The politics of leaving the Euro not as simple as Govt’s critics make out…

Nice piece from Brian Feeney in the Irish News yesterday… It’s worth quoting at some length, not least for those who imagine that default is likely to be a pain free option… Not least because of the political cost…

Here’s the position. Over the next three months or so, the nuts and bolts of the Merkel/Sarkozy pact to stablise the Euro will be screwed together and what in effect will be a new treaty will emerge. The Republic will have to hold a referendum the government believes it will lose.

That’s why Irish officials struggled in vain at the EU Summit to avoid changes to the treaty. Faced with the combined might of Germany and France they were bound to be steam rollered. At present they are hoping that they’re desperately hoping the wording of the deal will avoid the need for a referendum. It won’t.

Here’s the rub, and what you don’t hear much of in the southern commentary on the crisis (though there is little ambiguity on this amongst those parties anywhere near the realities of power in this tiny European country):

Michael Noonan has been getting in a bit of pre-emptive scare-mongering by warning that a no vote is saying the republic wants to leae the eurozone. What would happen then? Return to the Punt? You/re kidding.

Economic catastrophe is what would happen. The Republic can only borrow on the international bond market this year if it meets the terms agreed by the EU-IMF bail out. It they don’t have the euro behind them they will have to default on their debts.

That means no money to pay for teachers, nurses, medicines, you name it. It’s back to the 1930’s.

And for those who think this is just a problem for that ‘foreign country to the south of the border, here’s the First Minister back in November on what the crisis in the south means for Northern Ireland:

The economic difficulties which you have been experiencing in the Republic of Ireland have also impacted the Northern Ireland economy. The Republic is one of our key markets for exports and tourism, and it is in our interests, as neighbours and trading partners, to strengthen those economies, recognising what works and taking a pragmatic approach to guide us through these difficult economic times.

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  • cynic2

    They could adopt Sterling or the Dollar

  • wee buns

    Mc Williams writes on the trauma of the crash – insists that default of ECB must form part of the plan, regardless: else decade long Japanese type stagnation is on the cards……

    ”But what if the state is also bankrupt? What happens if the financial markets don’t want to lend to you – as is the case in Ireland?

    One obvious solution is to impose capital controls and force – or at least incentivise – Irish savers to finance the government. Thus the government recycles the savings of the anxious savers, thereby
    propping up demand, and eventually allowing the broken balance sheets of the Irish people to be repaired. Once the balance sheet is repaired, normal economics will resume once again.

    But this could take time, and the government’s debt-to-GDP ratio would rise to possibly 200 per cent – where Japan’s is now. Doing something like this would require the state to leave the euro, impose capital controls and issue its own currency all in one weekend. Even if you thought it was the right thing to do, it might be a tall order to execute. Plan B perhaps?
    The other way out is to have a massive programme of debt relief because without the debt, people’s anxiety lifts. This would mean defaulting on huge amounts of debts and stiffing the ECB in the
    process, because the only way Irish banks could absorb all this domestic debt relief would be if they defaulted on their main creditor, the ECB. This must still be part of plan A. If neither of these choices is being entertained, then the anxiety recession looks likely to condemn this country to possibly a decade of stagnation. It is hard to see – with the huge debt we are carrying, and the trauma associated with the crash – how the economy can perform otherwise. If this excessive caution proves to be enduring, rather than temporary, the economy will not rebound for years. If you doubt that this can happen and can go on for years, consider that the Nikkei Index, Japan’s stock market, ended 2011 at a 19-year low.”

  • Alias

    Feeney is wrong. The reason bond markets won’t lend to the Irish government is that it won’t default, not because it will. The state has guaranteed too much eurosystem debt, and bond markets are well aware of the fact. Once it defaults on eurosystem debts that do not belong to it and that it should never have underwritten, bond markets will be lining up to lend to it again – and at very low rates.

    True, some bondholders who got burned might not lend again but most will not put vindictiveness before profit. The classic mistake Feeney and ilk make is to see bond markets as a single group when the reality is that it is comprised of multitude of different lenders who would kill each other for a percentage.

  • Alias,

    Bond markets will of course lend again – eventually. They will only do so once they are confident that the state will not default again. In the case of Argentina it took nearly a decade for the markets to regain confidence. In the meantime there was complete economic collapse.

  • DC

    Where’s Bertie now, where is Bertie now!

  • Zig70

    The Greeks are going to play chicken with the ECB because they realized quicker than the dumb Irish that the stakes for the ECB where a lot higher than theirs. The intervention stopped the bubble bursting but prevented the markets finding a second wind. Need to deflate the market as quick as possible while maintaining liquidity. It won’t matter for the Irish anyway when we hit oil this year.
    Feeny is just playing tabloid. There is a whole host of measures and scenarios in between bust and broke.
    Interesting article from Martin Wolf in the FT, I don’t totally agree but then I’m no expert
    I think the big experiment is only fragile because they placed the importance of protecting the banks ahead of the EU’s self-interest. Committees rarely embrace risk.
    Here is his ending quote.
    “The high-income countries have been running a series of fascinating experiments. One was with financial sector deregulation and housing-led growth. It failed. Another was with a strongly interventionist response to the financial crisis of 2008. It worked, more or less. Yet another is with post-crisis deleveraging and a return to more normal fiscal and monetary settings. The jury is out on this effort. In the eurozone, however, this shift to fiscal austerity is running alongside a still bigger experiment: the construction of a currency union around a structurally mercantilist core among countries with negligible fiscal solidarity, fragile banking systems, inflexible economies and divergent competitiveness. Good luck for 2012. Everybody will need it.”
    Wolf uses bigger words than Feeny.

  • Zig70

    In a lot of ways the SF proposal is the most in line with right wing thinking (common thread?). It’s the approach the US went for before they realized it would bankrupt half the country. How many business’ would have folded in Ireland with default, thousands. The current situation is that the investors have bet on default and the ECB are preventing them from getting at the poker table winnings. Ireland possibly showed the way with Nama and manage the bad debts in a quick but staged deflation. Otherwise the bubble will burst and there will be no management tool left. Possibly a side swipe from the Asian markets. Leaving the Euro would be nuts without being kicked out. Just look at Hungary and how investors used to attack currencies pre Euro times.

  • Neville Bagnall

    “The reason bond markets won’t lend to the Irish government is that it won’t default, not because it will.”

    Err, no. If the markets believed we wouldn’t default, there would be no risk and they’d be happy to lend to us.

    The markets believe we will be forced to default, despite all the statements to the contrary by ourselves and the EU/ECB. Thats why they won’t lend to us. At least not until we default.

    Lets say we do default. Assume for the purposes of this exercise that there are no cascade effects on the eurozone and the world economy (i.e. a Lehmans II – the reason the ECB is so dead set against default).
    What would be the reaction?

    On the positive side, we won’t have a GGD debt mountain to be serviced and we may exit the Euro and devalue which would make us more competitive overnight, by effectively slashing the purchasing power of wages – a national wage cut.

    But we will still have a private debt mountain. And if we devalue, an inflation problem. (Most of our exports have a high percentage of inputs that have to be imported).

    The reaction of the MNC sector is hard to judge, there are positives and negatives.

    But lets ignore all that. Based purely on our fiscal position would we be a good place for the markets to loan to in the short term?

    I think not. Even without debt servicing, we’ll be running a large deficit. Add to that the Moral Hazard, and the markets will simply rate us as Junk and avoid us until we get our house in order – just like they are doing now.

    Iceland hopes to return to the markets this year to roll over some of its debt. Why this year? Because this year its budget will have a primary surplus. Yet its debt is still rated as Junk.

    We are still a long way from a budget surplus.

    To give an idea of what getting to that surplus has meant for Iceland, its 2012 budget includes the following measures:

    National Salary Tax – 37% on first €16,000, then 40% and 46%
    Municipal Salary Tax – 11% up to 14%
    Employee Tax credit – €3364
    A Wealth Tax (I don’t have the details, I presume applies to all assets including property)
    Additional 10% Salary Tax levied on Financial Institution payrolls.
    A new Value Added Tax.
    Increased Carbon Taxes.

    Not what I’d call the model of a progressive tax system.

  • Alias

    “Err, no. If the markets believed we wouldn’t default, there would be no risk and they’d be happy to lend to us.”

    I’d explain that counterintuitive statement but that would defeat the purpose of it. Besides, you explained it yourself: “Based purely on our fiscal position would we be a good place for the markets to loan to in the short term?”

    On the other hand, based on a fiscal position that didn’t have several hundred billion of private sector debt on the government’s books (and those hidden contingent liabilities hidden in NAMA and on the Central Bank’s books), Ireland would be an excellent country to lend money to. Until the state defaults on these debts which it can never repay and should never have underwritten, no lender in the bond markets would consider lending money to it.

    It is, of course, delusional nonsense to pretend that this state can generate several hundred billion of wealth during the terms of these loans, along with the rest of the 1.64 trillion of wealth that it (meaning its private sector) must generate to repay its external debt during the term of those loans.

    The only reason the state could repay 160 billion of that external debt within the last year is because the debt was transferred to the Central Bank by the expedient of the ECB loaning it the money which it in turn loaned to the banks to repay foreign lenders that amount. The economy did not generate that 160 billion in wealth.

    Indeed, most of that 1.64 trillion has vanished into assets that are worth considerably less than the price paid for them. There is no possibility of selling all these assets and using the money to repay the debt. The ones that can be sold are being offered in a firesale to raise some of the next 150 billion due to exist the state as external debt repayment in the next year.

    The rest of that 1.64 trillion – after just the junk assets remain – will have to be raised by the state creating a few thousand brilliant entrepreneurs who can form multinational corporations within a few years by raising funding from non-lending banks and thereby generate 100 billion per year in wealth which the state can tax at 10% and thereby raise an extra 10 billion in taxes. Sadly, they’ll have to do that while selling their products initially to a public which is busy trying to generate another 150 billion in wealth to export to foreign bondholders and simply isn’t buying goods it can’t afford.

    Oh wait… I forgot that foreign exporters are going to save us. It’s just a shame that these are now half the level in real terms than they were before we joined the eurozone and will be even sell when tax sovereignty is lost to the EU.

    Nope, sorry, but it looks like the state is banjaxed and the bond markets know it. Until the state exits the eurozone and defaults, the nation will continue exporting every last cent of wealth it has until the EU finds some practical use for the island…

  • Alias

    Incidentally, Iceland’s credit default swap rate is 10 basis points lower than the CDS of France, so markets will lend to it more cheaply than they will lend to Sarkozy’s ilk.

  • cynic2

    “Over the next three months or so, the nuts and bolts of the Merkel/Sarkozy pact to stablise the Euro will be screwed together”

    …..or not, as the case may be

    “At present they are hoping that they’re desperately hoping the wording of the deal will avoid the need for a referendum. It won’t.”

    Dear God. I agree with Brian Feeny!!

    “Economic catastrophe is what would happen. ”

    That all depends on how the break up of the Euro (which WILL Happen) is managed

  • cynic2

    “Iceland’s credit default swap rate is 10 basis points lower than the CDS of France, so markets will lend to it more cheaply than they will lend to Sarkozy’s ilk.”

    Precisely. In 6 months Cameron will be seen as the only sane voice in the EU. They are all being swept along as flotsam in the tide of economic history