Jeremy Warner When politics and economics collide, it is often said, the economics always ends up winning. The curiosity of the euro is that it has managed to defy this otherwise universally applicable rule; the politics somehow continues to triumph over the single currency’s self-evidently flawed economics. For how much longer can this continue? Events in the bond markets this week make it more or less inevitable that Ireland is going to have to follow Greece in seeking support from the European Union’s new bailout fund. Unlike Greece, Ireland is fully funded through to the middle of next year, so there is no immediate danger of a liquidity crisis. All the same, markets aren’t waiting around to find out: some kind of denouement seems to be fast approaching. Yields on Irish government debt have rocketed to their highest level since the launch of the euro, threatening to wipe out virtually all the benefit that Ireland has derived from the eurozone’s low interest rate environment. As is often the case when it comes to the EU, this latest blow to fiscal stability is almost entirely self-inflicted. Having in May agreed a 750 billion euro financial stability facility to support countries unable to repay their debts, temporarily causing the sovereign debt crisis then sweeping the peripheral eurozone economies to abate, European leaders have proceeded to undo much of the purpose of this fund by declaring that bondholders might indeed have to take "haircuts" in future restructurings. Failure to explain precisely what this meant created new uncertainties in markets and a resumption of the debt crisis. Attempts to clarify the position since, by stressing that the default mechanism would apply only to bonds issued after 2013 and not existing debt, have failed to stem the panic. And why would it? If by 2013 the fiscal position of the eurozone's beleaguered fringe hasn't improved - as things stand it seems most unlikely it will have done - then bondholders will charge exhorbitant yields, thus making a restructuring of existing debt inevitable. Either that or the rest of the eurozone would have to give an open ended guarantee. In the blink of an eye, Europe has in any case moved from a position where no act of default would be allowed, with the funding to make good this promise apparently in place, to one where some sort of undefined default has now been officially sanctioned. Markets have reacted accordingly, by driving up rates to a level where the costs of refinancing and servicing Ireland’s national debt would make default virtually inevitable. If Ireland wasn’t bust before, it is now. Other peripheral eurozone economies could follow. The Irish people have been betrayed by their European “friends” as surely as was Britain during the fiasco of the ERM in the early 1990s. Unfortunately for Ireland, there is no similarly obvious escape route. It cannot devalue its way back to growth. It is as permanently imprisoned in its eurozone sarcophagus as an Egyptian mummy in the Valley of the Kings. What makes this fate so galling is that Ireland has done everything that could reasonably be expected to set its fiscal house in order, and, unlike others, it has done so ahead of time and voluntarily. Wages, pensions and public services have been slashed, and taxes raised in a manner that makes the UK’s yet-to-bite fiscal consolidation look like a stroll in the park. Yet it’s all been in vain. Overwhelmed by the monumental costs of bailing out its banking system, Ireland’s fiscal position continues to deteriorate, forcing the country to cut even further. A downward spiral of growing unemployment, mortgage defaults and shrinking credit has established itself. The way things are going, the deflationary funk that Ireland is condemned to won’t end until living standards are returned to those of a Third World nation. This might eventually allow the necessary degree of competitiveness that would allow it to start growing again. Even the self-flagellating Germans would flinch at the brutality of the discipline the euro is imposing on the Irish. If the economics of the single currency is coming apart at the seams, the political glue that holds it together is weakening too. The forces that earlier this year pushed the eurozone towards outright federalism with the establishment of the bailout fund are now pulling in the other direction. True, the decision to make the resolution fund permanent goes hand in hand with a system of macro-economic surveillance that severely compromises fiscal sovereignty. Previously, there was no answer to what happens when things go wrong in the eurozone. Now there is. We seemed to be tip-toeing to a federal Europe. But we are still light years away from the full-frontal federalism of the United States, for which there appears to be little appetite anywhere in Europe. The reason the resolution mechanism is being reformed is to address the fury of German taxpayers at being asked to bail out the profligate fringe. No European nation is ever going to subjugate its tax-raising powers to the interests of the whole, least of all the Germans. Does that doom the euro to eventual destruction? The best guess is that the currency will limp on in its compromised form, though there is always the possibility that social unrest and/or German disillusionment might tear it apart sooner. It also remains to be seen quite what further damage sovereign debt default will do to an already seriously impaired banking system. In any case, we are not there yet. The tragedy is that with both Europe and the US in a state of economic and political paralysis, the door is left wide open to the onward and upward march of China’s deeply sinister form of centrally controlled, authoritarian capitalism. Time is running out for our liberal democracies. If they cannot come up with solutions soon, crueller alternatives may eventually prevail.Ireland has been betrayed by its EU 'friends’
The country is now effectively bust – its brutal cuts will have been in vain, says Jeremy Warner.
Saturday, 13 November 2010
Posts
