If fiscal sloppiness is not Ireland’s problem, then what’s the solution?

So much of yesterday was spent examining the government’s four year plan to get spending and tax in line with each other. It’s both a gamble and as Brian points out a malleable tool. Joan Burton’s main criticisms of it last evening were that it didn’t include Labour’s plan for a strategic investment bank (to be part funded by the national pension fund).

But since the biggest impulse to rein down debt within three years is coming from the outside (mainly the German’s presuming the fiscal straightjacket the prescribed for Greece will just jolly well have to do Ireland too, nothing about this plan is likely to be permanent. Especially in consideration of the fact that the ECB are still only playing the game according to Plan A.

But in the FT, Martin Wolf thinks Ireland has an opportunity to escape a German fiscal straightjacket. He begins by noting,  that Irish public indebtedness is a consequence, not a cause of the crisis. He draws from the analysis of Paul De Grauwe at Leuven University:

…the proposed mechanism is based on the view that the sovereign debt crisis in the eurozone is the result of irresponsible behaviour of governments that exploited the implicit bail-out guarantee while private investors had no incentive to discipline these governments.

This interpretation of the source of the debt crisis in the eurozone has become popular mainly because it fits the Greek crisis well. It cannot, however, explain the debt crisis involving the other eurozone countries, where the root cause of the debt problems is to be found in the unsustainable debt accumulation of the private sectors.

As if to illustrate:

Ireland and Spain, two of the countries with the severest government debt problems today, experienced the strongest declines of their government debt ratios prior to the crisis. These are also the countries where the private debt accumulation was the strongest.

It had nothing to do with irresponsible governments that failed to be disciplined by financial markets. The reverse is the truth. Financial markets were undisciplined and governments took their responsibility when they saved them.

He believes the ECB’s strategy is merely inviting speculators to shoot the cash fish swimming in the EFSF barrel:

When governments solemnly declare that in times of payment difficulties they will devalue the government bonds (that’s what a haircut means), this will introduce the speculative dynamics in the eurozone that destroyed the ERM. Once investors expect payment difficulties of a particular government, they will sell the bonds, thereby raising the interest rate on these bonds. This is exactly what speculators in the ERM did when they expected a devaluation of the currency: they sold the currency.

Last word to Martin Wolf who points out that for all the self flagellation (or FF flagellation) amongst the media and political class in Dublin, this is (as Lenihan has been insisting from the start) a private sector debt crisis of much wider provenance than poor wee Ireland:

The crisis is a huge challenge for Ireland, which should surely convert unsecured bank debt into equity rather than force its citizens to bail out all the improvident lenders. But the Irish case also shows that the German view of how the eurozone should work is mistaken: fiscal sloppiness is not the main problem and fiscal retrenchment and debt restructuring are not the sole solutions. One cannot learn from history if one does not understand it. [Emphasis added]

For all the argument going on in Dublin today over the four year plan, that’s not one being pushed by any political party.