The Eurozone resembles a vast dyke which is full of holes and liable to disintegrate at any moment. This note concentrates on Portugal, where the recent resignation of the very able finance minister, Vitor Gaspar, was a huge disappointment. (It must be said that the Eurozone’s holes in Greece, Spain, Italy and France also remain large and conspicuous, despite international officialdom’s attempts to patch them.) Portugal’s problems arise partly because the economy’s trend rate of growth is now very low, perhaps even zero or negative. Gross domestic product per head is lower than ten years ago. With inflation almost zero, nominal GDP is at best flat. As a result, any deficit leads to an increase in the ratio of public debt to GDP. A May 2011 bailout negotiation with the ‘troika’ extended €78b. of loan and other financing, to help the Portuguese government and banking system. It must be acknowledged that Portugal has tried hard, with Gaspar at the finance ministry, to meet the conditions attached to the bailout plan. The cyclically-adjusted budget deficit fell from 9.0% in 2010 to 4.0% in 2012. Nevertheless, the debt-to-GDP ratio has kept on rising and is now over 120%, the kind of figure that was associated with the Greek dégringolade in 2012. (A fair verdict is that a debt-to-GDP ratio of 120% is sustainable when the nominal interest rate on the debt is 5% or less, but – once the interest rate goes into double digits – the debt interest burden runs amok like a Frankenstein monster.) The Portuguese people are apparently weary with austerity, and it has to be said that – without a resumption of growth and particularly of asset price appreciation, which would help banking solvency – the danger has to be that further deficit-reduction measures would not restore fiscal sustainability or national solvency. Holders of Portuguese banks’ bond liabilities and depositors with Portugal’s banks, you have been warned! PEXIT (Portuguese exit from the Eurozone) is – almost certainly – a better option than staying in.
Recent reports in the newspapers suggest that the Greek budget deficit might be 8½% - 9% of GDP in 2011, above the target of 7½% or so agreed with the IMF and the EU, but within striking distance of it. In fact, the data available so far indicate that the deficit is heading for about 15% of GDP, although this might be an over-estimate if the closing months of 2011 see immense receipts from privatisations. Assuming that privatisation receipts are negligible (which is reasonably in the current traumatic environment), Greece’s budget deficit is like to be about double the target agreed in last year’s bail-out package. Greece cannot be allowed any more wiggle room. But, because cutbacks in government spending (i.e., a tighter fiscal policy) cannot be offset by an easier monetary policy, attempts to slash the budget deficit are counter-productive. The debt is rising remorselessly towards 175% - 200% of GDP, while the market interest rate on new and maturing public debt is far into the double digits. Greece is completely bust and beyond rescue.
Financial crises in the Eurozone periphery are being accompanied by regulatory demands that banks have more capital and shrink their assets, along with reinforced fiscal stringency. So Eurozone M3 – which saw a resumption of growth in summer and autumn 2010 – has stagnated again in the last few months. (M3 was 9,302b. euros in January 2010 and 9,522b. euros in August 2010, implying an annualised growth rate in the seven months of 4.1%. In February 2011 it was 9,543b. euros, barely higher than six months earlier. Last week’s e-mail showed how Ireland’s money supply crashed in 2010, even while banks in other Eurozone countries were expanding their balance sheets. The official pressures on banks in the peripheral countries [i.e., the ‘PIGS’, Portugal, Ireland, Greece and Spain] to raise capital and sell of loan portfolios are clearly a major factor in the latest money slowdown. Because of the recent oil and commodity price surge, real money balances have been falling since autumn 2010. This fall has been most pronounced in the peripheral countries, and is negative for demand and output in their economies this year.) But demand pointers for the Eurozone as a whole, such as leading indicator indices, are satisfactory, even good. The messages have to be that the divergence in macro conditions between the core and periphery will widen in the rest of 2011, putting further strain on the Eurozone’s integrity, and ii. although German export strength may continue, the Eurozone economy will face a monetary headwind in spring 2011. A weakening in business activity would have been likely even before the ECB’s rate rise. The risk of a pause in the Eurozone’s recovery has been increased by the fall in the dollar against the euro, which has advanced since early January from roughly $1.30 to almost $1.45. The euro’s advance, of about 10% or so, seems difficult to justify by the change in interest rate differentials.