Collapsing Europe
They must be keeping their
fingers firmly crossed in Brussels, even praying that
the Irish rescue package will do more, much more than
buy a little breathing space. Relying on divine
intervention will not be good enough, because there are
three separate problems that will now make the financial
collapse of the euro area a racing certainty. These
problems are the large amounts of cross-border lending,
misguided economic responses, and creditor-debtor
politics.
The scale of the Irish
financial threat is considerably greater than commonly
realised and presented, because the relative size of the
Irish economy is being confused with the size of its
external banking obligations which are significantly
larger than those of Spain or Italy. Cross-border loans
to Ireland by BIS-reporting banks amount to the
equivalent of $715bn, and the comparable figures for
Spain are $534bn and for Italy $467bn.[i]
Of course these are not the only cross-border financial
flows, because they do not include outward banking
deposits and securitised debt issued by the Irish
government and large companies. But they are the figures
that matter.
So we must focus on the
banks, because they are at the heart of the real crisis.
The cross-border loans by BIS-reporting banks for all
the PIIGS amounts to $1,982bn at mid-year, which is 32%
of the euro area total and disproportionate relative to
the size of the economies involved. So if the largest
of these debtors, which is Ireland, is allowed to fail
there would probably be a full-blown banking crisis even
before markets turn their attention to either Spain or
Italy.
These same statistics show
that between September 2008 and June this year the PIIGS
between them have also suffered loan withdrawals of
$611bn, which indicates how hard their economies are
being squeezed by the withdrawal of credit. For Ireland
alone the figure is $165bn, about the same as one year’s
GDP, and more withdrawals will have taken place since
June, putting the proposed rescue package of only $113bn
into context. This acute deflation is being conducted at
the same time as taxes are being increased, which brings
us to the serious mistakes being made in the management
of the economy.
The Irish government has
got one thing right: the importance of keeping
corporation tax low. Brussels views things differently,
partly because Germany and France see Ireland as unfair
competition with respect to corporate location. So
between Brussels and Dublin an ugly camel is born, and
their attempts to close the budget deficit by a mixture
of tax rises and public sector wage cuts while robbing
state pension funds betrays a lack of resolve to tackle
banking solvency properly. It is madness to punish the
Irish people for the current banking crisis, because
Brussels is shooting at the wrong target: rescuing the
European banking system does not require the Irish
economy to be driven into the ground, it requires
Brussels to recognise it has a full-scale banking
problem on its hands.
Both lender and borrower
must bear responsibility for such wrong-headedness. It
amounts to a protection of jobs in the public sector,
while taxes are raised from the private sector and
pensions are robbed. Taxing individuals and the private
sector to reduce budget deficits prevents vital capital
formation and so condemns Ireland’s economy to a
prolonged period without recovery. This socially-driven
approach is counterproductive, a point which will not be
lost on the markets, when they work out that Ireland
will be less able to repay its creditors because
economic recovery, upon which government finances rely,
is effectively cancelled.
So markets are now faced
with a bail-out too small to reverse the run on the
Irish banks, and by an Irish economy that has no chance
of economic recovery in the foreseeable future. A
bail-out of $113bn amounts to an injection of only half
of the money withdrawn from Ireland by the banks in the
last two years. It is simply not enough.
The crisis is not helped
by the understandable reluctance of the German people to
commit more good money after bad. It was difficult
enough for Angela Merkel to come up with the funding for
Greece, which was sold to the German electorate as a
one-off. Six months later it’s Ireland, presumably then
Portugal, then Spain. It is no surprise that she wanted
someone else, like senior bondholders to share the pain.
But talk of bondholder haircuts merely creates a new
bond market crisis to add to the banking crisis and will
drive up Irish bond yields even further; and
back-peddling on this issue is unlikely to undo the
damage.
The importance of Ireland
is that is the biggest cross-border banking debtor of
all the PIIGS. If the Irish banks are not saved, the
European banking system will probably go under, and
soon, without waiting for the pressure to mount on
Portugal Spain and Italy. The politicians and
bureaucrats of Euroland have not demonstrated a
sufficient sense of urgency and understanding of the
true crisis to resolve it: rather they have made it
worse. It is now becoming impossible to see a way out
of the euro-banking problem without the ECB giving in on
its anti-inflation stance and implementing aggressive
quantitative easing. However, the ECB was set up to
survive attempts to get it to inflate, so if it backs
down from its sound-money stance in the middle of this
crisis, the euro itself will suffer a loss of
confidence.
It looks like divine
intervention is the best hope after all.
28 November 2010
[i]
These figures are as at the end
of June 2010 and are from the Quarterly External
Debt Database portal of the World Bank.
