I am one of those people who regard the EU as one of the greatest achievements of global politics, ever. To bring together former warring imperial powers who, between them, caused and fought most of the worlds most brutal and widespread wars into a partnership that has provided 65 years of relative peace is one of the greatest achievements of statecraft of all time. Minor squabbles over British budget refunds, CAP reform, or the institutional ineptness of European leaders are very welcome alternatives to war. A bit like the current Northern Ireland elections, where people are celebrating how boring the elections have become, given that the most recent alternative was a sectarian driven low intensity war.
So why have I headed this story with such a melodramatic title? Is the current financial crisis in peripheral European state really such an existential threat to the future of the EU? Is my disillusion with he European project not as much a product of the unrealistically high expectations of the EU that I have articulated in the first paragraph as it is of any fundamental change in the nature of the EU itself? Are we not just witnessing the normal growing pains of the development of a European superstate? Well, if we are, it is a very different EU to that envisaged by its founders, and one that has internalised a whole new concept of war – one in which the poor and peripheral are mercilessly and unscrupulously sacrificed to the interests of the central European elite.
Let me illustrate this thesis with a few pieces recently published in the Irish press. Exhibit A is today’s article by Morgan Kelly, one of the few domestic economists who predicted the Irish property crash and subsequent economic collapse.
Ireland’s future depends on breaking free from bailout
The negotiations went downhill from there. On one side was the European Central Bank, unabashedly representing Ireland’s creditors and insisting on full repayment of bank bonds. On the other was the IMF, arguing that Irish taxpayers would be doing well to balance their government’s books, let alone repay the losses of private banks. And the Irish? On the side of the ECB, naturally.
In the circumstances, the ECB walked away with everything it wanted. The IMF were scathing of the Irish performance, with one staffer describing the eagerness of some Irish negotiators to side with the ECB as displaying strong elements of Stockholm Syndrome.
The bailout represents almost as much of a scandal for the IMF as it does for Ireland. The IMF found itself outmanoeuvred by ECB negotiators, their low opinion of whom they are not at pains to conceal. More importantly, the IMF was forced by the obduracy of Geithner and the spinelessness, or worse, of the Irish to lend their imprimatur, and €30 billion of their capital, to a deal that its negotiators privately admit will end in Irish bankruptcy. Lending to an insolvent state, which has no hope of reducing its debt enough to borrow in markets again, breaches the most fundamental rule of the IMF, and a heated debate continues there over the legality of the Irish deal.
Six months on, and with Irish government debt rated one notch above junk and the run on Irish banks starting to spread to household deposits, it might appear that the Irish bailout of last November has already ended in abject failure. On the contrary, as far as its ECB architects are concerned, the bailout has turned out to be an unqualified success.
The one thing you need to understand about the Irish bailout is that it had nothing to do with repairing Ireland’s finances enough to allow the Irish Government to start borrowing again in the bond markets at reasonable rates: what people ordinarily think of a bailout as doing.
The finances of the Irish Government are like a bucket with a large hole in the form of the banking system. While any half-serious rescue would have focused on plugging this hole, the agreed bailout ostentatiously ignored the banks, except for reiterating the ECB-Honohan view that their losses would be borne by Irish taxpayers. Try to imagine the Bank of England’s insisting that Northern Rock be rescued by Newcastle City Council and you have some idea of how seriously the ECB expects the Irish bailout to work.
Instead, the sole purpose of the Irish bailout was to frighten the Spanish into line with a vivid demonstration that EU rescues are not for the faint-hearted. And the ECB plan, so far anyway, has worked. Given a choice between being strung up like Ireland – an object of international ridicule, paying exorbitant rates on bailout funds, its government ministers answerable to a Hungarian university lecturer – or mending their ways, the Spanish have understandably chosen the latter.
The entire article is well worth a read – replete with references to the faintly dim former rugby players who ran the Irish banks – surely not a dig at Peter Sutherland, former chair of Ireland’s then largest bank, AIB, as well as a former EU Commissioner, Head of the WTO, and Chair of BP and Goldman Sacks – and a broadside at Patrick Honohan, current head of the Irish Central Bank, who is accused of “playing for the other side” as a Council member of the ECB.
So what “solution” does Morgan Kelly propose?
Ireland’s future depends on breaking free from bailout – The Irish Times
This allows Ireland to walk away from the banking system by returning the Nama assets to the banks, and withdrawing its promissory notes in the banks. The ECB can then learn the basic economic truth that if you lend €160 billion to insolvent banks backed by an insolvent state, you are no longer a creditor: you are the owner. At some stage the ECB can take out an eraser and, where “Emergency Loan” is written in the accounts of Irish banks, write “Capital” instead. When it chooses to do so is its problem, not ours.
At a stroke, the Irish Government can halve its debt to a survivable €110 billion. The ECB can do nothing to the Irish banks in retaliation without triggering a catastrophic panic in Spain and across the rest of Europe. The only way Europe can respond is by cutting off funding to the Irish Government.
So the second strand of national survival is to bring the Government budget immediately into balance. The reason for governments to run deficits in recessions is to smooth out temporary dips in economic activity. However, our current slump is not temporary: Ireland bet everything that house prices would rise forever, and lost. To borrow so that senior civil servants like me can continue to enjoy salaries twice as much as our European counterparts makes no sense, macroeconomic or otherwise.
Cutting Government borrowing to zero immediately is not painless but it is the only way of disentangling ourselves from the loan sharks who are intent on making an example of us. In contrast, the new Government’s current policy of lying on the ground with a begging bowl and hoping that someone takes pity on us does not make for a particularly strong negotiating position. By bringing our budget immediately into balance, we focus attention on the fact that Ireland’s problems stem almost entirely from the activities of six privately owned banks, while freeing ourselves to walk away from these poisonous institutions. Just as importantly, it sends a signal to the rest of the world that Ireland – which 20 years ago showed how a small country could drag itself out of poverty through the energy and hard work of its inhabitants, but has since fallen among thieves and their political fixers – is back and means business.
Sticking the ECB with ownership of the Irish banks in return for the €160 Billion it has lent them will have political consequences, but things have come to the point where, Ireland as well as Greece, must seriously consider leaving the Eurozone if that is the price it must pay. Unlike Greece, Ireland will have a €50 Billion trade surplus this year, so at least it can survive without the Euro if that is the price our “partners” demand for “restructuring” our debts. That trade surplus also provides scope for raising taxes to balance the national budget – as well as the expenditure cuts Morgan Kelly advocates – as argued by Daniel Gros recently (Exhibit B):
Low foreign debt means State will not go broke
IS IRELAND broke? Short answer: no. Long answer: The Government should be able to service its large debt because the external debt of Ireland is rather low, about 20 per cent of GDP.
The net external debt of Ireland can be measured easily by summing past current account balances. Since the country has run a surplus for many years, the sum of the current account balances over the last 20 years amounts only to about minus €30 billion, about 20 per cent of the Republic’s GDP of €150 billion.
Greece and Portugal, by contrast, have foreign debt which, at about 100 per cent of GDP, is four times higher than Ireland’s.
Why is foreign indebtedness more important than public debt – which is much higher now in Ireland than in Portugal?
The reason is that EU states retain their full taxing powers. This has a simple corollary if one takes a country with a high public debt but no external debt.
In this case, the public debt must be held by residents and the Government can always ensure the service of its debt by some form of lump sum taxation, such as a wealth tax.
For example, the Government could just pass a law which forces every holder of a government bond to pay a tax equivalent to 50 per cent of the face value of the bond or tax interest payments. The value of public debt would thus be halved, much in the same way as it would be if the Government ordered the Central Bank to double the money supply, which would presumably lead to a doubling of prices.
The nature of the tax needed to pay off public debt might be different if the public debt is held by pension funds because in this case the Government would have to tax either pensions or expropriate in some other ways these funds. This might be politically painful, but for the country it just represents a transfer from one set of residents (and voters) to another one. The workers and pensioners who have to pay higher taxes and see the value of their pensions reduced will of course object to being fleeced for the benefits of the holders of public debt, the rentiers . But if income and wealth are not too unevenly distributed, many will be at the same time both taxpayers and rentiers .
Moreover, this internal redistribution would not alter the consumption possibility of the entire economy and thus does not require an increase in exports or a reduction in overall consumption.
The key point thus remains: as long as a government retains its full taxing powers, it can always service its domestic debt, even without access to the printing press. However, this is not the case if the public debt is held by foreigners because the Government cannot tax them.
The government of a country whose public debt is held by foreign residents cannot simply expropriate them. It is thus foreign debt which constitutes the underlying problem for the solvency of a sovereign.
Things get of course more complicated if a large part of public debt is held by foreign residents but domestic residents have large foreign assets. If the government debt of a country with a balanced net foreign asset position is held by foreign residents its citizens have to hold net foreign assets of an equivalent amount. In principle then a government can still always service its debt by taxing away the foreign assets of its citizens.
However, in this case the Government faces the temptation to default on its foreign debt while its citizens can still enjoy the returns from their foreign assets. This temptation will be reinforced the more difficult it is for the Government to tax the foreign assets of its residents.
The importance of this point was illustrated by the case of Argentina where the country as such did not have a large net foreign debt. The private sector had large foreign assets while the government had about the same amount of foreign liabilities.
However, Argentina went bankrupt with little net foreign debt because wealthy Argentines had spirited their assets out of the country, and thus out of the reach of the government, while the poor Argentines refused to pay the taxes needed to satisfy the claims of the foreign creditors.
However, when the foreign assets of the country are held not by households, but by institutions, such as pension funds, they can be taxed. This seems to be the case for Ireland. If there is a political way there should be a way for the Government to service its debt.
Another indicator of the relatively comfortable solvency position of Ireland is that the external adjustment is already almost completed. This year Ireland should record a smallish current account surplus so that there is no immediate need for further cuts in consumption.
Exhibit C is another Irish Times article by Fintan O’Toole:
Treatment of Ireland a disaster for European project
EVEN IN the midst of an existential crisis, Irish politics can’t shake off its addiction to false alternatives. At the moment, there’s an apparent choice between two equally unpalatable approaches.
We can be “good Europeans” – take our medicine, behave responsibly and hope that somewhere down the road we will be rewarded. Or we can be “bad Europeans” – deny our responsibilities, kick up a fuss and cause trouble for our neighbours by talking of default.
What if, however, the real good Europeans are those who think that the crucifixion of Ireland is a disaster for the European project? What if the German philosopher Jürgen Habermas was right when he warned that present policies are leading to the “creeping death” of the EU and said that “we are currently going about sinking 50 years of European history”?
Does it not behove us as “good Europeans” to shout from the rooftops that the policies being imposed on Ireland are profoundly anti-European?
There is a grotesque irony at the heart of the European approach to Ireland. It relies entirely on the crudest form of nationalism. The basic proposition is that “the Irish” borrowed loads of money and “the Irish” must pay it back.
Each and every citizen of a particular nationality is responsible for the misdeeds of others who hold the same nationality. National identity trumps everything else. It doesn’t matter that you didn’t borrow the money or that you had no way of knowing what decisions private banks were making. You’re Irish, the banks are Irish, so you’re all guilty.
This applies even when none of the money originated in or was spent in Ireland. Take, for example, the way Anglo Irish Bank increased its UK loan book by a staggering £1 billion (sterling) in just six months between September 2004 and March 2005.
That billion quid was borrowed almost certainly from German and French banks. It was lent largely to British property funds such as St James Capital, Nomura and Warner Estate Holdings.
The money went from Germany to the UK, via an Irish intermediary. Somehow, this makes it “Irish” money, so the nurse in Ennis and the factory worker in Portlaoise have to pay it back.
The underlying assumption here is that of extreme nationalists everywhere: nationality defines everything. This is, in itself, extremely stupid. There’s no such thing anymore as Irish money or German money or British money. There’s just money, moving around the world in vast quantities. (Every day, about $4 trillion is traded on foreign exchange markets alone.)
The Irish bubble would not have been possible without the inflow of vast amounts of capital, including the €88.4 billion that German banks were owed by Irish banks and companies at the end of last year.
The idea that these international financial transactions carry a passport is, in the era of globalisation, innately absurd. But coming from the European Union, it is also staggeringly hypocritical. The EU has been driving the idea of a single European market for financial services since the 1960s.
Yet that is the sort of nationalism which is now driving German and EU institutional responses to the crisis. The “nurse in Ennis” is indeed being held responsible for irresponsible German bank loans which inflated the Irish property bubble and which forced her to buy her house at inflated prices and for which s/he is now in negative equity. To add insult to injury, s/he is now facing redundancy as a result of Government cutbacks, swinging reductions in income and interest rates increases at the behest of the ECB. Just how is this supposed to work without default at both the personal and national level?
The question of Ireland leaving the Eurozone could in any case be moot if an economic implosion in Spain leads to a a complete breakdown of the zone as suggested by Dan O’Brien recently (Exhibit D):
Future of the euro balanced on a Spanish knife edge
WITH THE three weakest peripheral Euro zone economies already on a lifeline, Spain is now closest to the precipice. A Spanish bailout would dramatically increase the chances of the Euro breaking up. The probability of a disorderly disintegration of the world’s second-largest currency would rise from low to near even if Spain goes.
The capacity of the Spanish state to fund itself is a central question not only for Europe, but for the world. It is difficult to see how a global depression could be avoided in the wake of the utterly unprecedented levels of default that would accompany euro break-up.
Whilst extolling the Spanish economy as having many strengths, Dan O’Brien suggests that the true costs of the Spanish property bubble collapse have not yet been reflected in official figures:
Future of the euro balanced on a Spanish knife edge
According to the IMF, the net direct cost of the banking clean up in Spain has amounted to just 2 per cent of GDP – below the average for advanced economies and a fraction of Ireland’s world-leading 28.7 per cent.
But such a small bill looks fishy. Could the authorities and institutions be hiding something? Far stranger things have happened. The forthcoming Europe-wide stress tests might give more certainty.
And even if nothing is awry, with further falls in residential property prices all but certain, a 20 per cent unemployment rate and rising interest rates, the amazingly low percentage of banks’ loan books not performing looks certain to swell. If Spain were to see anything like the repeated upward revisions to its banking costs that Ireland has experienced, holders of its sovereign debt would drop it like a hot brick.
In the Financial Times Wolfgang Münchau has argued that Spanish property prices have a further 40% to fall and that Spanish debt restructuring and an existential crisis for the Eurozone is the all but inevitable consequence.
So how is it that Europe’s Leaders, Principally Merkel and Sarkozy, have managed to allow a situation to develop where the future of the whole Eurozone is being put at risk for the sake of short term nationalist demagoguery? Has the European dream already collapsed and the reality is gradually reflecting this change? I can’t see another EU Treaty change being passed by an Irish referendum and yet a fundamental reform of the ECB – so that it regulates banks more effectively and has a broader remit including full employment and structural balance between periphery and core regions – looks like a key requirement for ensuring the Eurozone does survive.
Perhaps it will take a complete collapse of the Eurozone to drive home to Germany and France the importance of stability in that zone to their own economies. Unfortunately that realisation will probably come much to late for peripheral members – who will be severely damaged before any such reforms are even considered. Unfortunately visionary leaders only seem to come to the fore at times of existential crisis. You do not appreciate what you have until you are faced with the reality of losing it. The current generation of political leaders are not worthy of the rich political heritage of pan-European action they have inherited. We are governed by narrow nationalist bigots and spoofers. The dream has ended.
