Portugal Cedes Financial Control to EU (or, why the euro is a bad idea)

Telegraph UK ^ | 6/28/02 | Ambrose Evans-Pritchard

[walden]

Portugal is to face austerity measures imposed by Brussels under threat of punitive sanctions, making it the first country to lose control over tax and spending policy as a result of joining the euro.

The European Commission said yesterday that it was legally obliged to take action against Portugal after it emerged that the country's budget deficit was far above the 3pc of GDP limit established by the EU's Growth and Stability Pact.

The shock figures were announced by the new centre-right prime minister, Jose Manuel Durao Barroso, who accused the outgoing socialist government of "reckless mismanagement" and concealing the disastrous state of national finances.

The original estimates had been 1.1pc of GDP for 2001, but the EU's statistical office had never agreed to vouch for the figures. Now the European Central Bank has drawn up a report estimating the real figure at 3.9pc.

A spokesman said that once new data is confirmed "the commission is obliged under the treaty to initiate the excessive deficits proceedure".

This means invoking the "nuclear option" of Treaty Article 104 that authorises the EU to dictate draconian measures to any state that threatens the integrity of monetary union by pursuing inflationary policies.

While Lisbon will be encouraged to come with its own proposals to control spending, it will do so knowing that EU finance ministers have the treaty power to order "deficit reduction measures" and can ultimately impose fines of up to 0.5pc of Portugal's annual GDP, equivalent to £4-£5 billion.

Portugal's best hope is that the stability pact unravels altogether before the matter is put the the test. EU finance ministers meeting in Madrid last week agreed to relax the deficit timetable for France - and therefore for everybody else - if economic growth fails to reach 3pc.

The new French government was told it could go ahead with promised tax cuts, provided this was matched by lower spending. The French deficit for 2002 is rising to 2.6pc. Italy has since seized on the concession to push through its own programme of tax cuts.

All EU states had agreed last March to bring their budgets into balance by 2004, but this is now a dead letter. Both the Commission and the ECB are alarmed that all the key states are using up their fiscal shock absorbers, leaving them with nothing in reserve should any one face a real crisis.

Portugal is in a class of its own, however, and is emerging as the first real test of the euro's one-size-fits-all monetary policy.

The economy is now facing a severe downturn after a credit and property boom - induced by a halving of interest rates after Portugal joined the euro - was allowed to mushroom unchecked.

It is now saddled with the most uncompetitive cost structure in the euro zone and a current account deficit of over 10pc of GDP.

Analysts say that constraints of monetary union leave it no choice other than it deflating its way painfully out of the crisis, popping a debt bubble that could threaten the more vulnerable banks. The rising euro, and heavy exposure to the financial crisis in Brazil, are both twisting the knife deeper.

The new Portuguese government has little room for manoeuvre. Hemmed in on all sides, it is now compelled by EMU rules to tighten further by pursuing a "pro-cyclical" fiscal retrenchment.

Austerity measures in Portugal have already had serious consequences, including a near mutiny by the Portuguese navy, which recalled its ships to port in February claiming there was no money for fuel.

[walden]

Until I read Thatcher's new book "Statecraft", I thought the euro was a good idea. This is a clear illustration of why it isn't.

[Shermy]

The Portuguese are just not sophisiticated enough to make the deficit look like it's under 3%. The game afoot is each EU member "bonuses" with deficits higher than the others - it's the profitable thing to do. I suspect France and Germany will fair better at this accounting game.

[wimpycat]

Just you wait! Germany's finances are in a sorry state; not up to EU standards YET, but I doubt you'll see them manhandle Germany like they can poor, puny little Portugal. If they take over Germany's finances, I'll take it back, but the EU is not about equality in practice; only in theory. The stronger countries always get out of consequences that the weaker countries can't.

[joeyman]

So what happens if Portugal tells'em to go pound sand. What is the EU gonna do? Send an army of men in 3 piece suits with brief cases marching into the country to forclose on the place?

[walden]

I don't know what happens then. It just seems to me that, either through economic conditions largely beyond a country's control, or through imprudent policies, the time could come when either a country would want out, or the EU would want them out. If more than one country at a time had a problem, especially if one of the big ones was in trouble, it seems to me that the entire EU and the currency could be at risk.

[LarryLied]

Until I read Thatcher's new book "Statecraft", I thought the euro was a good idea.

An excellent read.I typed out a few of her comments:

What we should grasp, however, from the lessons of European history is that, first, there is nothing necessarily benevolent about programmes of European integration; second,the desire to achieve grand utopian plans often poses a grave threat to freedom;and third, European unity has been tried before, and the outcome was far from happy.

I believe that:

• The European single currency is bound to fail, economically, politically and indeed socially, thought the timing, occasion and full consequences are all necessarily still unclear.

• It therefore follows that countries which have not already joined the project would be well-advised to keep out.

• This failure cannot be rectified by American or other international attempts to rescue the euro, because the fundamentals are irremediably unsound.

• The most important priority for the non-Europeans is to see that European policies do as little harm as possible now or later to the world economy.
  ---Margaret Thatcher, "Statecraft"page 354

[walden]

It is indeed a wonderful book-- without a doubt, Thatcher is the smartest woman in the world. You know, I like hearing from wise elder statesmen; I find it reassuring. But poor Reagan can't talk to us, Bush can't speak out because of President Bush's position, and the rest of our former Presidents are such a poor lot. It was great to hear Thatcher's thoughts on the world.