One forward gear

A man hears what he wants to hear and disregards the rest – Paul Simon

The accountants are down in Lisbon. It’s a nice time of year to be there, with the breeze blowing off the sea and the beautiful people hopping on and off their trams as they grind up the hill. What are they going to find? Will it be (a) things are much as we expected (b) no problems, really, far better than we thought or (c) Oh God! They never told us about..... Make a little bet with yourself.

A deal will be stitched together for Portugal, not dissimilar to that for Greece: some austerity measures and some more loans, like giving a bottle of whisky to an alcoholic and remarking that at least he has stopped sweating. Of course the Portuguese have already democratically rejected an austerity package, which didn’t look all that tough. How are they going to react to one imposed by an outside power? These are people who can still remember Dr Salazar, and cherish their democracy and their independence.

How has it gone for Greece, about a year after the bailout was announced? Not too good, I’m afraid. The markets are certain that Greece must default, this year or next year. What we mean by default here is that rather than saying they can’t repay their debt and borrowing more, they actually agree not to pay some of it back. It seems Greece will have to write off more than half its debt.

Who owns this debt? Who is going to take the haircut?

Greek banks own €80 billion. A €40 billion loss will pretty well bankrupt them, which means they will need...... oh, yes, more debt. The European Central Bank owns a good €50 billion which will weaken it fatally. Of course the ECB can’t go bust, it just calls for more capital from its members. It is doubtful whether given the other dodgy debts on the ECB books that Italy and Spain can afford to pay their share, meaning... oh, yes, more debt. The rest, over €200 billion, is owned by European banks, particularly German.

How so? Well, banks have to provide capital to back their lending and different amounts of capital are required for different types of lending. The worst category is making unsecured loans to private individuals. Then, rather less capital is required for mortgages, where the bank has security. Obviously a certain amount of the bank’s assets have to be in the top category, which would be sovereign debt: European sovereign debt.

Now, the regulators aren’t stupid people. They became aware some time ago that the debts of peripheral Europe were only worth 80 cents on the dollar and that Greece and Portugal were only worth 60 cents on the dollar. They considered making new capital requirements, but the answers were too horrid. So they buried their heads in the sand.

German banks alone have over €200 billion of loans to peripheral European countries, loans which really should be written down, and billions more capital provided. But they can’t. So when they announced the ‘stress tests’ for the banking system they ignored the issue. This is as much a crisis of European banking as of sovereign debt, and even if all you can see in front of you is sand it doesn’t mean the problem isn’t there.

But it’s an ill wind that blows nobody any good and there are some people who see an upside here. In attaching conditions to the bailouts, the budgets of these countries will be decided by the European Commission and the ECB. They will be colonies of Brussels. Wherever the problem lies, these people assert, the solution is more European integration.

So how did we get here, with previously independent democracies suddenly governed by a superstate? You have to remember that the economies of Greece, Portugal and Spain are almost moribund (I exclude Ireland here which simply allowed a property bubble to exist: the underlying economy wasn’t bad). They are so fantastically inefficient, particularly in relation to Germany, that they were always going to go bust at the exchange rate fixed by Frankfurt, and unless steps are taken to change their competitiveness they always will be. And the political elites knew this: they’re not stupid. They knew that sooner or later a crisis would develop to which the answer would be more political integration. This is why I often say that the euro was conceived in dishonesty. Damn the little people, full steam ahead with integration!

It is my hope that the Greeks or Portuguese will finally say No, we don’t want to be governed by others, we want to be free.

Now that will be interesting.