Portugal president warns Europe's leaders to back off austerity demands

Picking up the baton from the leaders of Greece and Cypress, Portugal's president has come out and said that Europe's leaders need to back off their austerity demands as there are limits to what is economically and socially sustainable.

Austerity is a policy promoted by Germany that results from the choice of protecting bank book capital levels and banker bonuses under the Japanese Model for handling a bank solvency led financial crisis.

This choice puts the burden of the excess debt in the financial system on the real economy.  At best, this results in a never ending Japan-style economic slump.  At worst, this results in a depression and a rewriting of the social contract as the real economy is unable to generate enough capital to cover both the debt service burden and existing needs for reinvestment and social programs.

Regular readers know that there is an alternative to the Japanese Model that protects the real economy and does not require austerity or re-writing the social contract.  That choice is the Swedish Model under which the banks do what they are designed to do and recognize upfront the losses on the excess debt in the financial system.

Banks are able to do this because they can operate with low or negative book capital levels.  Their ongoing operations are supported by the combination of deposit insurance and access to central bank funding.  With deposit insurance, taxpayers become the silent equity partners while banks are rebuilding their book capital levels.

As reported by the Telegraph,

President Anibal Cavaco Silva called for urgent action to halt the “recessionary spiral”, warning Europe’s leaders that the current course had become “socially unsustainable”. 

In a speech to the nation, he said Portugal would “honour its international obligations”, but in the same breath called for a tough line with the European Union-International Monetary Fund Troika over the pace of fiscal tightening under Portugal’s €78bn (£63bn) loan package. “We have arguments, and we should use them firmly,” he said. 

“Fiscal austerity is leading to declining output and lower tax revenue. We must stop this vicious circle,” he said, cautioning the Troika that there would be no way out of the crisis until policy was set in the interests of the “Portuguese people” as well as foreign creditors.... 

Please re-read the highlighted text as Mr. Silva summarizes the argument that your humble blogger has been making.

Pursuing the Japanese Model, including fiscal austerity, does not work.

The Swedish Model balances the interests of the Portuguese people and foreign creditors.  Creditors take the losses they should take for extending too much credit.  The result of this write-down is the Portuguese people are left with debt that they can afford to repay.

Portugal’s jobless rate has risen from 13.7pc to 16.3pc over the past year, reaching 39pc for youth, even before the full impact of austerity hits....

Clearly, Portugal is in a severe recession that austerity would only make worse.  This in turn would decrease the ability of the Portuguese people to service any debt and increase the losses for the creditors.

The strategy with the best outcome for both the Portuguese people and the creditors is to forget about implementing austerity and rather write-down the debt.

“There are well-founded doubts over whether the distribution of sacrifice is just,” he said.... 

Popular anger is building over the over the Troika’s fiscal shock therapy, which will push up average income tax rates by 3.4 percentage points and bring in a plethora of surcharges and fees. It aims to cut the budget deficit to 4.5pc this year, largely through tax rises. 

Markets have so far brushed off worries that the country risks a Grecian vortex as austerity bites in earnest. ... 

“Investors are willing to give Portugal the benefit of the doubt right now, but the country still hangs in the balance,” said David Owen from Jefferies Fixed Income. 

“Our concern is that the fundamental economic situation is still getting worse. The European Central Bank’s policy is still too tight. They need to do quantitative easing and cut overnight rates below zero,” he said....

Adding austerity to a situation with deteriorating fundamentals in not a prescription for improvement.

Portugal has taken its medicine with stoicism until now, winning praise from the EU leaders for sticking to its bail-out terms. But Troika officials fear that “social cohesion” is fraying as the slump deepens. The country saw the biggest street protest this autumn since the end of the Salazar dictatorship.

As Ireland has shown, there is no benefit to stoicism as frankly Germany's leadership cares more about the book capital levels of its banks than the people of any debtor country.