UPDATE: An excellent interview on Bloomberg of Lombard’s Dumas. I put the link in the comments below but it summarizes this post well so I thought I would bump it up to the top. Worth watching. (H/T The Boiling Frog Blog)
A Citigroup organized conference call with the Irish Finance minister and around 300 investors, descended into chaos last week as investor’s poked fun at the minister by making monkey noises and crying “Dive! Dive!” Immature as the behaviour was, it illustrated the dire predicament Ireland now finds itself in.
The Government’s effective nationalization of Anglo Irish Bank has pushed the budget deficit for this year to 32% of GDP (the danger level for deficit/GDP is considered by many economists to be 14%) sending the yield from Ireland’s government debt beyond that of Iceland and into default territory. The nationalization of Anglo Irish may have cost up to €35 billion or nearly €10,000 for every person in Ireland with its junk bond purchase scheme adding another €22,000 per person.
Last Thursday, the Irish finance minister Brian Lenihan made clear that while junior debt holders would make a “significant contribution” to the cost of the bank bailouts, depositors and senior debt holders would be protected. However, some hedge funds holding this junior debt are not happy about taking a ‘haircut’ on their holdings while senior debt holders are to be paid in full. They are taking the Irish government to court threatening that they will force Anglo Irish to be declared insolvent. Having guaranteed 100% of all bank deposits this would likely tip Ireland over the edge into bankruptcy and the embrace of the European bailout fund. This would end all semblance of financial independence for Ireland, as well as for its low corporation tax rate – one of the few sensible economic policies of the Irish Government in recent years.
Now there is much to criticize about the actions of the Irish banking industry. Those chief executives should all have lost their jobs and Anglo Irish allowed to fail with a much lower deposit guarantee. The hedge funds’ high stakes game threatening to declare Anglo Irish insolvent could be considered to be immoral, given the consequences to the Irish taxpayer. However, the lion’s share of the blame for this whole sorry state of affairs lies squarely with the political class. The hedge funds have a fiduciary duty to protect their investors’ money and are acting accordingly. Irish politicians had a duty to protect the interests of their citizens and instead acted against them. For the reason why Ireland is now staring into the financial abyss is mainly due to its government’s decision to take it into the Euro.
The Euro was created as a political construct. Its purpose was to force the need for the creation of all the institutions of a European State. It would necessitate a central bank, a unitary interest rate and monetary policy, financial supervision and further down the line, a unified economic and taxation policy. However, as an economic idea it really didn’t make much sense. A one-size fits all interest rate and monetary policy can only create financial bubbles in high growth economies, and depress growth in the low growth economies. The European Central Bank set the interest rate at a sensible level for the German economy, but the rate was way too low for Ireland whose economy was inflated by essentially ‘free’ money from Frankfurt. In 2006, the GDP in Ireland was cracking on at a pace of 6%, pushing inflation to 4.5%, while the main interest rate from the European Central Bank was 2.25% (H/T Tax Payers Alliance). Ireland effectively therefore had negative interest rates, which meant that any project made sense. Without a proper pricing of money, all you needed to do was borrow some money, buy or construct something and then watch your wealth, grow no matter how bad or worthless the project was.
So how does Ireland find its way out of this disaster? My suggestion to the Irish people would be to grab some pitchforks and expel the entire political class to one of the deserted isles of the west coast. However, over at the Adam Smith Institute they have some more boring ideas. Essentially, get out of the Euro, let the banks fail, don’t guarantee all the deposits, make some real budget cuts, and sell off as many assets as they can.
Ireland should take three painful steps to end its purgatory and put itself on the road to recovery. Firstly, it should end its 100% bank deposit guarantee and stop protecting banks and savers from their own mistakes. This would remove a large part of the budgetary burden. Secondly, it should default on some or all of its debt and fix its budget deficit through cuts in current expenditure. A fire sale of capital building projects and the privatization of other state assets (the state-owned gas and electricity companies, for instance) would bring in some much-needed revenue and help with the private sector recovery by opening up the number of industries subject to competition. Finally, the government should withdraw from the euro zone immediately. This would allow for a currency revaluation that would end the trade stasis that the euro has locked Ireland into, with artificially high prices depressing Irish exports.
I still think my idea was better.