July 16, 2008
Is it time to think the unthinkable? With banks shares in free-fall, lending collapsing and bad debts rising by the hour, what can we do? Now that the slowdown has spread well beyond houses and construction — evidenced by falling retail sales, rapidly rising unemployment and faltering tax revenues — is there an option out there, which, although dramatic, might be plausible in the context of the recession the country is facing?
What we are talking about here is pulling out of the euro. It might never happen, but it is worth considering how and why this might come to pass.
Now that the hollow platitudes of the “soft landing” merchants have been exposed as nothing more than cynical sales pitches, while the various paid PR men who rabbitted on about our “fundamentals” were obviously talking through their posteriors, it’s time to replace catchphrases with hard thinking.
Our problem is pretty straightforward. If a Martian economist landed in Ireland, he’d see straight away that Ireland is caught in a currency arrangement which will make our recession much deeper than necessary. This is an economic fact, not a political slogan. The euro is now part of the problem, not part of the solution.
In economic history, no sovereign country has faced a property downturn, inspired by a ridiculous credit binge, resulting in such huge personal debts without devaluing its currency.
Look at what is happening in the UK and the US. Both countries find themselves in the same bind as we do. They thought that they could get rich by buying and selling houses to each other using other people’s money.
Once this ponzi scheme has been revealed, they let their currency fall. This allows them to recharge their exporting sector, making it more competitive and, more significantly, it gives them the opportunity to inflate their debts away.
Ireland, in contrast, is trying to fight its way out of a recession without any macroeconomic policy. This is political suicide.
We find ourselves in the bizarre situation where we can’t reflate our economy either by printing money or by borrowing. This bad dream is a superannuated version of what happens in American states following a boom bust cycle.
Because American states can’t pull out of the dollar when their housing markets go into reverse, they usually experience mass migration as people up and leave. But crucially, the state gets a Federal bailout through more dole coming from the central government in Washington. So economic policy makes things better.
Think about Ireland now. We do not get any dole transfers from the EU. Quite the opposite, we are net contributors to the EU budget. The EU also prevents us from borrowing more than 3pc of our GDP so that we can’t borrow our way out of the downturn — which is what most countries do.
So we are in the counter-intuitive situation whereby our taxes go to pay Romanian farmers, while our Government is cutting spending on our own health service.
Therefore, unlike the US states, our recession will be endured without any macro-economic solutions.
As a result, unemployment will rise to a much higher level and house prices will fall much further than necessary in the next few years.
The example of this folly is Germany, which experienced the first EMU-inspired recession in the late 1990s to the early part of this decade. Germany had its unification boom in the early ’90s, it spent enormous sums of money trying to absorb the East, the economy boomed for a while, wages rose as did property prices and immigration.
Then in the late 1990s, German industry realised it couldn’t compete at these new higher wages and it retrenched. The engine of Europe went into a decade long downturn. Euro interest rates — although low — were not low enough for a faltering Germany and the euro was far too strong for German exporters so they took the recession on the chin.
Unemployment rose to over four million and stayed there for close to a decade. German companies became competitive again by shedding jobs. Now after 10 years of a slump, they are world beaters again, but many ordinary Germans suffered much more than they would have had they had their own currency.
Now let’s see what happening at home. We need a rapid injection of cash to stabilise the economy. But we don’t have the cash, so we are, in effect, reduced to a barter economy where we can’t create money.
Any Leaving Cert economics student will tell you that the reason the 1930s depression in the US was so severe is that the American government stayed with the Gold Standard for too long and didn’t print money to bail out its debtors. Ireland is now facing the same prospect.
The only way Irish people straddled with huge mortgage debts (the legacy of our stupid binge) will be able to pay these off is with a bout of massive inflation. It sounds radical but this is the truth.
Inflation in a debt crisis bails out debtors and penalises lenders — those with savings suffer, those with debts prosper. It’s simply a transfer of income from one section of the society to another. Yes, this is unpalatable but arguably, it’s an obvious way out of our present dilemma.
In recent days, much has been made of the fact that the multinational sector is still strong. Well it would be stronger still if our exchange rate were to fall.
Equally, the reason the Irish banks and the stock market are in free-fall is that investors realise the extent of the problem and there is nothing else to sell in Ireland Inc — no currency, no interest rates swaps, nothing. So they sell what they can — Irish companies.
When an economy is in a nosedive, it is the democratic responsibility of the elected government to do something about it. In bad times, ideas that seem extreme in “normal” times are sometimes entertained.
As our crisis deepens, the “currency” issue is likely to re-emerge as a political option. It is worth remembering that our boom was triggered by a forced devaluation in 1993. At the time, the establishment regarded the 1993 devaluation as a calamity; in the event, it proved to be a godsend.