Thursday, March 31, 2011

The Noose Tightens on Southern Europe

We've been waiting a long time to see when interest rates would rise in Europe. The ECB has been giving signals for the last month that it will raise them at its next board meeting in early April.

The ECB is concerned about inflation, so rates will rise. That means the euro zone's countries with deficit problems are about to see them get worse.

Monday, March 28, 2011

Greece's search for the exit

Greece's Finance Minister, Giorgos Papakonstantinou, has started to look for the exit. Emerging from a cabinet meeting today, he declared that Greece's economy is on the road to recovery, that tax cuts will be introduced on fuel, and that privatisations should not be pursued rashly, lest the country lose control of the foundations of controlling its destiny.

This comes just days after the EU Heads of Government committed fresh new funds to the European Financial Stability Facility under the Euro Plus Pact. That pact provides funds, but increases the likelihood that countries who let the finances spin out of control will face financial penalties, and eventually be left on their own.

The ink on that agreement is hardly dry and the Greek government does not look impressed. It claims that economic growth rates between 30 and 40 per cent are removing the necessity to make hard choices.  How convenient.

Assuming Greece's financial statistics are as poor as they ever were, Europe now faces a choice. It can drive a sword through its freshly-minted Pact (and indeed, there might be good reasons for never having agreed to this pact). Or it can turn the sword on Athens. You can imagine which option Berlin would prefer.

This should be interesting. The Greek governmnent sees itself not as Persephone, but more like  Asterix and Obelix. Whose view will turn out to be right?

Popcorn, anyone?

Tuesday, March 22, 2011

Portugal's next

It's been clear for some time that Portugal would be the next target, but the timing was an open question. This week, however, interest rates for Portuguese bonds have held above 8 per cent, and a political crisis has followed, which is likely to collapse the Portuguese government. 

The Prime Minister's office will now reap what it sowed when it acquiesced to tighter fiscal constraints on national governments that Germany and a few other creditor countries have demanded in return for institutionalising financial aid to the euro zone's debtor countries. That deal has been cemented just recently. It remained silent, hoping that financial markets would believe they had reason to be confident they wouldn't be next in line. 

But this is folly. Bluffing doesn't work when the situation is entirely clear to everyone. Portugal has never had anything resembling control of its public finances. Yes, it has had devastating natural disasters that have hurt the economy and the government's tax revenue for which it can do nothing, but Portugal also has no discipline. This is key in assessing its capacity to reform its finances. There is no evidence that successive Portuguese governments every intended to restrain the country's finances. They got a free ride during the euro's early years, as Germany and France were breaking the rules, but the free ride is over.

There are three ways to interpret the behaviour of the Portuguese government with regard to the austerity measures demanded by Europe's creditors. The first is that they realised they were in grave financial danger, and were willing to reform, but simply hoped that signalling strength would reassure markets not to flee the country. The second, is again that Portuguese parties are willing to exercise discipline, but no one wants to be first and reap the political backlash that ensues. The third possibility, and the one I fear is most likely, is that Portugal is in the grip of a Greek-style delusion that they can go on living as they have, because someone will bail them out. 

They're in for a rude awakening.