By Ambrose Evans-Pritchard | 19 September 2010
Portugal was a net foreign creditor in the mid-1990s. EMU has turned it into a net foreign debtor to the tune of 109% of GDP Photo: AP
Portugal neared the line on Friday when Diário de Noticias cited three ex-finance ministers warning that the country might have to call in the International Monetary Fund (IMF). One spoke of a "reckless reliance on foreign debt"; another spoke of "runaway public spending". No matter that all were complicit in euro membership, the policy that incubated this crisis and now traps Portugal in its depression.
Portugal was a net foreign creditor in the mid-1990s. EMU has turned it into a net foreign debtor to the tune of 109% of GDP. That is what happens when you cut interest rates suddenly from 16% to 3%.
Be that as it may, the comments struck a nerve. Yields on 10-year Portuguese debt surged to 6.15%, back to May crisis levels when the EU faced its "Lehman moment" and launched a €750bn (£625bn) rescue blitz. António de Sousa, head of Portugal's bank lobby, said his members are in dire straits. Banks cannot raise funds abroad, remain "extremely fragile", and "quite simply" will have nothing more to lend unless foreign capital returns.
Portuguese banks cannot survive on local savings. They rely on foreign funding to cover 40% of assets (IMF data). Hence an urgent meeting between the central bank governor and President Cavaco Silva for an hour-and-a-half late on Friday. The governor said global funding for Portugal was drying up. Markets would no longer tolerate Portugal's leisurely pace of fiscal tightening.
Hours later, Portugal's leaders agreed in principle to bring forward the 2011 budget. So much for hopes that they could avoid cuts and let growth trim the deficit from 9.3% of GDP in 2009 to 7.3%. The first casualty is likely to be the high-speed train to Madrid.
Yet what exactly will austerity achieve? Combined private and public debt is 325% of GDP (viz 247% for Greece), so the country already risks a debt-compound spiral. Lisbon has been cutting state jobs for several years. This has certainly crimped growth, but not cured the problem. Productivity is stuck at 64% of the EU average.
The brutal truth is that Portugal lost competitiveness on a grand scale on joining EMU and has never been able to get it back. Convergence never came. Ireland has shown what happens when you grasp the fiscal nettle, slashing public wages by 13%— to applause from EU elites— without offsetting monetary and exchange stimulus. Irish bonds have spiked even higher to a post-EMU record 6.38%.
This was triggered by two client notes: Barclays said Ireland may need the IMF's help. Citigroup's Willem Buiter said Ireland "may not be able to make whole" creditors of both sovereign debt and the bank. Dr Buiter has also said a default by Greece is "a high probability event".
Two years into its purge, Ireland has a budget deficit near 20% of GDP. It is 12% if you strip out the bank rescues, but the reason why the bad debts of Anglo Irish keep spiralling upwards is that the economy keeps spiralling downwards. House prices have fallen 35%. Nominal GDP has contracted 19%.
"Ireland's debt is ballooning, while its capacity to pay has collapsed," said Simon Johnson, ex-chief economist at the IMF. He said the country has made a Faustian pact with Europe, able to draw ECB loans worth 75% of GDP so long as Irish taxpayers shield European creditors. In any case, the IMF itself has become the problem, operating as an arm of EU ideology under Dominique Strauss-Kahn. It offers no remedy since it acquiesces in the EU's ban on debt-restructuring.
In Greece it backs a policy that will leave the country with public debt of 150% of GDP after its ordeal— allowing French and German creditors to shift a big chunk of Greek risk to Asian taxpayers through the IMF, and to EU taxpayers through the eurozone rescue. Mr Strauss-Kahn committed up to €250bn of IMF money for Europe's rescue without prior approval from the IMF Board, to the fury of Asian directors. He has promulgated an insidious doctrine that sovereign defaults are "Unnecessary, Undesirable, and Unlikely".
Let us be honest, the Fund has become a font of incoherence, an engine of moral hazard. In August, it abolished its credit ceiling and created a new tool to rush fresh debt to states that need more debt like a hole in the head. Simon Johnson says the solution for EMU's orphans is debt reduction along the lines of "Brady Bonds" in Latin America in the 1980s, forcing creditors to share pain in an orderly fashion and giving debtors a way out of the morass.
In fairness to EU policymakers, perhaps the problem really is simply too big. If they let Greece, Portugal, or Ireland restructure debt, they risk instant contagion to Spain, and from there to Italy. Perhaps they really have no choice. If so, monetary union has indeed created a monster.
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