The implications of the new (flawed as usual) bailout plan from the Euro Zone for Portugal Ireland and Greece

After covering Japan in-depth so far this week I intend to move onto other economic  matters today. Before I do there are some matters to touch on.Looking at the markets Japanese shares have staged something of a recovery overnight with the Nikkei 225 equity index rising over 5% to 9093. However I have to confess concern at two things. Firstly that the Japanese Emperor spoke to his people and secondly that he said that he was “deeply worried”. If you look at Japanese culture that has an ominous tinge to it. Things may have changed a little since the end of the Second World War but the Emperor then managed to avoid saying that they had lost! As Japanese Emperor’s speak very rarely this news makes me concerned that there may be more bad news to come from the four stricken nuclear reactors.

Japan and a problem with how we measure economic growth

The Japanese situation illustrates a clear problem with how economic growth is measured. Ordinarily we use estimates of Gross Domestic Product (GDP) but it does have flaws. Consider this. We have seen a lot of destruction in Japan due to the earthquake and tsunami but this is not recorded as a loss of economic output whereas when such buildings are replaced we see a positive contribution to economic growth as measured by GDP. If you are currently homeless until a new one is built you may wonder as to why there is no measure of your loss and to my mind you would be right. I doubt if anybody will ask if you prefer the new home.

My suggestion would be that for the purposes of measuring economic output we should also have a measure for improvements in the national stock of wealth. For example a new modern building may well be better than the one it replaced and we should try to measure this. Otherwise we run the danger of any destructive national disaster leading to an increase in GDP growth when reconstruction begins without allowing for the losses which take place. For countries unaffected by the disaster the situation is simpler as if they produce something it increases their GDP but for the country affected we need to develop a measure of the loss in my view. Otherwise our estimates for GDP will diverge from the true economic situation and the bias is always likely to be upwards.

The Euro Zone’s new policy for the peripheral nations

Over the weekend Euro zone ministers and officials met to discuss what they can do about the problems afflicting the peripheral nations of Portugal, Ireland and Greece and which looked like they might spread further to say Spain and Italy. Let us look at what they came up with. By ESM they mean European Stability Mechanism and by EFSF they mean European Financial Stability Facility.

The ESM will have an overall effective lending capacity of 500 billion euros. During the transition from EFSF to ESM, the consolidated lending capacity will not exceed this…………. Until the entry into force of the ESM, the agreed lending capacity of 440 billions euros of the EFSF will be made fully effective.

This addresses in theory the main problem of the EFSF which is that whilst it has a theoretical capacity of 440 billion euros because of incompetence in its design it can lend in reality only up to 250 billion Euros. However you may note that there is no description of how they are going to increase its size! We have been told this many times before and it has not happened so readers may be forgiven for an attack of deja vu. Also when the ESM replaces the EFSF in mid-2013 it is going to be larger. This rather contradicts the official view which to quote D Ream is that “Things can only get better” does it not? If so why do they need a larger rescue fund? Also the ESM will require individual nations to raise some of its capital er Greece, Ireland Spain……

However, to maximize the cost efficiency of their support, the ESM and the EFSF may also, as an exception, intervene in the debt primary market in the context of a programme with strict conditionality.

This has led to something of a stir as it suggests that these instruments could for example take up a bond issue or issue from a country in trouble. This is different from the Securities Markets Programme of the European Central Bank which only buys in secondary markets ( However the SMP has recently operated at the same time as debt issues in Portugal which blurs the line a little). However I do not feel we will see debt issues from say Greece taken up by these mechanisms yet as there are many checks and balances in the system as otherwise such purchases would go straight to the German Constitutional Court. Should it begin to operate this is one of the steps towards fiscal union which is probably the real reason it has been proposed. Rather than for use now it is intended for later use in response to a further crisis. Somewhat sneaky I think.

Pricing of the EFSF should be lowered to better take into account debt sustainability of the recipient countries, while remaining above the funding costs of the facility, with an adequate mark up for risk, and in line with the IMF pricing principles. The same principles will apply to the ESM.

Finally a genuinely good idea although yet again the German Constitutional Court is hovering in the wings. It may yet rule such assistance as being illegal.

Some better news for Greece

Against this background and in view of the commitments undertaken by Greece in the context of its adjustment programme, the interest rate on its loans will be adjusted by 100 basis points. Moreover, the maturity for all the programme loans to Greece will be increased to 7.5 years, in line with the IMF.

Essentially in return for promising to continue with its austerity programme and intending to make some 50 billion Euro’s of privatisations Greece gets a cut in the interest-rate applied to it from 5.23% to 4.23% which is good news for her. Also the period of her loans gets extended too. Whilst these are both helpful moves they remind us of the confusion at the heart of Euro Zone policy. When the ” rescue” for Ireland was instituted we were told that Greece’s loans were going to be  at 5.8% and for ten years which was an extension of 7 years and a rise in interest -rate of around half a percent. Now they are at 4.23% and are for 7.5 years. No wonder markets have lost faith many may be wondering what the next interest-rate and term will be! It would appear that the concept of planning for the long-term is alien to Euro Zone politicians and officials.

Why not Ireland too?

This is rather simple. Greece had to give up her objection to more privatisations in return for a cut in interest-rates and regular readers may remember the dispute on this point a few weeks ago. But Ireland has stood firm on the issue of raising her Corporation Tax rate which is currently the quid pro quo of a cut in the interest-rate on her bailout package.


The reduction in the interest-rate for Greece is welcome although I wonder how many time s the Euro Zone will announce it has extended its loans to her! Most of the other changes have a heavy element of deja vu and ennui as we have seen them before. But there is a proposed move towards fiscal union with the concept of the EFSF and the ESM potentially purchasing primary government bond issues. This brings the idea of a joint “Eurobond” nearer. It is plain to me that such a Eurobond would need many conditions and with the Euro zones record of sticking to conditions the words of Charlie Brown’s dog Snoopy come to mind “Good luck with that (with the implication that you are going to need it!)”

Portugal is downgraded by Moodys ratings agency

Moody’s Investors Service has today downgraded Portugal’s long-term government bond ratings to A3 from A1 and assigned a negative outlook.

Not entirely as auspicious welcome for the new improved Euro zone support package (which implicitly stands behind Portugal) is it? If we put to one side the fact that the three main ratings agencies as a minimum need major reform let us look at the detail of why Moodys have done this. From the Financial Times we get.

1. Subdued growth prospects and productivity gains over the near to medium term until structural reforms, especially in the labor market and the justice system, begin to bear fruit;

2. Implementation risks for the government’s ambitious fiscal consolidation targets;

3. The government’s balance sheet may need to expand further in the event it has to provide financial support to the banking sector and government-related institutions (GRIs), which are currently unable to access capital markets; and

4. Challenging market conditions that have led to increases in the government’s financing costs, which, if sustained, will cause its debt affordability to weaken, particularly in the context of generally higher European interest rates.


The essential problem at the root of this is a lack of economic competitiveness in Portugal which has led over time to slow economic growth and consistent and somewhat chronic balance of payments deficits. I have put on here several times a chart which shows how slow Portuguese economic growth has been relative to the rest of Europe since 1990 so the problem way predates the credit crunch. Also Portugal has had to call in the International Monetary Fund before to help with balance of payments problems. Accordingly her issues are quite different to Ireland and Greece.

The Portuguese government may feel hard done by after announcing a new range of austerity measures last Friday which mean that she now plans to reduce her fiscal deficit to 4.6% of GDP in 2011 and make further reductions in 2012 and 2013. So in 2011 the pace of austerity is now expected to accelerate which has downward implications for expected economic growth. Portugal now also expects to hit the Euro zone target of a fiscal deficit of 3% of GDP. In total the additional deficit-cutting measures are equal to 4.5 % of GDP over the three years up to and including 2013.This is, of course the flaw in continually asking for more austerity as I explained with the example of Latvia a year ago and that is the danger of a downward spiral before you (hopefully) improve. You need a plan for economic growth too.

Portugal’s opposition oppose the new austerity plan so the brief political consensus has broken and today just to add to her problems she has one billion Euros of twelve month bills to issue. In a way the fact that she is issuing twelve month bills rather tha longer-dated paper highlights her problems and reminds us that yes in a year’s time they too will have to be refinanced in a bond market example of having to run ever faster just to stand still!

The Price of Oil

I understand that recent rises in the price of oil left the price somewhat inflated but am I the only person wondering why it has setback? For example there are continuing problems in North Africa and Arabia as well as Japan which will have to increase oil imports to replace much of her nuclear output.


16 thoughts on “The implications of the new (flawed as usual) bailout plan from the Euro Zone for Portugal Ireland and Greece

  1. Hi Shaun,

    Ref Crude Oil – Fundamentally yes there is an argument for increased imports by Japan.
    I personally think that the reason is that as of last Friday there was a massive amount of commercial traders short crude oil – the level of shorts as can be found from the comittments of traders reports that the US produce is the largets ever position. So you have the commercial producers hedging on the short side and you have the non-commercials (hedge funds, pension funds etc) massively long.

    Now traditionally these Non-comms follow the market and the comms 9/10 times predict where the markets going.

    If the comms are wrong and the markets continue to rise then the comms are going to have to cover their short positions and if that happens then the price of crude oil will rise further simply due to the short covering!
    Now if the comms are right, then the non-comms are going to be hit hard as they are betting massively on further rallies.

    If readers are interested head to
    to view the chart.

  2. Shaun, Very interesting as ever.

    I can’t help linking your reports on Greece, Ireland, Portugal etc to the NIESR report this morning on the intergenerational theft in the UK.
    It does seem to me that all of these governments (including the UK) have spent and made spending promises far in excess of the realistic tax take. This has led to borrowing, not just for war/capital programmes, but for welfare spending and other annual costs.

    To see the effect quantified at an individual level, however inaccurately, by NIESR, is pretty shocking. Everyone aged 65 in the UK will have £220,000 more spent on them by the state than they paid in tax, while younger people have the pleasure of paying £70,000 more in tax than they will ever get out.

    Frankly, if I were in my twenties, I would rather default on these debts than spend my whole life paying for the excesses of the previous generation.

    If I were a politician (which, thankfully, I am not), I would dread this type of NIESR research. I doubt one person in a hundred understand the ESM, bond markets, the deficit, debt expressed a billions or trillions, quantitative easing etc. However, even a moron in a hurry (to use an old judge’s phrase) will understand that the old people have spent more than they have paid in tax and the bill is to be paid by young people.

    • Not sure your comments related to what you term “intergenerational theft” are correct, Jiminy Cricket. You have to consider the present value on a discounted cash-flow basis and real (not the mickey mouse ONS numbers) inflation over the period since those taxes and contributions were made. The real problem is that successive previous governments have never ring-fenced the NI contributions and never invested the funds contributed to accrue for the state and public pensions so as to accumulate for when due. They misappropriated those funds lumping them with general taxation, so as to profligately waste public money without a care.

      Now they have the belated approach that these liabilities will be paid out of present taxation cash-flow. That is an absurd approach and is a deliberate dereliction of duty and without proper accountability for the contract governments entered into. That now results in the unfair situation which you identify. However, even then the reality is that UK state pensions are the lowest in the civilized world!

      • I agree entirely with your comments about discounting for time, NI etc.
        I do however see a lot of evidence for this intergenerational theft around me, in the private sector as well.
        I am as guilty of it as anyone (in my fifties). I had a free university education (even the living expenses were paid for by the council in those days). I left university with no money and no debt. I was then able to buy a (grotty) house at age 24 and now have no mortgage without any parental help. My pension will, I expect, be pretty low unless the economy changes, but at least I will have one.
        Going one generation up, my father in law took early retirement at 51, is now 76 and is still on an index linked pension and going strong.

        I would suggest strongly that, while anecdotal, this type of experience is pretty common. There is no way on earth that people will take early retirement at 51 in the future. University students do not leave with no debt. They cannot get on the housing ladder at all at 24.

        Perhaps the phrase generational theft is wrong, but I do think that there is strong evidence that the rise in longevity has effectively transferred huge resource to the first generation to enjoy the extra years. They did not contribute adequately to prepare for those years and, while I take your point on NI not being a fund, this older generation did have the benefit of the government expenditure at the time, which rather offsets the DCF issue.

      • Hi Jiminy Cricket.; I did not comment on the additional issues which you now raise, only those related to state and Public pensions, and the dismal failure of successive governments to honour these obligations in the proper fashion. You seem to essentially agree with my points on those issues.

        With the other issues you now raise, such as free university education, and comparative ease of earlier house purchasing etc. I think you are expanding your arguments into much wider horizons, which are essentially about opportunities existing at different times in history. These have nothing to do with “fairness” or social equality. They just happen at various times in the progress or otherwise of life and economies in civilization!

        For example, I could never afford the house and lifestyle of my parents, even though I actually achieved more than they did in real terms and was much more highly educated than they ever were. By then everything had changed in the UK and most things had become prohibitively expensive due to inflation. So I feel that many of the comparisons you are now attempting to make, as if they were on any basis of fairness, are not about that, but rather are a function of at which time you happened to be born. I wish for example that I had been born in the late 20s or early 30s; the life which I would have then enjoyed with the effort I put into my career and the relative success which I achieved would have then been much better. Thus you cannot really make the comparisons which you are now attempting to make on the basis of fairness or equality.

        For example in the future as energy costs rise and growth slows it is likely that some will look back at what we enjoy now and feel that life is not fair to them! That will not really be so, but the issue will actually be the luck of the draw in terms of the period in which they were born.

  3. Shaun,

    As regards Greece’s “improved” deal, someone pointed out that, if the average privatisation were to raise 100m Euro, she would need to complete 1 such event every three working days between now an 2015 to ensure compliance with the new terms of the loan………………..

  4. Hi Shaun
    Thanks for the continuing analysis. I have become familiar, through your site, with the ESM and EFSF and I now see the proposal that these collective funds might be used to buy primary issuance in sovereign debt. I agree that this looks like a debt transfer mechanism/union. Presumably, the UK are underwritng this?

    There is another aspect to all of this. There is something called the EU Cohesion Policy and Europeam Regional Development Fund administering huge and targeted assistance to help uncompetitive EU regions become competitive. Do you have any stats and measurable success outcomes for all of this money. I never see much comment on these huge public investments going in to Portugal, Greece and other regions in need.

    • Hi Shire
      The EFSF has been set up and guaranteed by the Euro member states only so they back it in their shares of the European Central Bank’s capital. Whilst we have a small stake in the ECB it is much smaller pro-rata than our economic size and is calculated separately from the Securities Markets Programme and the EFSF.

      The bit we are involved in is the EFSM (after a while the acronyms start to merge… ) where 60 billion comes from EU funds of which we are a shareholder although it was denied by our Chancellor of the Exchequer when it was incepted. Our exposure or share of lending under this is 13.5%.

      You are right about the investment and we could include the Common Agricultural Policy and the Common Fisheries Policy. Both have many flaws but if we look at them as regional policies then they have failed…

  5. Hi,

    The analysts and commentators in Greece state that the ESM new status-quo, enabling it to purchase government bonds, is intended for periphery countries which cannot go the markets.

    Greece is a prime candidate for this to happen, since in 2012 it’s “either go to the markets, or the money isn’t enough”. I suppose Ireland (and Portugal?) might be there as well.

    The catch is that ESM lending would probably be accompanied by “MoU-like progress reports”, effectively forfeiting policy decisions, or rather deferring them to Brussels / IMF.

    • Hi Ioannis
      This move was clearly either a sop to the federalists or they forced it in as it is potentially a real game changer and I am not surprised at its reception in Greece! However the announcement has not yet even specified exactly how it will raise the capital of the EFSF so there is a lot to do and I would suspect as you point out that should it exist the conditions will have a heavy Germanic influence….

  6. You relate: “You need a plan for economic growth too.”

    I have been reading on European economic events for about a year and have not heard of any plan for growth in Portugal. The people in Portugal should be thankful that they have not seen the depths of the austerity plans that are being enforced in Romania.

    In today’s article …. European Financials Fall Turning The Euro Lower … As Exhausting Quantitative Easing Turns The Nasdaq, Technology And World Shares Shares Lower … I relate European shares, VGK, fell 3.1% lower on falling European Financials, EUFN, -3.6%.

    The falling European Financials turned the Euro, FXE, 1.8% lower. Germany, EWG, -3.6%, Italy, EWI, -4.3%, Spain, EWP, -4.1%, The United Kingdom, EWU, -3.2% and Sweden, EWD, -3.1%.

    Competitive currency devaluation is now underway as the US Dollar,$USD, is rising and most all currencies except the Yen and the Franc are falling.

    The failure of quantitative easing is specifically seen in the trading lower of the distressed Fidelity mutual fund FAGIX, which approximates the value of the US Federal Reserves’ assets taken in under TARP, and which together with Excess Reserves, serves as the basis of Neoliberalism’s seigniorage.

    Today’s rising Dollar is evidence of quantitative easing failure and also the end of neoliberalism.

    Junk bonds, JNK, manifested massively bearish engulfing today providing even more evidence of the failure of neoliberalism’s seigniorage.

    Failed neoliberalism means there will not be economic growth.

    Failed neoliberalism also means the world is passing into The Age of Deleveraging which will be characterised by inflation destruction, debt deflation, credit ill-liquidity, instability, economic contraction and austerity.

    The European Leaders Pact on Competitiveness, which will be formally announced, will be yet another Leader’s Announced Framework Agreement such as the Greek Debt Bail Out Agreement of May 2010, the vetting of national budgets before national legislatures meet, and the Ireland Bank Bailout.

    Germany has all the strong cards and is playing its hand fully to its advantage; and from my perspective is even laying the groundwork for a future exit from the Euro if needed. In so doing Germany is further entering into a most dangerous embroglio, which will reach out and engulf and consume this fiercely strident country.

    The European Leaders are effecting a bloodless political economic coup which draws out an important concept that the rule of the sovereigns replaced neoliberalism and democracy in February and March of 2011.

    The rule of the sovereigns is now the governing political and economic regime and construct.

    Neoliberalism was the political and economic regime that governed mankind from the time that the Free To Choose economic theory of Milton Friedman replaced the gold standard in the early 1970s, to the exhaustion of Ben Bernanke’s quantitative easing 1 and 2 on February 22, 2011, which was reflected in the fall in value of the distressed securities, which underwrote quantitative easing, and which are approximated by the Fidelity Mutual Fund FAGIX.

    It was on February 22, 2011 that the value of FAGIX, and world stocks, ACWI, both fell lower.

    Under the rule of the sovereigns, leaders meet in task groups such as the Pact for Euro, that is the Pact for Competitiveness, to develop Framework Agreements.

    Then leaders meet in summits to formally announce Framework Agreements, which set forth regional political and economic governance which replace treaty, constitutional and historic rule of law. The Leaders’ Agreements waive national sovereignty. One is no longer a resident of a sovereign nation state; rather one is a resident living in a region of global governance, as called fro the Club of Rome in 1974.

    Government minsters and business leaders appoint stake holders who effect the mandate of the leaders which promotes global corporatism, that is combined state corporate rule. Policies are enacted which promote the security and prosperity of corporations, and enforce austerity for the people.

    Neoliberalism and democracy are replaced by the rule of the sovereigns, where the word will and way of the leaders is law.

    The European sovereign crisis will intensify, and out of Götterdämmerung, an investment flameout, a Sovereign, and a Seignior an Old English term for top dog banker who takes a cut, will emerge to establish a common EU Treasury with fiscal sovereignty, as well as a new seigniorage replacing the currently failing US Federal Reserve’s Quantitative Easing seigniorage; and the Bank of Japan’s failed Yen Carry Trade seigniorage.

    These two will assure the security and prosperity for select corporations while providing austerity for all people. Global Corporatism and the Rule of the Sovereigns will replace Neoliberalism as the world’s economic and political regime.

  7. It is surely a myth that a disaster adds positively to a country’s GDP, as is often stated. The impression given in your post is that GDP is boosted by disaster, but there is no mention that it will be balanced by an equal depression in growth later. This must surely happen when, for example, loans for reconstruction are paid back, or existing money that could have been invested in new plant was spent on reconstruction instead. There is no need to complicate matters with contentious assessments of “stock of national wealth”.

    Is it your contention that ‘the broken window fallacy’ is not a fallacy? Or that GDP falsely indicates growth permanently, when no real growth has occurred? Or that short term GDP fluctuations can be deceptive, but over the long term GDP is ‘correct’?

    In my opinion, the last option is the most correct, but with the proviso that people’s behaviour is affected by economists’ ‘bigging up’ of the short term fluctuations, thus preventing the long term GDP from settling and providing a true measure of an economy’s performance.

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