By CHRIS GRAEME [email protected]
In the last few days we have seen a wave of indignation against the ratings agencies, in particular Moody’s, for downgrading Portugal and her banking system – despite the fact four of her banks passed European Central Bank stress tests.
Part of the problem, it seems to me, is that the ratings agencies are not so much deliberately picking on Portugal, or Ireland or even Greece for that matter.
What is really going on is a knee-jerk reaction to the general lack of political consensus within the European Union to act in one voice and deal with the crisis.
Moody’s decision to slash Portugal and Ireland’s ratings and Standard & Poor’s threat to also downgrade various European economies seem to indicate that they do not believe that the austerity plans are really working.
Within the context of the high national indebtedness of Portugal’s families, firms and the state, any move to slash the public deficit quickly by raising taxes or cutting services runs the risk of strangling the internal economy, internal demand and, as a consequence, the amount of taxes that the government can raise.
The events of the last few days have clearly shown the extent to which political power in Europe is being held hostage to the European financial system which doesn’t want to accept any further losses to its tax payers – particularly tax payers in Germany and France.
It is very easy to blame profligate southern European countries for living beyond their means and failing to reform their inefficient and costly bureaucratic systems.
But before we point the finger, perhaps we should take a look at the French economy and system.
The United Kingdom and Portugal have been propping up their agricultural system for years with subsidies through the Common Agricultural Policy which has left Portuguese agriculture high and dry.
At the same time France has never seriously tackled its unions, over-generous social welfare system and the inflexible contracts that make the country and its firms so uncompetitive.
At the same time the European Union demands a strong euro for its expansion strategies, which is why there have been counterproductive interest rate increases by the European Central Bank.
With the imminent threat of Greek default on the horizon and that phantom of fallout spreading to sovereign debt markets dealing with Spanish and Italian bonds, we are inevitably heading for a new phase in the crisis which is spreading across the Atlantic to the United States.
We are no longer dealing with a few small peripheral countries like Greece, Portugal and Ireland whose total debt percentage represents barely 6% of the total. We’re now talking about Spain and Italy, large economies combined debt represents over 40% of Europe’s total.
The German magazine Der Spiegel has revealed that former German Chancellor Helmut Kohl believes that Angela Merkel’s policies are “very dangerous” and “destroying the European project”.
Referring to a conversation he had with a friend, Kohl criticised the way Germany has been dealing with the current sovereign debt crisis in the Euro zone and the role Merkel has had in the European project and the single currency.
Kohl believes that Germany has always been successful when it helped others and that Germany needed to continue the European Union project since the future of Germany, after two world wars, was clearly with its European neighbours as partners in a European Union.
Perhaps he is being unfair on her. She has lost major regional elections giving ground to the right in Germany who no longer believe in the European project and want a return to the Deutschmark.
Large sections of the German parliament and society agree. According to polls in that country the majority of Germans (80%) believe that helping countries like Greece and Portugal is akin to throwing money down the drain.
The majority of German citizens believe that Berlin should never waste tax payers’ money on countries that do not obey the European Union’s budgetary rules.
But the truth is that until the 2007 crisis, which started in the United States, Portugal had for many years met the strict EU Stability & Growth Pact rules which demanded that Portugal’s debt had to be below three per cent of her annual GDP.
The problem was that Portugal, like many European countries, was forced to throw money at the financial system to stop the economy collapsing and didn’t have the savings, growth rates or tax revenue to support the additional spending.
But that is academic. We are now we are dealing with a systemic North Atlantic and pan-European crisis affecting not only Portugal, which has its own particular failings and problems, but also the United States which in the words of Barrack Obama is facing a “default Armageddon”, Italy, Spain, Belgium, Ireland, Portugal, Greece and possibly France too.
So what are the choices on the table that one way or the other the European Union must take? The first scenario, after a probable Greek default is for Greece and perhaps other European Union countries to leave the Euro. This will happen with Greece, certainly, if the European Union fails to reach agreement on issuing a further bailout or restructuring the debt soon.
This would, in the short-term, cause hyper inflation, the banks would be unable to get any credit, and many would go bankrupt because of their external debt in euros.
Three crises would coincide at the same time: a debt crisis, a banking crisis and an exchange crisis. This in turn would lead to record unemployment and social upheaval.
The second possibility would be an organised exit from the euro, sovereign default would be done through exchange devaluation and payments would be made in escudos instead of euros.
The third possibility is for the European Union to show a common front, renegotiate the debt repayment schedules over a longer period and move towards greater fiscal and budgetary centralisation at a European level.
None of the options on the table are easy and all have their opponents. But if Europe and the United States don’t come to an agreement soon on debt restructuring soon, the whole European project will unravel and we will face the worse economic crisis since the 1930s for real.
