Friday, 8 April 2011

The Future of the Past

History does not repeat itself, but in Portugal it certainly rhymes. It's easy to say now that the request for foreign aid made yesterday by the Prime Minister was the inevitable outcome of the accumulated stress of the last two years. But during that time the government, the European Commission and even the IMF sought to persuade us that the Portuguese case was different from the Greek and then the Irish. There might be merit in this differentiation, but sometimes it's useful to compare the present with our own past, even if distant. A quarter century of European integration and ten years of Euro membership were enough to convince us that Portugal had 'graduated' in the class of nations, leaving behind a past of financial and currency instability. The dreaded return of the IMF (or EFSF, as the President insists) re-evokes the memories of 1978 and 1984, but in my opinion the past that best rhymes with the present is the late nineteenth century. I speak, of course, of the crisis of 1890-92, which culminated in the last Portuguese bankruptcy. The parallels are striking and instructive.

For the most forgetful among you here's a brief recap. The problems began in April 1890 when the government had trouble placing a loan in Paris. A banking crisis followed in September with a run on the Montepio Geral, which was saved by the Bank of Portugal. Meanwhile, the current account took a wrong turn by the fall in the remittances from emigrants in Brazil. Despite the guarantees (avais) given by the Bank of Portugal and the government to a number of banks and railway companies, heavily indebted abroad, capital started flowing out of the country. Until 1892 the government committed about 12% of total public expenditure to these guarantees to not much avail. In November, the house of Barings, one of the most reputable London bankers, went bankrupt under the weight of its exposure to Argentinean debt (Argentina had defaulted in June). This precipitated a financial crisis worldwide, with capital drying up to peripheral nations such as Portugal. To make matters worse, Barings was the main external agent of the Portuguese government, and its failure cut off the access of Portugal to critical short-term credit. 1891 opened up with a failed republican uprising in Porto and, more importantly, with the bankruptcy of the Banco Lusitano, which the authorities were impotent to prevent. The Bank of Portugal itself had dried up its sources of credit and was in trouble to make up on the debt raised the year before. Under a situation of renewed capital flight (gold), and the threat of a banking collapse the government responded, in May, with a moratorium of 60 days and the suspension of convertibility in gold. By the end of June the currency had lost 6% of its value, adding up to more than a quarter until December. In the second half of 1891 the government negotiated a 'bridge financing' of £6.4 million, in exchange for the 35 year monopoly of the production and sale of tobacco to a group of domestic and foreign investors. Finally, in January 1892, Oliveira Martins (another Northerner at the finance ministry) decreed the suspension of debt payments in gold and began negotiations with foreign creditors. These were quickly interrupted, on 13 June 1892, by a change of government and the imposition of a partial default on the external debt.

Now replace Montepio and Lusitano with BPN and BPP; the railway companies with Refer and the Lisbon and Porto subways; tobacco with the pension funds of PT and the Social Security; and the Barings case with the current fears of exposure of European banks to the 'PIGS' and the story begins to sound like déjà vu. Today, as 120 years ago, the structural imbalance of the current account, particularly in the context of exchange rate stability, brought about an excessive foreign debt under the guarantee (directly or implicit) of the Portuguese state and the inevitable failure to honor the debt service.

There are, to be sure, important differences. Even though the abandonment of the gold standard was perceived to carry severe reputational costs, it was much easier to organize than the putative opting out of the Euro. It also helped that back then the external indebtment was mostly a sovereign affair, compared to today. Although it is hard to reconstitute the magnitudes, my own research suggests that the level of external debt just before the default represented about 40% of GDP, 35% of which government owed. These figures are in strike contrast with the statistics quoted here earlier by Ricardo Cabral. Despite their many design flaws, a network of European and international institutions (EFSF, IMF, ECB) form today a guarantee against an immediate dry up of financing to the Portuguese economy, which would result in a banking meltdown and a painful current account reversal – particularly under the no devaluation option. I agree with everyone who has rejected here the option of leaving the Euro, given the devastating balance sheet effects it would entail, but I also believe that Portugal, Greece, and Ireland should demand a better deal than what has been on offer. Adding up to the high interest charged by the EFSF to Greece and Ireland, the recent reference of Trichet to the peripheral nations as the 'collateral damage' of the fight against inflation in the Eurozone and yesterday's rise of the ECB rate are disturbing. I hope Trichet is playing Janus: indulging the inflation hawks while keeping the floodgates open to the banks.

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