What a comedown for Ireland in the past few weeks. The respected Celtic Tiger
of yore, singularly the economy that benefited the most from the creation of
the European Union, has fallen prey to the speculators of today and been pushed
to the corner to do the bidding of Brussels and carry out a controversial bank
rescue.
In so doing, its plight resembles another supposed miracle economy that is
moored just a few hundred kilometers to its northwest and is also an island -
Iceland. The travails of the lands of Ire and Ice are not so much at odds with
each other and come down essentially to the same point - the size of banking
assets to that of the general economy; but they do differ considerably in
how the two economies approached the battle.
The venerable Oxford English Dictionary defines the two terms, ire and ice as
below. Poetically, the definitions themselves appear to have had an impact on
how the countries approached the financial crisis:
ire (aI@(r)), n. ... [a. OF. ire, yre (11th c. in Littre), ad. L. ira
anger, wrath, rage.] Anger; wrath. Now chiefly poet. and rhet.
ice (aIs), n. ... [Com. Teut.: OE. is, OFris., OLG., OHG. (MDu., MHG.)
is (Du. ijs, Ger. eis), ON. iss (Sw., Da. is):-OTeut. *iso-. There are no
certain cognates outside Teutonic.] I. 1. a. Frozen water; water rendered solid
by exposure to a low temperature.
Ireland adopted the "way of the fire", namely to show massive irritation with
the conduct of its bankers, but nevertheless stopped to bail them out and
imposed austerity measures on the rest of the economy. Iceland on the other
hand adopted the tactic of "freezing out" bank creditors, and in so doing may
well have put itself on a quicker path to economic recovery. So how did the two
opposing strategies work out?
The graph of Ireland vs Iceland in credit default swap markets, derived from
Bloomberg, and shown below, highlights a moderate blowup for the Icelandic
sovereign early in the year when there was some expectation of a new bank
bailout; once this was denied, the sovereign tightened through the course of
the next few months.
In contrast, Ireland chose to save its banking system by essentially
guaranteeing all deposits and also bailing out private creditors who owned the
senior and subordinated debt of the Irish banks. That wasn't enough though -
Irish banks saw a steady worsening of their funding ratios over the past few
months and finally had to resort to extreme reliance on the European Central
Bank (ECB).
This in turn became a mark of no-confidence in the markets and very slowly
investors came to the realization that if the ECB altered its lending criterion
in any way, Irish banks would have to depend exclusively on the government.
The Irish government embarked on a severe austerity program in the past few
months, and as I noted in my recent articles on debt and democracy (see
Pay up or wiggle out, Asia Times Online) it is among the few Western
sovereigns to expect a significant decline in debt issuance next year.
Its own borrowing program, totaling around 28 billion euros (US$38 billion) for
2011, is largely in place. That isn't, however, the key problem that the
markets are fretting about - rather it is the fact that borrowings for banks in
the order of 80 billion euros or so would need to be coughed up by the Irish
government. This is the unsustainable part of the equation and one that Ireland
can blame not so much on itself but rather on the very construct of the
European Union.
Columnist Matthew Lynn writing in Bloomberg maintains that the EU would need to
be split and the currency union done away with entirely in order to avoid
future contagion around the continent. I found many aspects of his article both
entertaining and edifying (emphasis below is mine):
Nov. 16 (Bloomberg)
-Who's next? First Greece went bust. Now Ireland is on the brink of a bailout
from the European Union and the International Monetary Fund. When it happens,
we'll hear plenty of soothing words about how contagion has been stopped, the
euro area has been put on a firmer footing, and the single currency saved.
... Don't listen to a word of it. The euro has turned into a bankruptcy machine.
Once the markets have finished with Ireland, they will simply move on to
Portugal and Spain, and after that to Italy and France. There is a domino
effect at work, and, with each rescue, the fault lines within the euro grow
wider and wider. This process isn't going to stop until the euro is taken
apart.
... But it is very hard for the single currency's remaining supporters to
explain why it has come to his. The Greeks fiddled their way into the euro. ...
No one can say that about the Irish. Ireland had one of the most successful
economies in the world over the last two decades. Its government was never
profligate. When the crisis hit, it didn't bury its head in the sand the way the
Greeks did. It took every austerity measure imaginable to try and fix
its problems by itself
... In short, the problem wasn't Ireland. It was the euro. The logic of that is
inescapable. If it is the single currency that is at the root of the crisis, it
won't stop here.
...This crisis will keep moving from country to country. The only permanent fix
is splitting up the euro into more manageable currency areas. Until the euro
area’s leaders recognize that simple truth, every bailout they come up with is
only going to shift the attacks elsewhere.
The point, however,
is missing in Lynn's analysis of the situation - namely that the common
currency is a safety value but is also a pressure cooker. Inside the cooker,
Ireland wasn't allowed to let its banks fail while protecting depositors;
instead, to avoid the spread of financial system risk across Europe, Ireland
was forced to save its banks.
In contrast, Iceland had no such constraints and allowed its banks - whose
assets over gross domestic product exceeded even Ireland's - to go under. In so
doing, the Icelandic government effectively forced the losses on Icelandic
borrowing to be borne by German and French banks. As banks shed their total
debt and separated into "good" and "bad" bank entities, normal banking
activities resumed in Iceland. While the economy has become smaller and asset
values (measured in euros) have plummeted, there is a chance of stronger
economic recovery in coming years driven by fishing, tourism and aluminum (the
traditional businesses of Iceland).
The Irish simply didn't have this option. Being forced to adopt austerity
measures while keeping up with the good graces of the French and German banks,
they soon realized that all the austerity measures of the government were
essentially helping out the bankers on the continent rather than their own
countrymen.
It isn't clear to me that the Irish will persist in their austerity drive; nor
indeed that they should adopt this course of action, particularly if the easier
one of allowing various banks to go bust remains on the table.
The markets this week have sent the clearest signal that the European project
is over. Brussels will become a ghost town once again, and euro notes will
become collectible items. There is nothing wrong with that - in the unforgiving
world of capitalism, there is no room for fantasy bankers.
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