Euro update (21): Round up of events in Q2

I am back from my break. In my 3 month blogging absence, Portugal, Japan, North Africa, the Middle East and Greece figured prominently on the news. The following is a fairly chronological list of the events.

1)The Portuguese government messed up the proposal of the Stability & Growth Package IV on March 18, leading to its rejection on Wednesday March 23 and prompting the resignation of the PM and a call for new elections. It’s not clear to me that they messed it up or whether the finance minister pulled the plug on the government by purposely messing up. Although this is based on nothing solid, it is plausible. Nonetheless, Ocam’s razor would imply that stress, tiredness, lack of time or incompetence might be better suitors. Whatever the reason, they messed it up by presenting it as a fait accomplit without debating it with the opposition and while still in the middle of negotiations with social partners. Although a bailout was inevitable, the political crisis certainly speeded things up, with credit rating agencies chopping away.
The PSD campaigned miserably bad, as we can see in the chart below. It was unable to both compete with the well oiled communication machine behind Socrates’ PS and rein in on the language of it’s own officials (a pubic hair analogy was used at a certain moment). Nonetheless good debate performances by Mr Pedro Passos Coelho, the party leader, gave them a bump in the polls which were sustained by the dishonesty of Mr Socrates once it was revealed by the IMF that his interim government had agreed to a “substantial” contraction in social security rather than the more “modest” version he had advertised.

Anyway, in the middle of all this internal political mess, the markets just gave up on Portugal, the yields exploded and we had to get bailed out. Here’s the agreement, which after much wrangling and noise from populist parties in Finland, was finally signed on May 17 (EC and IMF versions). It was amusingly scary to witness the ignorance of Portuguese bankers and commentators who kept on expecting some sort of intermediate lending facility to be unconditionally provided until the election was over. The only thing that beats that was to see Barroso’s reaction when asked about that possibility. Finally, here is what Portugal’s sovereign bonds have been up to:

2)Japanese earthquake Tsunami – This was a greyish Swan, at least. A sad and avoidable loss of human life and most likely a shock to the supply chains of the world economy.

3) Muslim freedom spring: It’s 1848 all over again, this time in North Africa. That Tunisian vendor will get a statue somewhere, sometime, and that statue will make despots and their parasitic acolytes fear digital networking and the frustration of their people. This is a lesson that should not go unneeded in Europe, where democracy provides only a limited release for social frustration.

4) War with Lybia – lawyers might quibble over the correct wording and apparently depending on the interpretative generosity of the judge it would have been classified as either a Genocide or a Massacre, but we can all agree that the attack on Bengazi would have been a revolting loss of life. The fact that the intervention is UN sanctioned, Arab league sanction and GCC sanctioned was a great and necessary legitimiser. The fact that European countries took the initiative gave great pride. The fact everything was logistically a mess was rather embarrassing. At least it did not jeopardise the intervention and at best it exposed the outdatedness of a military infrastructure that is underfunded, inefficient and outdated. Hopefully these and all other problems will be fixed on time.

5) ECB increased interest rates. A painful measure required by a myopic law, the origin of which is not so stupid…

6) Greece failed to meet targets of IMF/EU assistance package and so now it needs a new bailout. This wasn’t very surprising, because the underlying growth assumptions were unrealistic under the recessionary environment created by fiscal austerity. What is surprising is the “smart-arsery” of Greek politicians who believe they can get away with not privatizing some state enterprises. These are not public goods that cannot be provided by a well regulated private sector. This is pork, political currency, which politicians use to pay for support and favours. To value it that much is indicative of how dysfunctional the political environment is in Greece. The idea that they could agree to something and refuse to implement it signals that Greek officials are willing to exploit potential time inconsistencies, which undermines the credibility of future commitments.

7) The new Portuguese government took office on June 21. It has +/- 5 PPD/PSD politicians, 3 from CDS/PP and the rest are independent technocrats, among whom the Finance Minister, an old economic counsellor of Mr Barroso in Brussels. Good officials. Now the success of the government depends on party and coalition cohesion and discipline, which should last at least as long as the crisis doesn’t create too much civil unrest.

8)Germany started another mess. First by publicly demanding that private holders bear some of the weight by “voluntarily” accepting to take debt rollovers or debt exchanges. Markets have not enjoyed the confusion that ensued and it led to a lot of attrition in the Eurozone. It all calmed down a week or so ago, when Mr Sarkozy got Ms Merkel to roll back her most ambitious demands. Whether the voluntary debt rollover will actually occur is still to be seen. Don’t get me wrong. The problem isn’t private bail in. That might be inevitable. What is problematic is Germany’s necessity to lead/be part of the cacophony of voices creating uncertainty. There should be internal debate and public union. For now at least, we are left with “Vienna Plus“, a solution akin, but different from what international (Austrian, German and Swedish) banks did in Eastern Europe during the zenith of the financial crisis.

9) Greek cabinet reshuffle on June 17: by replacing a technocrat by a political operative with his own power base, Mr Papandreou stately put his country before his ambitions and ego (the man offered to resign if it helped bring the opposition New Democracy party (the one that started this mess by wreaking havok in the public accounts)). Mr Venizelos is a big man with a big voice, an agenda and not a lot of financial knowledge or experience. However I think he’ll help hold the peace for however long it is possible, but not much longer. It should however facilitate the passing of the Medium Term Fiscal Package necessary to get the next tranch of IMF/EU assistance.

There were also some minor (under the radar) events, with important repercussions:

1st: This actually happened before I left, but I didn’t pick it up then: The Eurozone member states discovered that they could use something called Emergency Liquidity Assistance (ELA) to deal with their banking problems. This is basically a very dark situation where the ECB turns a blind eye to what its national Central Banks are doing. Although they have to warn the ECB that they are pursuing these measures, the procedure for allowing this is semi automatic meaning that the national central banks are allowed to do it unless a blocking 2/3 majority is found. They can then channel their pooled resources to give almost unlimited assistance to banks. I’ll need to read a bit more on this, but here and here are some introductory insights by FT Alphaville and a good article by Citi’s Buiter. Expect a post on ELA asap.

2nd: ESM Treaty draft started circulating [March 25, 2011 Draft (as found @ Open Europe)]: in it’s preliminary version Eurozone countries seem content to pursue that time honoured EU mistake – decision by unanimity… It’s a great way to find deadlocks and to create legislative bottlenecks. Nonetheless, recent Council reports describe a willingness of member states to be treated par-i-passu with private investors when the Irish, Greek and Portuguese debt is transferred from the EFSF to the ESM. This means that if they default, the ESM won’t had to be paid before private creditors. The usefulness of this fact is probably rendered mute by the fact that a default on sovereigns would probably be considered a credit event by rating agencies, which would force the ECB to reject Greek sovereign debt as collateral and thus leave the Greek banks underfinanced, which could lead to bank runs in Greece, if not on the German landsbanken. By the way, this is a policy choice, not a strictly legal or constitutional requirement of the ECB. Given how flexible it has proven in the past, it is likely that it would prove flexible on this matter as well. More scenario analysis later, though.

2nd: FRONTEX commitments became irrevocable on June 22.

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