WATCHING A CRASH IN SLOW MOTION 1101 XXIII

“WATCHING A CRASH IN SLOW MOTION

Several months ago I
wrote about the big picture in Europe in the context of the survival of the
Euro. This issue has now moved centre-stage at disconcerting speed.  If the Euro
is to survive a major shake-up will be necessary – soon. Whether this is the
beginning of the end of the Euro, or whether it is (taking an optimistic view)
merely the end of the beginning, remains to be seen. Ireland, a minor player,
has been caught up in a maelstrom involving our partners in the Eurozone, with
unfortunate results for the economy and the people.

Ireland has now
joined Greece in requiring outside assistance with its budget; for different
reasons but the end result is similar – the IMF and the ECB are now calling the
shots. Ireland’s fiscal and banking crises have become intertwined. The net
result is that Ireland has been unable to borrow the funds to keep the economy
going (roughly $23 billion per annum) on the open market and hence has had to
seek outside help. The fiscal crisis on its own could have been managed. The
cost of the bank rescue proved the tipping point.

Ireland’s blanket
guarantee to the banks – given in September 2008 on the basis of
information now seen to be horribly inadequate and inaccurate – included the
bond holders, (mainly) international institutions which had loaned money to the
banks. The initial estimates of the losses of the Irish banks were around $6
billion. The latest official estimates are around $110 billion; some
commentators put the figure higher. The international markets doubted the
ability of Ireland to combine its national sovereign borrowings with covering
the banking losses. Credit began to dry up.

Cue our European partners.
When Greece suffered a financial crisis early in 2010, there were fears of a
domino effect among the weaker members of the Eurozone. Lying at the heart of
the problem was an inherent instability in the mechanisms initially devised for
operating the Euro. These included inadequate sanctions against Eurozone
countries breaching the limits for government deficits (3%). The limitations of
these have now been exposed with a vengeance. Prior to the Lehmann collapse, and
its worldwide effects, any minor transgressions on deficits could be and were
sorted out.

The Greek crisis, with potentially alarming situations
developing elsewhere, including Ireland, was of a new order of magnitude.  The
rescue plan ultimately cobbled together in the wake of the Greek crisis ( the
European Financial Stability Facility) had been pitched large enough to cover
any problems Ireland and Portugal might have and beyond. However, it was ad hoc
and not covered by the European Treaties.  Germany, with its conservative public
opinion resolutely opposed to bailing out more profligate countries, touted at
the autumn European Council the idea of a permanent, treaty – backed mechanism
after 2013.

This might have held but the German Chancellor, Angela
Merkel, then suggested, logically, that, after 2013, bond holders in the new
situation would be expected to take a risk on new investments after that date.
Factoring this into the growing concern over Ireland’s capacity to handle its
combined debt was bound to precipitate a crisis – and so it proved. Ireland was
forced to withdraw temporarily from the bond markets as the interest demanded
soared. Within weeks the pressure on Ireland to accept a rescue plan which would
salvage the economy and protect the bondholders became irresistible.

A
loan facility of roughly $90 billion was negotiated with the IMF and the ECB in
late November with stringent conditions attached. These included linking
quarterly advances to regular satisfactory reports on progress achieved. Taken
in tandem with the separate four year plan to reduce the deficit required by the
European Commission, the detailed Memorandum of Understanding signed with the
IMF constitutes in effect the road map for Ireland’s economy for the next four
years. Both Right and Left have had a field day with allegations that Ireland
has lost her sovereignty. The ghosts of 1916 have been invoked. Our European
partners (particularly Germany) and the IMF have been attacked.

However
no credible alternative plan has been suggested to raise the money to keep the
country going and to lay foundations for recovery. The waters were muddied
somewhat by critics on the left claiming that the harsh budgetary measures
required were related to the bank bailout and specifically to guaranteeing the
bond holders in full. This was simply not true. Certainly the implications of
upholding the bank guarantee affected Ireland’s ability to borrow, and down the
road the bondholder issue will have to be faced. However, the yawning fiscal gap
is separate from, and a present as well as a clear danger if the country is not
to grind to a halt.

The first step towards fiscal recovery has been one
of the harshest budgets in the country’s history, outdoing that of 2009.Three
more severe budgets are in prospect. Every remaining welfare state sacred cow
except one – the state old age pension –was tackled and cut. There was only
muted criticism from the main stream political opposition, who have gloomily
accepted that there is no alternative to the overall policy framework. Vocal
opposition has come from a motley collection of Sinn Fein and miscellaneous
groups and individuals on the left whose predictable alternatives smack of
unreality. Nevertheless, with an election pending in or around St. Patrick’s
Day, and Fianna Fail languishing terribly in the polls, these others see the
prospect of an electoral breakthrough. We shall see. A lot can happen in three
months – particularly if the bigger picture of developments in the Eurozone
intrudes.

Quite what will happen regarding Ireland’s bank debt as opposed
to her sovereign, i.e. fiscal, debt is a matter for conjecture. A condition of
the IMF/ECB deal was that bond holders would be fully protected. This is the
current position. Yet an increasing number of commentators, both domestic and
international, doubt Ireland’s ability to cope with both debts, particularly
since devaluation is impossible within the Euro. The interest costs alone
threaten to swamp and cripple the economy.

The position may clarify in
the coming months, particularly having regard to developments in Europe. The
Euro is at a crossroads.  A post-2013 scenario in which bondholders would be
required to take risks sits badly with the current situation of 100% guarantee,
particularly when the short term result could see a default by Ireland,
threatening a domino effect among the other PIGS. The Eurozone major players are
currently trying to find a workable solution.  Whatever comes out, and it may
take some time, should the Euro survive there will be a different relationship
among and between participating countries and the European Central Bank (ECB).
The pace and complexity of events is such that it is impossible to predict where
we will end up. Indeed, Ireland may well escape the banking quagmire.

A
final comment on 2010. It was the year when the new young British Prime
Minister, David Cameron, only a small boy when it happened, apologised, on
behalf of Britain, for the unjustified and unjustifiable killings on Bloody
Sunday. Looking back, this will probably rate as one
of the high spots of the year just gone.”

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