the first place and now are heavily encumbered with poorly performing assets.
Obviously, as I have posted on many times, I have major issues with the way in which European authorities have handled this crisis. Its attempted resolution has been far too one-sided, ideologically driven, at times wandering into fairy-land in expectation management, monetary and fiscal policy are out of alignment, the lack of swift resolution of non-performing assets has been a major failing as has the inability to implement something closer to a fiscal and banking union. That’s not to say it has been a complete failure, there is some evidence that a re-balancing is slowly taking place, but without far more support from creditor nations in accepting further responsibility for the issues at hand, this is a very slow and painful process and is therefore at risk of stumbling at any time, for many different reasons.
Moody’s latest warnings on Cyprus is as good an example as any:
The risk of another default by Cyprus over the coming years remains elevated, according to a report by Moody’s Investors Service.
The ratings agency says this is due to very substantial risks to the country’s economic performance and, as a result, the government’s finances.
This is reflected in the negative outlook on the Caa3 rating of the government. Although it is not the rating agency’s central scenario, Moody’s sees a material risk of a Cypriot exit from the euro area, which is captured in the Caa2 country ceiling.
There are a number of inevitable outcomes from all of this, the most obvious being large rises in unemployment and banking system issues in nations force to “re-balance” via internal devaluation. The other is the domestic political issues generated as the economies of debtor nations retrench.
This month it was Portugal’s turn:
Portugal’s borrowing costs have spiked dramatically after key political parties failed to agree on a national salvation front, raising the risk of a snap election and an anti-austerity revolt.
Yields on 10-year Portuguese bonds jumped more than 100 basis points to 7.85% in a day of turmoil Friday, kicked off by a government request to delay the next review of the country’s European union, International Monetary Fund and European Central Bank “Troika” bailout until August. President Anibal Cavaco Silva set off a constitutional crisis on Thursday when he vetoed a reshuffle by the two conservative coalition parties, insisting on a red-blue national unity government with greater legitimacy to see through austerity cuts until mid- 2014. Socialist leader Antonio Jose Seguro has so far refused to take part, demanding fresh elections to clear the air. “We must abandon the politics of austerity, and renegotiate the terms of our adjustment program. The prime minister must accept that his austerity policies have failed,” he said.
Some Socialist leaders have threatened debt repudiation as a way of fighting back at Germany and the creditor powers, though that is not the party position.
Standard & Poor’s downgraded Banco Comercial, and placed a string of banks on negative watch. The agency appeared to endorse warnings that austerity overkill was making matters worse, saying continued fiscal cuts “are eroding the resilience of the private sector.”
It said banks were building up a “high volume of problem assets.” ricardo Santos from BNP Paribas said it was unclear whether Portugal could withstand a further €5-billion ($6.8-billion) of cuts ordered by the Troika. “The bottom line is that the policy is not reducing the debt ratio. We think public debt will reach 130% of GdP in 2014. The country is near the tipping point,” he said. “Everybody has been saying that Portugal is so different from Greece, but if this political crisis goes on for long, that won’t be so clear any more.”
Nothing new here really in terms of economics, although I will note that Portuguese yields have actually been rising since mid-May. That point aside, I’ve been warning for quite some time that Portugal is heading down the same path as Spain and Greece. The continued attempts to suck greater amounts of wealth out of the private sector as government sector revenues plummet is creating a self-defeating dynamic that we’ve seen time and time again across southern Europe.
What’s new here is that the political strain of trying to implement this ridiculous strategy has once again blown up a national government, and the markets know that without a “troika-friendly” parliament the monetary backstop provided by the ECB becomes questionable sending yields up and making the underlying issue of debt sustainability even worse.
The Portuguese political parties have given themselves a dead-line of this Sunday in order to re-form a workable government. That is possible given the numbers, but it’s only one more year before Portugal is supposed to exit its existing bailout program, and it is already behind in terms of meeting targets.
Again this highlights the unrealistic policy implementation as prescribed by the Troika, and Portugal is very unlikely to be the last nation to find itself in political strife. Having said that creditor nations certainly aren’t immune to the political fallout either, because it is their banking systems that were a major part of creating the problem. This is why we continue to see German politicians push against a banking union as it would allow non-German oversight of domestic banks, something they desperately want to avoid.:
German Finance Minister Wolfgang Schaeuble on Friday rejected the proposal by the European Commission for a European Resolution Board that would, from 2015, have the power to shut down struggling banks.
In an interview with the German daily Bild, Schaeuble said the proposal rested on “shaky foundations.” The newspaper also said that Schaeuble has sent a letter to EU Internal Market Commissioner Michel Barnier in which he characterizes the proposal as “very risky.”
“What we need now is a trustworthy and legally justified solution,” Schaeuble said in the interview. “The decision to close a bank is a decision with widespread consequences which cannot be taken by Brussels on its own,” the minister stressed.
Earlier this week, the German government argued that the Commission was overstepping its competence and risked delaying the implementation of an European banking union.
As I mentioned last week, I believe this is a ploy by the German government to protect its own banking system’s secrets. Just this week, in the lead up to the German election, Mr Schauble himself appeared very keen to support a move to sell down his governments’ interest in Commerzbank.
Overnight the bank managed to unload a small proportion of its trouble loan book to Wells Fargo, but the lack of transparency in the transaction has done little to appease concerns that the bank is in far worse shape than is being reported:
Sure, it’s nice to see that a couple of outsiders were willing to pay something close to book value for a block of the bank’s loans. But this is small potatoes. The latest sale covers less than 1 percent of the assets on Commerzbank’s balance sheet. (The German government still owns a 17 percent stake in Commerzbank after bailing out the bank in 2009.)
Because the transparency of Commerzbank’s financial statements is so poor, investors can’t see if Commerzbank might have sold its best loans and kept the worst ones stashed on its books at inflated historical values. During the 1980s U.S. savings and loan crisis, this practice was known as “gains trading,” although the term doesn’t fit this situation, given that Commerzbank is recording a loss. To be fair, the lack of transparency at Commerzbank isn’t unique. It’s a problem at most large banks, especially in Europe.
So this is the battle ground I described above. Creditor nations have little interest in implementing any policy that would provide support to non-domestic banks because by doing so could expose issues within their own banking systems. However, without these types of unions, and the support mechanisms that come with them , debtor nations struggle alone with the consequences of internal devaluation and while trying to build export markets against neighbouring nations also trying to do the same.
It must be said, however, that it isn’t just austerity that can bring down a government. As I noted above corruption and greed also played their part in this mess as Mr Rajoy is reminding us this week:
Spain’s Prime Minister Mariano Rajoy faced calls to resign Sunday over a slush fund scandal roiling his ruling Popular Party.
The issue blew up again after the publication of friendly mobile text messages he purportedly sent to the disgraced treasurer at the heart of the affair.
The leader of Spain’s main opposition Socialist Party, Alfredo Perez Rubalcaba, said he was severing all contact with the prime minister and his party.
“Given the unsustainable political situation in Spain, the Socialist Party calls for the immediate resignation of Mariano Rajoy as head of the government,” he told reporters in Madrid.
And more from Reuters:
Spanish Prime Minister Mariano Rajoy on Monday rejected calls to resign over a ruling party financing scandal and said he would not allow the matter to hold back his reform plans.
The political pressure mounted on Rajoy as the former treasurer of his center-right People’s Party gave new testimony before a judge looking into the affair, saying he had made 90,000 euros in cash payments to Rajoy and party secretary-general Maria Dolores Cospedal in 2009 and 2010.
Rajoy had so far managed to limit the impact of the scandal, which involves alleged illegal donations by construction magnates that were supposedly distributed as cash payments to party leaders in return for juicy contracts.
“I will defend political stability and I will fulfill the mandate given to me by Spanish voters,” he told a news conference.
Yet another political story to keep your eyes on.
In other news overnight the German ZEW showed German investors were a little more gloomy while Italy showed an improvement in its balance of trade. We’ve got European PMIs coming in early next week, so hopefully we will continue to see some improvements in those numbers.