Monday, 19 April 2010

No German rescue for Portugal

Because of the volcanic ash crisis the monetary experts from the EU and the IMF have been unable to get to Athens to deal with the Greek debt crisis. Next up is Portugal. They cocked up the EMU entry, got ticked off by the EU, but took their medicine and were good boys for the next 10 years unlike the spendthrift Greeks but their economy has stubbornly refused to improve. Their public debt is 86% of GDP compared with 123% for Greece but their private debt reached 239% of GDP in 2008 compared with 123% for Greece. Their private debt is estimated to be headed for 300% of GDP this year! Too many expensive villas on the Algarve perhaps.

Portugal has been better run financially than the UK for the last 10 years. They have been cutting public sector jobs for a number of years. House prices have been restrained. Its banks did not need bailouts. That is a huge warning to what is going to happen to the UK. Their problem is their export industries cannot compete and their productivity is low probably due to a rigid labour market.

Their budget deficit is 9.3% of GDP. The Brussels solution? More cuts in the public sector! All this to a minority Socialist government. Sounds like more riots to me.

The Germans now realise they have been conned by the EU 'crats into underwriting the Greeks. Once bitten twice shy. They are also reading up on the history of the Latin Monetary Union of 1865. I quote from the Wilkepedia description of this previous European attempt at monetary union.

It was dreamt up by the French, obsessed, as usual, by their declining geopolitical fortunes and monetary prowess. Belgium already adopted the French franc when it became independent in 1830. The LMU was a natural extension of this franc zone and, as the two teamed up with Switzerland in 1848, they encouraged others to join them. Italy followed suit in 1861. When Greece and Bulgaria acceded in 1867, the members established a currency union based on a bimetallic (silver and gold) standard.

The LMU was considered sufficiently serious to be able to flirt with Austria and Spain when its Foundation Treaty was officially signed in 1865 in Paris. This despite the fact that its French-inspired rules seemed often to sacrifice the economic to the politically expedient, or to the grandiose.

Now does that not sound chillingly familiar? It does to Dr Frau Merkel who has developed a sudden recent interest in this bit of monetary policy history.

The central banks of the member countries pledged to freely convert gold and silver to coins and, thus, were forced to maintain a fixed exchange rate between the two metals (15 silver to 1 gold) ignoring fluctuating market prices. A sure recipe for silver smuggling as its price fell below 1/15 of the gold price. The Scandanavian monetary union of the late 19th century eventually fell apart under similar pressures to buy gold at the official price.

The perceived reason for the LMU failure was no central bank. The Brussels 'crats fixed that in the Maastricht Treaty with the ECB but then realised they needed political union as well hence the Lisbon treaty was pushed through against national opposition. Now a central bank and a political union are as we mathematicians say, are necessary but not sufficient conditions for monetary union. A sufficient condition is a unified Treasury which Dr Frau Nerkel knows means handing over control of German wealth to club Med. She can never agree to this and remain in power in Germany so a line in the sand has to be drawn and that line is Portugal.

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