What exactly is the yen doing at this level? I have been asked this question more frequently than any other since the financial crisis and the collapse of the carry trade. Questioners have been particularly insistent these past few weeks. I now anticipate the euro version: Portugal will be the third sovereign EMU bailout, why is the euro strong?
The Irish elect a government committed to modifying the terms of the EU bailout. Jose Socrates’ government in Portugal falls because it could not force another austerity plan through parliament. Lisbon will be without an elected government for at least 55 days. The Portuguese Treasury must rollover €4.2 billion euros in sovereign debt on April 15th and a further €5.0 by June. Presumably Lisbon will need a bailout for which there is currently no one on the Portuguese side with the authority to negotiate with the EU and in all of this turmoil the euro rises? Is this another case of European and euro insouciance as in the summer of 2008 when faced by the US subprime crisis?
There are two issues here. The euro is strong because the Europeans will do as they have done twice before, they will bail out Lisbon. Last January sovereign debt was a new item. Default was a possibility. Not only were there no European mechanisms for rescuing Greece, the decision to do so had not yet been taken. In the absence of experience, market speculation was rife. Will Greece default, will the euro collapse, and will the political leaders on the continent prove up to the task? Could they put together a rescue mission depending on the agreement of 17 or 27 nations (always an exaggeration since only two really count)?
Now we know the answer to these questions. The European leaders will not permit a default, staggering nations will be propped up and Germany will pay. The political capacity, unity and determination of the European Union have been established in this crisis. If the path to this conclusion was messy, the results sometimes tardy and not always to the liking of commentators, the Europeans have proved capable and willing to defend their currency and the union that stands behind it.
The bailout of indebted EMU nations is no longer an open question. That is the chief reason for the lack of drama in the euro despite the fall of the Portuguese government and the apparently open road to a bailout.
Another reason is that the European Financial Stability Facility (EFSF) as constituted can fund a Portuguese bailout. That was true from the inception of the facility. For that reason even the EU summit Thursday and Friday is not a crucial factor. Given the new Portuguese circumstances it is hardly likely that the Europeans will give the market another reason to sell Portuguese debt by failing to fully fund the facility, but even if they did the facility can pay for a Portuguese bailout tomorrow.
There is, however, a much more serious and longer term question. I wrote last year that the problem with the bailouts and the austerity budgets that have preceded and followed the rescues is that Europe is democratic. Governments and politicians lose elections and replacements will almost by definition have different policy ideas.
What will happen if European voters, in the southern tier austerity countries, but also in Germany, change governments and elect the opposition? In the south and Germany it was always likely that that opposition would use the most handy and popular issue to defeat the current government. In Ireland already, and one presumes in Portugal and Greece if it came to a vote, that issue would be the austerity budgeting forced, as it appears to the electorate, by their fellow Europeans. In Germany it is the unpopularity of the rescue payments. From different sides of the problem there are potential electoral results that could be equally damaging to the current course of the bailout union.
The reason the Papandreou government is still in power is that it assumed charge a few months before the crisis with a large majority in parliament. It has not had to face the Greek voters. In Ireland the voters demolished the standing of Brian Cowen’s Fianna Fail with its worst election defeat since independence. It is easy to assume that when Jose Socrates faces the Portuguese voters the verdict will be similar. The prognosis for Angela Merkel's Christian Democratic Union in the two upcoming state elections is not much more sanguine.
No major opposition party in Europe is yet advocating leaving the EMU or the union. Yet dire economic times can produce dire results. The history of Europe is a cautionary tale. The European Union and the EMU will have to bend to the will of the electorate or risk their unity. The greatest threat to the union and the euro will not come from governments but from obdurate voters. So far the antipathy of the European voter has been directed at the austerity measures and the governments' responsible. Without accommodation it could well turn on the EMU and the European Union itself.
Chief Market Analyst