October 1, 2000
The voters in Denmark and the rioters in Prague have arguably set the key political agenda for the next 10 years by asking the crucial geo-political question.
Is it possible for a country to preserve its own political and economic identity and still play an active role in the process of globalisation? And, if these two aspirations are found to be mutually exclusive, what next?
The Danes rejected the euro on the basis that joining the euro would eventually lead to a watering down of their welfare state and the imposition of wrong and hostile policies from Brussels.
The Danish people argue that their high income, high valued added economy, which (like Ireland) does a significant amount of trade with non-euro countries (in Denmark’s case with Sweden, Norway and Britain), does not need the euro.
Furthermore, given their trade patterns many Danish economists argued that it would not be logical for Denmark to embrace the euro. Better to have tools at your disposal than none at all.
Finally, many Danes asked what extra benefit could be gained from the euro to compensate for these risks. When they weighed it all up they concluded nej.
During the run up to the elections a Danish economist friend of mine, working as it happens in the European Commission, told me that many previously pro-European Danes regarded the present Irish dilemma as a sufficient reason not to gamble on the euro.
His message was simple. He pointed out that due to globalisation, our economy has become increasingly American yet over the past few years our politicians have tied us politically and monetarily closer to Europe.
We have been pursing a US low-tax, low-wage economic policy while at the same time tying ourselves ever closer to a European high-tax, high-wage trading bloc.
The low-wage, low-tax environment typically leads to high productivity and higher levels of profits, resulting in investment capital flowing from Europe to America, where a small proportion is recycled back to Europe through America’s client economy, Ireland.
This ebb and flow has been the case throughout the 1990s and is clearly evidenced by the increased synchronicity between the American and the Irish business cycle which was not the case in the 1970s or 1980s.
The American and Irish economy now move in synch, sending Ireland on a totally different cyclical orbit to that of the rest of the eurozone.
This financial fault line means the story gets a little bit more complicated, confused and dangerous. If Ireland is increasingly becoming America’s 53rd state but operates with German interest rates and exchange rate policies, Ireland has a problem. The nature of the problem is pretty straightforward. The only way Germany can compensate for the outflow of capital to the US is to have a much weaker currency and, for as long as it takes, reasonably low interest rates.
Raising interest rates now as the ECB is trying to do will just put an extra cost on capital, reducing profits further and exacerbating the original capital outflow. (In fact, intervening to prop up the euro has precisely the same effect because the term “intervening” is financial shorthand for buying your own currency.
By buying euros the central banks are taking them out of circulation and squeezing the money supply. Long term, as the man said, this ain’t where it’s at.
As a result this leaves Ireland in the ridiculous situation due to euro commitment which means negative real interest rates and an excessively weak exchange rate.
The combination is making Ireland far too competitive, increasing the net inflow of investment from the US. At the same time, the negative real interest rates eliminate any incentive to save so people spend like there’s no tomorrow. The net effect is an economy pumped up on steroids with both consumption and investment exploding while wages and house prices continue to rise.
Given that competitiveness has become a rather perplexing obsession in Ireland (seen by many as an end instead of a means), our politicians feel more than justified as they cut taxes even in the face of such a spending frenzy. Globalisation gives us the perfect intellectual justification for cutting taxes.
But there is not a shred of evidence to suggest that US capital would pull out without the cutting of tuppence off the bottom rate or that the effect of any tax cuts will not be eroded by wage inflation. The emergence of wage inflation exposes yet another fault line between our freewheeling American economy and our incredible European political rhetoric.
Social partnership does not seem to be up to the job when inflation takes off and no amount of bluster disguises the fact that labour unrest will lead to much higher wages.
The ‘soft landing’ school argues all will be grand, the euro will straighten and inflation will fall.
There has never been a so-called ‘soft landing’ anywhere in the world and in reality it is America and not the ECB which controls the euro.
This week the US Treasury reiterated its strong dollar policy — hardly surprising when you have a huge current account deficit to finance.
And so we are likely to continue spinning out of control and recession, as raised by my former employers in the Central Bank on Thursday, would seem to be the only end game.
Coming up to the referendum on European enlargement in December we will continue to delude ourselves with the inconsistent political couplet of Scandinavian-style rhetoric and American-style taxes, aspiring to decent public services which aren’t delivered. Meanwhile, the Danes looking on from the sidelines have made “probably the best political decision in the world”.