April 1, 2013
Judging by the outraged reaction of Ireland’s stockbrokers – the publicity wing of the Department of Finance – Moody’s decision not to upgrade Ireland and keep us on a negative outlook was nothing short of scandalous. This indignation, in a week when we saw retail sales fall for the fourth month in a row, house prices fall for the third straight month and bank lending stall, seems a bit excessive.
Although, that said, I admit to feeling a little bit sorry for the Department of Finance because it would be nice for them if the rating agencies would acknowledge the seriousness of the government’s intent to turn the economy into a large debt-servicing agency. In this pursuit, the mandarins will not be deflected no matter what the cost to the local economy in terms of output, sales and employment.
So why, after so much pain, did the rating agencies not reward Ireland with an upgrade? After all, the promissory note deal – notwithstanding the long-term impact on the debt burden – has reduced substantially the amount of cash that will have to be taken out of the economy in the years ahead. A similar deal is also in the offing for other bailout-related government debt.
In addition, while the economy is relentlessly weak, it has not fallen off a cliff in the past few months, and surely the stabilisation, along with the fall in bond yields, could be acknowledged by the ratings agencies.
Isn’t the central policy aim of ‘exiting the bailout’ still on the cards?
Here is the rub: exiting the bailout depends on the financial markets’ appetite for risk in Europe. If the appetite for risk wanes, Ireland – which is perceived as a poor credit risk with too much debt, not enough growth and dodgy banks – will simply be too risky and money will flow into Germany.
This is already happening because the Cyprus deal – which imposes massive haircuts on large depositors – is likely to become the ‘template’ for future bank bailouts.
If you were a large depositor in Spain, what would you do? You would move your money out of the country before the capital controls imposed in Cyprus are envisaged in Spain, imprisoning your money. Delay and it will be too late. You won’t be able to move it.
Obviously, the EU is vigorously denying that this might happen, but when there is even the faintest risk, surely the best policy is safety?
The Cypriot debacle has led financial markets to have a second look at the banking systems of Malta, Estonia and Slovenia – all small in overall terms, but outsized in comparison to each individual country’s economy. And, of course, what if it doesn’t stop there?
Think about the following: the Cyprus banking sector was too big at eight times GDP, so what does that make Luxembourg, where the banking system is 24 times GDP?
Of course, unlike Cyprus, Luxembourg isn’t referred to disparagingly as a ‘tax haven’ for hot money. Could this possibly be because the big depositors who have their money parked there happen to hold German, not Russian passports?
Quite apart from the eurozone’s banking woes, there is the little problem of the recession.
Undergraduate economic students could have told you that the likely outcome of fiscal tightening and a strengthening currency when the banks are broken and money supply growth is faltering would be higher unemployment and lower output. But, then again, they don’t ask undergraduates about economics, they leave policy to people that believe in the ‘confidence fairy’ who will, like the Easter Bunny, arrive out of nowhere to sprinkle presents, yummy chocolate and the confetti of economic growth – and all will be well.
But all is not well. In France, jobless claims have risen for 22 months in a row. Not surprisingly, money flowed out of France into Germany this week as evidenced by the spread between German and French bond yields widening to 0.75 per cent up from 0.5 per cent two weeks ago.
But even in safe-haven Germany, unemployment was widely predicted to fall in March by 2,000, but it rose by 13,000.
Meanwhile, in Italy, the leader of Italy’s Democratic Party, Pier Luigi Bersani – whose left-of-centre bloc won the most votes in February’s parliamentary elections – said that he would not try to put together a government.
Bersani also said that only an “insane” person would want to run the country in the current environment. This rhetoric is hardly the stuff of the political decisiveness that might usher in a sustained period of financial market tranquility.
In short, the eurozone economy is a mess, without any growth strategy and characterised by severe mistrust between the countries of the northern core and those on the periphery. The weakening of the German economy ahead of its elections in September implies that the tolerance for any more bailouts is extremely low.
This, in turn, implies that if any of the small countries mentioned above endure a banking crisis, the ‘template’ will have to be depositor haircuts because there will simply be no other money being made available.
Without some new positive economic development, it is likely that money will move from the periphery and risky countries towards Germany. This means that bond yields in the periphery are likely to rise again.
Where does this lead the political strategy of exiting the bailout?
There are two ways of looking at this. The first is that these economic developments will make exiting the bailout more difficult. The logic of this is straightforward enough.
In contrast, a second – more political – view might also be that, given the importance to the EU of a ‘success’ in Ireland, exiting the bailout on time may be facilitated by another politics-driven debt deal. Such a move could lighten the financing burden in the immediate years ahead. This would be the only environment where you could be confident that the government’s core economics strategy might work.
If the first view prevails and there isn’t the risk appetite in the markets and bailout fatigue dominates in Germany, it will provide a mighty headache for the coalition, which has put its entire credibility on exiting the bailout. If it doesn’t succeed because of adverse events, what is the price for the coalition staying together? If there is no market/sovereign reward for all this austerity, people will rightly ask, what’s the point?
Taking the events of the week in totality, you would be advised to be healthily sceptical when our spindoctors tell you that the Cyprus deal has no impact on Ireland. The channels through which policy in one country affect another in the euro are many, varied and not always obvious.
On a lighter note, I’ve just noticed that the first name of the new Cypriot Central Bank governor, the man charged with bringing financial tranquility to the island and who promised that this week’s capital controls would be ‘temporary’ is, wait for it, Panicos. How about that for getting lost in translation.