February 1, 2009
Last Friday, former Maoist – and head of the European Commission — Jose Manuel Barroso mentioned Iceland and Ireland in the same breath.
He intimated that, without the euro, Ireland would be Iceland. The same day, Jean-Claude Trichet, the head of the European Central Bank (ECB) and a man who has never had a job outside the cosseted French – and then European – public sector, claimed that there were no difficulties with any eurozone member. Yet, maybe as a result of Barroso’s claim, the markets in London decided by last Friday afternoon that Ireland was more likely to default than Greece.
So, are they right? Will Ireland default? Will Ireland become Iceland within the eurozone? Will we become the first country to default in the currency union because we do not have the cashflow to fund ourselves? Was Trichet simply blurting out what had been on his mind for some time, which is that the euro is weakened by the parts of its sum?
Those parts are Ireland, Greece, Spain, Portugal and Italy. While we are in the eye of the storm, we are by no means alone. In fact, we should probably try to keep bad company for awhile, rather than standing out as uniquely delinquent.
What both Eurocrats know is that, if this gets any worse and liquidity continues to dry up, either the euro will break up or one of the countries within the eurozone will default. It is quite possible that one or more of the high borrowing group – which includes us – will run out of money at some stage.
The dilemma then for the EU will be whether it has the stomach, or indeed the political will, to organise a huge bailout for the weaker countries. If this is even being partly contemplated, then we’d be better off hiding for as long as we can behind the shield of delinquency with our newly acquired Club Med friends.
In return for a bailout, federalists in the EU would demand increased political integration as the quid pro quo for the money. If you doubt this, look a bit at European monetary and political history.
A monetary union with the euro was fast-tracked following the last currency crisis in Europe. As a result of the 1992-93 devaluations – which saw Britain leave the European Monetary System (EMS), and Ireland and Italy devalue by 10 per cent – the European elite decided that the only way to lock Germany into the EU was through monetary union.
This was particularly the case following what Brussels saw as an alarming attack on the French and Belgian francs. If the markets would not believe that the rest of the European currencies were as good as a Deutschmark, they believed that the EU would eliminate this risk by creating a single currency.
The moral of the story is that Eurosceptic traders in London need to appreciate what happens when they attack the foundations of the EU through its monetary chinks. The reaction is always more federalism, not less federalism. With the likelihood of an EU-wide bailout in mind, let’s go back to the utterances from last week at Davos. Barroso appeared to suggest that Ireland was a basket case, and was only being kept alive by the paternalistic protection of Europe’s single currency.
By extension, he must believe – if he has an ounce of economic grey matter in his head – that, without the euro, an independent Irish currency would collapse.
If this is the case, he has just made the most compelling case for why the single currency is inappropriate, and why much greater central EU tax and budgetary powers are necessary if the euro is not to break up. For this to come to pass, the EU has to become a much closer political entity.
The point of a currency union is that it must be appropriate for the country concerned. If a country’s debt position and economic predicament is so perilous that it would find it difficult to maintain a particular exchange rate if it were outside the union, then the euro is an overvalued currency for that country.
This means that the country would suffer social explosion from membership, resulting from huge unemployment and bankruptcies. Most countries wouldn’t tolerate this for long.
They would try to become more competitive by cutting wages, but workers wouldn’t accept this – and the country would either defaultor pull out of the euro, or most likely both.
Trichet has figured this out, which is why he is telling anyone who cares to listen that the euro is okay. He obviously thinks it’s not, because he has followed recent events through to their logical conclusions. So does all this mean that the credit default swap (CDS) traders were right last week? After all, they are betting now that Ireland, the country with the lowest debt to GDP ratio in Europe, will default more quickly than Greece – the country with the highest.
The answer is that they might not be right, but we should be concerned. We have seen (and I am no conspiracy theorist) an orchestrated campaign against Ireland in the British financial press of late.
This is how defaults happen. First, the country gets itself into a mess. Then the tail starts wagging the dog.
The CDS traders start to take positions against the country in the thin CDS market. Then, the much bigger sovereign bond market begins to reflect this. So people start to say things like ‘‘the CDS market is saying that Ireland is moving into default territory’’, even though we might have huge borrowing capacity.
The traders who are taking abet against Ireland continue to drive the CDS prices upwards, and they leak stories to the media about us. This activity attracts others. Large investment banks start to write notes about the deteriorating Irish position.
Suddenly, what began as a trickle – with a few isolated traders taking a punt – becomes a torrent. It is important to remember that the CDS market is still small, but its ramifications are felt everywhere.
Ultimately, Ireland goes to raise money, and fails to get all the debt sold. This causes a run on the Irish government bond market and it becomes ‘common knowledge’ that Ireland is in trouble.
Because we are already going to borrow at least â‚¬18 billion to cover day-to-day spending this year, any shortfall in tax has to be paid for by borrowing. If the ability to borrow falters, we face the very real prospect of a fiscal crisis this year. A fiscal crisis is when the Minister for Finance informs the Taoiseach that we can’t pay teachers’ salaries next month because we don’t have the cash.
This is not so far-fetched. Our banks are being drip-fed loans by the ECB to keep them afloat – like many other banks across the EU. This is obviously what Trichet sees every day, and what worries him about the entire single currency. What has happened to our banks is likely to happen to our state.
Although it might not feel like it this morning, we are seeing the beginning of a process that is likely to lead to serious questions about the future of the euro, as well as the membership of the small countries which have borrowed highly, and about their ability to repay their debts.
We are one of this group. Our best hope now is that we do not end up on our own, and that at least a few strapped countries end up playing Russian roulette with the EU.