STAFF NEWS & ANALYSIS
EU 'Solves' Crisis as Portugal Catches Fire
By Staff News & Analysis - October 28, 2011

Data released by the European Central Bank show that real M1 deposits in Portugal have fallen at an annualised rate of 21pc over the last six months, buckling violently in September "Portugal appears to have entered a Grecian vortex and monetary trends have deteriorated sharply in Spain, with a decline of 8.4pc," said Simon Ward, from Henderson Global Investors. Portugal must cut interest rates "immediately" and launch a full-scale blitz of quantitative easing of up to 10pc of eurozone GDP. The M1 datacash and current accountsis watched by experts as a leading indicator for the economy six months to a year ahead. It has been an accurate warning signal for each stage of 2007. – UK Telegraph/Ambrose Evans-Pritchard

Dominant Social Theme: We solved Greece and now we face a bigger, brighter future. Hurray for us! Government DOES work. Woops … what's that? Portugal is crashing? Why didn't anyone say so? … now we have to do this all over again!

Free-Market Analysis: The UK Telegraph does us the service of pointing out that no sooner has the Greek crisis been solved than there is another one looming on the horizon. No, it's not Spain or Italy or even France. Those countries can wait. Apparently, it's Portugal's turn.

The Portuguese money supply is apparently contracting at a time when liquidity is being demanded throughout the Eurozone (see article excerpt above).

Portugal's problem begins with fiat money and central banking itself. But the proximate cause of the country's current problems – and what's begun to set off alarm bells – is a combination of "austerity" and "tightening" that has reduced the availability of currency just when Portugal needs it most. Here's some more from the article:

A mix of fiscal austerity and monetary tightening by the ECB earlier this year appear to have tipped the Iberian region into a downward slide. "The trends are less awful in Ireland and Italy, suggesting are rescuable if the ECB acts aggressively," said Mr Ward. A shrinking money supply is dangerous for countries with a high debt stock. Portugal's public and private debt will reach 360pc of GDP by next year, far higher than in Greece.

The EU deal was not designed to deal with such a threat. The working assumption is that Greece alone is the essential problem, and that other troubles are under control or caused by jittery markets. Officials hope that debt relief through private sector haircuts of 50pc will be enough for Greece claw its way back to viability, and that spillover effects can be contained by bank recapitalizations, 1 ratios to 9pc with €106bn of fresh capital.

A boost in the €440bn bail-out fund (EFSF) to €1 trillion or moreby opaque meanswill supposedly create a "firewall" to rebuild market confidence and stop contagion to the rest of Club Med. This rescue machinery may prove to be a Maginot Line ifas many economists thinkthe danger comes from within Portugal, Spain, and Italy. Like Greece, these countries have lost 30pc competitiveness against Germany since the mid-1990s. That is the root of the EMU crisis. A toxic mix of fiscal tightening, higher debt costs, and now the threat of a eurozone recession risks the edge. The hairshirt summit ignored this dimension of the crisis.

As we pointed out yesterday, the EU solution to the debt crisis just announced is no solution at all. We recall several years ago, a "grand plan" was supposed to solve the crisis – and yet the Eurocrats have just announced another one. Lost in the "memory hole" is the first one. This one won't work any better.

Austerity and "bailout" funds, no matter how big (especially leveraged ones) will not make a difference. This is a virulent fiat money crisis and only unlimited printing of euro-notes will do. Of course, there are two problems with such a solution.

First, the Germans likely won't allow it. Second, the price inflation that would result from so much printing would sink the Union anyway. Before this is over, however, the ECB will somehow have begun to print boatloads of money, never mind the Germans or the legality. This brings us to the third option, which is that angry citizens themselves will take the Union apart.

This is definitely a possibility. The "austerity" meme grinds on, we note, leaving chaos and fury in its wake. Italy was just ordered by the EU to cut further, balancing its budget by 2013. "The mantra was 'rigorous surveillance' of budgets and 'discipline'," the Telegraph explains to us.

This is part of Brussels's creeping authoritarianism and centralization of EU powers. This was, in fact, supposed to happen, but not perhaps in such a public way. The plan was that the unstable EU currency was to implode and give rise to a White Knight situation where Eurocrats would ride to the rescue by proposing a transfer-union and eventually a United States of Europe.

As the Eurocrats are about as imaginative as the euro is viable, this plan is still "on track." What wasn't figured into it, of course, was the impact of the Internet itself, which has spread far and wide the knowledge of EU manipulations.

The more Europeans who understand the crisis was foisted on them purposefully, the less chance the EU bureaucracy has to create the longed-for and full-fledged empire they have in mind. This is, in our view, the impact of the Internet Reformation. It is triggering the human "hive mind" and the resultant ramifications are far from controllable. The best laid plans of mice and men gang aft agley.

The Telegraph article points out that the current solution – so joyously received by stock markets around the world – does not include joint bond issuance; nor will there be shared budgets, debt pooling, or fiscal transfers.

Germany has dictated the agenda, vetoing calls to mobilize the ECB's full firepower to halt the crisis. The Bundestag even ordered Mrs Merkel to insist on ECB withdrawal from existing bond purchases. Jean-Luc Mélenchon, leader of the French leftist Front, said Europe is now marching to Germany's drum and "headed for disaster", a view gaining ground across Europe's Left. Albert Edwards from Société Générale said the ECB will have to act, over a German veto if necessary.

This last observation, of course, is an impossibility. Without Germany there is no EU. And the idea that Brussels can ride roughshod over the German voter – a voting public that emphatically does not want a "transfer union" is a non-starter in our view. More trouble, and still more trouble to consider …

So the fire is out in Greece, only it is probably not. Portugal now has increased monetary difficulty. The banks in Spain, Italy and probably France are still under water. Adding leverage to debt, as the EU has done, won't solve anything.

After Thoughts

Only little Iceland seems to have come out of the current Western crisis fairly unscathed. But Iceland repudiated its debt and let its bank go under. This is the logical outcome of insurmountable mathematics. It will likely happen in the EU, too, but only after a good deal more agony. Is that the plan?

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