Another weekend, another eurozone crisis. This time it’s Portugal.
The doughty little country has managed to stay below the radar for a surprisingly long period of time. Given that tiny countries — like Cyprus — can still cause tremendous headaches for the eurozone, that’s an achievement.
It’s come about primarily because Portugal has been a ‘good’ eurozone member so far, and taken its austerity medicine with gusto.
But now Portugal’s constitutional court has told the government that it’s taken austerity too far. On Friday night, it threw out plans to cut public sector wages and pensions, sending the government back to the drawing board.
The money will likely be found somewhere. But that’s not the point.
Portugal’s woes point to the next phase of the eurozone crisis — one that even the European Central Bank will find much harder to deal with…
Portugal got a bailout deal from the eurozone two years ago. In return, it promised to get its budget back on track.
That hasn’t happened yet. By now, Portugal’s budget deficit (its annual overspend) was supposed to be back below 3%. That deadline has already had to be extended to 2015.
It looks like it’ll have to be extended again. The Portuguese constitutional court has just blown a big hole in this year’s budget. The government had aimed to save about €5bn this year.
The court has said that some of the cuts to state pensions and public sector wages are unfair. So the Portuguese government now has to find other ways to save about €1bn of that €5bn.
This in itself is not a huge problem. Portuguese prime minister Pedro Passos Coelho said he will do ‘everything to avoid a second bail-out’. So services, rather than wages, will be cut.
And Portugal was set to miss the 2015 target anyway. So this apparent lack of co-operation by the court gives Mr Passos Coelho a good excuse to ask for more time. Portugal has enough brownie points with the ‘troika’ (the eurozone bail-out committee) to have earned a sympathetic hearing.
Because it’s yet another sign that national politics in the eurozone is starting to seriously undermine regional politics.
Let’s remind ourselves of the basic problem in the eurozone. Germany is the region’s biggest economy. So it’s only natural that it’s going to have a big influence on monetary policy.
The way Germany sees it, all of the countries that have ended up in trouble are in need of reform. And it’s hard to argue with that. Italy, Spain, Portugal, Greece — they could all do with more flexible labour markets, and probably with more efficient tax systems, among other things.
The trouble with structural reform is that it’s painful and uncomfortable. It’s also politically unpopular. So countries will often only do it when their backs are against the wall.
So Germany doesn’t want the European Central Bank (ECB) to use monetary policy to give these southern Mediterranean countries an ‘easy’ way out. That would remove some of the incentive to reform.
(Germany doesn’t really like the idea of money printing in general either, as it’s the country most likely to suffer from inflation as a result of it.)
Again, on one level, it’s hard to argue with this. Why should Germany take the strain of bailing these countries out if they’re just going to go back to their old ways?
But you can see it from the point of view of the Italians and the Portuguese too. At the end of the day, isn’t it up to them — as sovereign nations — to decide if they prefer to run their economies as borderline basket-cases? Particularly if the evidence so far suggests that austerity isn’t really working for them?
It boils down to the problem that has always been at the heart of the euro project. You can’t have currency union without political union. And no one has ever made that clear to the voters in the eurozone. In fact, they deliberately hid that fact because they knew that no one would vote to give up their sovereignty.
But in the heat of the crisis, the true nature of the problem is becoming increasingly clear. Politicians in Portugal and Greece and Italy have been trying to make their countries more ‘euro-worthy’. But amid the pain this is causing, voters and national political bodies are rebelling.
Italy has no government. The Greeks only narrowly voted in a pro-euro party at the election last year. Now the courts have struck a blow against Portugal’s current government. How long will it stay in power?
The longer this is allowed to continue, the closer that voters will come to the truth of the matter: if they want self-determination, they have to leave the euro. That means that to protect the euro — which is ultimately its job – the ECB has to find a way to make life less painful for voters in the periphery countries.
People are scared of the unknown. And ditching the euro is definitely a leap into the unknown. It would probably be better in the long run for many of these countries. But in the short-term it could mean savings are destroyed and businesses collapse.
What the ECB has to do is to stop voters from getting so desperate that they decide a leap into the unknown is better than what they currently have.
The big problem is the German election in September. Once that’s over, Angela Merkel (assuming she’s still in power) will no longer feel the need to adopt such a hard line on austerity. But until then, she has to act tough, and talk tougher. So the ECB’s options are limited.
However, the ECB’s job is fairly simple. It boils down to keeping the euro weak. And the worse the various crises become, the more excuses it has to act. And assuming the euro is still around come September, I can see quantitative easing being launched as soon as politically possible.
In short, I don’t see the euro being allowed to strengthen far beyond where it is now (about 1.30 against the US dollar) this year. And I can see it eventually becoming much, much weaker.
John Stepek
Contributing Editor, Money Morning
Publisher’s Note: This article first appeared in MoneyWeek
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