Sunday, March 27, 2011

Ireland's Task: Destroy the Euro

Ireland finds itself in an invidious position. Due to a combination of light-touch regulation, indecent capitalism, and cowboy banking, the state has an eye-watering budget deficit that in percentage terms (at around 32%) is more than Greece, Spain and Portugal combined, and a debt pile that is simply unpayable. Stringent austerity has not helped - sure, the deficit has been reduced - from €18bn to €9bn, roughly, but growth has still not returned. There is no stimulus, and now, there is very little fat to cut.

The bank debt - now sovereign debt - is simply unpayable. At somewhere in the region of €100bn, the interest alone amounts to almost €6bn per annum, which represents 66% of our current projected deficit. Burden sharing, debt restructuring, whatever mechanism is arrived at - none will significantly assist the position without compromising Ireland's future for decades to come.

The Euro mechanism managed to save Ireland from immediate freefall when the crisis hit, but at what cost? Three years into the financial crisis, and four years into economic contraction, we are still searching for the floor, and while the currency trundles along in step with the overweight Eurozone economies of France and Germany, everything else in Ireland seems to be falling in value - businesses, property, and even wages, while not impacted in currency terms, are being impacted instead by taxation, levies and cuts.

The long slow decline in the value of Ireland makes the hardship more difficult, extended and delays any sense of recovery. The ECB and Eurozone partners in the first instance encouraged Ireland to manage its own affairs. Any bank default by national institutions like AIB or Bank of Ireland would be seen as damaging to national standing, the partners suggested; internally, Ireland's leading bankers made similar soundings, in a desperate scramble defence of a system that had been wholly corrupted by several years of unfettered profiteering in a bubble economy. The Eurozone partners sought to protect their own bank exposures to the Irish Economy. With so much pressure on the Government in a single direction, and only Sinn Féin and Labour vocal on the other side, it is not surprising that they took the course of action that they did - issuing the bank guarantee - though it was to prove extraordinarily damaging.

So, we are where we are. Thursday will see the results of the latest stress tests on the banks, and it is likely we'll see a requirement for an additional €15bn-€20bn. We will not know definitively if that is the end. It doesn't really matter - we're long past the point where we can't afford it any more.

If de-merging from the Euro was an option, it would be the one to take. A subsequent devaluation of the Irish currency - and thereby, its debt - in the order of, say, 30%, would make our exports even more valuable than they are now, attract significant incremental investment, fix the problem with public sector pay at a stroke, and also much of the problem with pension funds. Imports would become very expensive, and multi national retailers would find it very difficult to adjust - Tescos especially comes to mind, with their recently found religion of centralism presenting Ireland with Ribena full of blackcurrants that are no longer from Wexford, but from Britain. Irish suppliers would of course be far more competitive for those multis, and given the real estate investment that these guys (particularly Lidl) have made, they will either stay, and switch suppliers back to Irish businesses, or go, and leave Irish businesses compete for themselves.

But of course it's not on the table. A Eurozone "de-merger" would be difficult to effect in cash terms, as the physical currency is easily portable to other European countries. All ports would have to be monitored, and everyone would be required by law to surrender all Euro cash held. We have an advantage in that there is no land border with a Eurozone country, and therefore enforcement would be easier as an option for Ireland rather than, say, Belgium. I don't know how much is in circulation, but any de-merger (and a presumed devalutation) would have to cost in significant cash leakage. It would of course have to be managed in conjunction with our Eurozone partners, and an alternative cash strategy would need to be developed - and cash would need to be printed somewhere.

In the spirit of solidarity (though there seems little enough of that particular tonic to go around these days), the ECB should consider a group de-merger - Greece, Ireland, Portugal, and even Spain could leave the Euro concurrently. This would be a far more structural adjustment, and many of the philosohpical proponents of the Euro would see it as a defeat for the project. While it would be presented as a structured measure, and that these countries could adjust and apply for re-admission, the validity of the project would be questioned, and arguments about political unity versus economic unity, and you-can't-have-one-without-the-other type stuff would permeate political discourse.

It seems however that the Eurozone partners can't agree on much these days, and the facilitate or agree such seismic adjustments in the Eurozone would be unthinkable for most. Domestic politics in Germany, Finland and other places has the current group of leaders hamstrung, and in the absence of weighted voting that the Constitution would have brought (and which arguably was essential for the management of the single currency) they are powerless to do most anything.

Which brings us back to Ireland. If the status quo is maintained, and essentially we carry on as we have been, Ireland's debt will remain unservicable, and Ireland - like Greece - will inevitably default. That would be messy, damaging, and - for Ireland - an awful thing. While the markets have priced in high default risk to bond yields, things are being managed now, and in any case there are no new issues to test the market. There are ongoing initiatives to ease the burden on Ireland, and the markets are betting that the Eurozone partners will not permit a sovereign default.

So we will continue to bleed, and bleed, and bleed, and when we have no more blood to give, the ECB will inject some more blood, and we will continue to bleed. However, should the contagion spread from Portugal into Spain, the sovereign debt crisis will become a major currency crisis. There are very many institutions in Spain that have significant investments in Portugal, and so the contagion effect is more possible in this case. A clean alternative for the Eurozone rather than a partial demerger would be an entire re-set; wind the clock back, and party like it's 1999 - back to your old currencies, allow free float to correct economic imbalances, and rebuild the Euro project over the next three to five years. The institutional work has been done; the project in itself was unique anywhere in the world, and hard lessons have been learned. And, in that circumstance, Ireland would be the least of anyone's concerns.

It is now in Ireland's interests to see the Euro fail. It can be argued that there are few whose interests would not be served, save perhaps the money markets and bankers who would see their Euro bonds converted back into constituent country bonds, and who would have previously thought they were investing in Germany, and now holding Irish, Portuguese and Greek paper (as well as a large chunk of German). As a race, and perhaps this is more about men than women, we do not see failure as progress. We find it difficult to grasp that the learnings from failure can make us stronger; perhaps for the individuals at the front line when failure strikes, it is hard to disabuse them of their discontent. With the passing of the Euro, perhaps Europe can again rediscover the joy of diversity, and all of the things that made Europe and Europeans once great. And perhaps as we rediscover ourselves, we can forge ever closer political unity, as a precursor for a stronger economic union in the future.

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