Why bail outs are not working

 

         I was no fan of the Irish bail out. I thought it would be bad for Ireland as well as for the rest of the EU. So far the markets have come to the same judgement.

         Last week Irish debt suffered a hefty downgrade to baa1 – a long way below AAA which sovereigns expect. The  market price for Ireland to borrow 10 year money was around 8.7%, compared to 3.1% for Germany in the same currency.  These events imply that markets are not convinved the bail out will help Ireland.

         As I sought to make clear, I did not favour leaving Ireland in the lurch. I thought it wrong of Mrs Merkel to talk down weaker bonds, and wrong of the ECB to seek a refinancing of its advances to Irish banks at such a tricky time. Of course Ireland needs to be able to borrow money,and Irish banks should be supported by the ECB all the time the EU authorities regard them as solvent, as they currently do. The words and some of the deeds of the EU in the last two months made the situation worse.

            Over the last three years Irish real GDP has fallen by 13% and nominal GDP by almost 20%. This is a huge fall. That is why Ireland finds balancing the books difficult. Tax revenues have been badly damaged by the decline, and unemployment has risen, increasing social security costs.

            The inability to devalue makes exporting more difficult. The inability to print more money makes keeping the Irish system liquid more difficult. The required cuts do not complement a growth strategy for the private sector, which Ireland badly needs. At least the Irish government defended the attractive Corporation Tax rate, which helps a bit.

           Instead of arguing about Treaty amendments and future bail out funds, the EU needs to be arguing about a growth strategy and how to resolve the problems in  Euroland banks. If they do not take sensible action to head off a Spanish banking crisis, then the full folly of the current Euroland model for crisis management will be unleashed on us all.

35 Comments

  1. Mick Anderson
    December 20, 2010

    The Euro abolished the need for devaluation in the same way that Mr Brown abolished boom and bust (shortly before saving the world). According to politicians, it was so large that nothing could go wrong.

    Low interest rates and easy credit created the fabled Celtic Tiger, pulled up by the Eurozone. Unfortunately they didn’t notice the “safety” rope around the neck of the Irish economy, and now the ECB has kicked the chair from underneath.

    There is no such thing as a free lunch, and there was always going to be a price for the banquets they have been enjoying.

    1. Howard
      December 20, 2010

      The shame is the ‘price’ will be paid by the less well off and future generations – those who are remain that is.

  2. lifelogic
    December 20, 2010

    The spread 8.7% to 3.1% clearly shows that the markets do expect a devaluation/realignment in some way or other. The Irish clearly cannot really afford to ever repay their debts at 8.7%.

    What rate was the EU bail out at and how much have we therefore lost on it all ready were the bail out loan to be sold on in the open market? At the reported 5.9% Osborne claimed we would “make” £440M on the £3.25 Billion so now perhaps a loss in excess of £1Billion just in a few weeks.

    Meanwhile countless perfectly sound small UK businesses go bust for the sake of tiny loans (with little real risk ) from UK banks on sensible terms.

  3. Ralph Musgrave
    December 20, 2010

    The last para of the article above suggests the EU do something “sensible” about EU banks, else we’re in trouble, and that the PIGS need a “growth strategy”. True, but that rather begs $64k questions: “exactly what are the least bad solutions to the latter two problems?” Well, here is a “growth strategy” idea.

    The notion that “monetary union requires political union” is nonsense. What political or other measures would a politically more united Europe take to deal with PIGS other than the current highly defective ones? Darned if I know.

    Monetary union does NOT require political union: witness the various countries that use the US dollar as their currency – Hong Kong and various south and mid American countries. They are hardly a political union.

    Indeed, the lack of some aspects of political union is a positive help: it allows South American countries to cease using the dollar relatively easily, as did Argentina. Then they can devalue and apply stimulus, and maybe revert to a dollar peg at some later date.

    Plus being outside the Euro does not preclude being in the EU: witness the UK.

    Re banks: just apply Bagehot’s dictum. If a bank is in trouble and cannot produce decent collateral to cover a loan, then it’s haircuts all round. That is disruptive, but the alternatives are kicking cans down the road and falling for moral hazard, which are even worse.

    1. A.Sedgwick
      December 20, 2010

      The difference with the US$ is it is a one nation currency with a massive historical pedigree albeit in decline. As a result it is and has been used in tandem or in preference in many countries. Whilst the Euro is 11 years old and destined for significant change in 2011. Had Germany not joined the project it may not have been created or become another franc, peseta or lira. Your suggestion may have been more likely had the DM remained and become the US$ equivalent for the EU.

  4. norman
    December 20, 2010

    It’s going to be very interesting (not really, if I were a betting man I know where my money would be) to see what the UK government is going to do when the time for future bailouts arrive.

    The Chancellor, one hopes, must have an open channel of communication to the likes of John Redwood in Parliament (otherwise why have a Parliamentary Party system?) and it makes one wonder what he thinks of such views as are expressed in this post.

    Does he simpy listen to the likes of JR for forms sake, say ‘Thank you’, give a metaphorical shrug of the shoulders and dimiss such views as outdated nonsense from the dinosaur right (we’re all progressives now, remember) or would he really be willing to stand up for Britain?

    1. BobE
      December 20, 2010

      “and it makes one wonder what he thinks of such views as are expressed in this post.”

      Nobody reads and npbody cares. Westminster lives in its own bubble.

  5. Eoin Clarke
    December 20, 2010

    Dear John,

    You are right of course but the only practical solution would be to create two Eur rates, a strong Euro and a weak Euro. This has been mooted before but if the Catholic/Mediterrean countries were collectivley allowed to devalue it would help them enormously. The concept of actually withdrawing from the Euro is too complex for a lot of reasons, not least the mother of all inflation woes. Irealnd is where it is. The hope of continuing exports, low corporation tax, and medium emigration of off set unemployment is the only escape route out. The UK on a local level has one small benefit. Local retail trading in Northern Ireland benefits as commuters from ROI do more and more of their shopping in my home town of Newry.

    1. JimF
      December 20, 2010

      Or create a new Punt to sit alongside the Euro, at a floating rate. The Irish State from day 1 re-denominates its debts and future liabilities in new Punts, and thereby gives a haircut to bondholders whilst notionally keeping the Euro as a trading currency, and infact insisting that Corporation Taxes are paid in Euros. No more local dignitaries driving around in shiny new Mercedes, but it should never have been that way.

    2. waramess
      December 20, 2010

      The only practical solution is the termination of the EU project. Fun for some whilst the party lasted but it is over and from now on any attempt to apply sticky plasters will fail.

  6. Nick
    December 20, 2010

    Instead of arguing about Treaty amendments and future bail out funds, the EU needs to be arguing about a growth strategy and how to resolve the problems in Euroland banks.

    ========

    There we go again. A politician not telling the whole truth, trying to deceive.

    Whenever you hear the world growth, you have to ask, what’s left off.

    The only thing that helps the Irish government pay its debts is growth in TAXATION

    That’s what politicians mean when they say growth.

    John, you should be ashamed

    1. APL
      December 21, 2010

      Nick: “John, you should be ashamed”

      Yea, it’s about time a Tory politician makes the moral and economic case for smaller government.

      The world economy is contracting after a period of artificial growth, goosed by borrowing. The contraction will be long and uncomfortable.

      Somebody in Westminster, insulated as they are by index linked pension, excessive salaries, uneconomic expenses and perks had better start making that case for cutting the public sector.

      And before JR pops up and says he has, no you haven’t John, you have made the case for public spending growing less than GDP, that is not ‘cuts’. That policy worked to an extent for Thatcher, not least because her government had the benefit of North Sea oil. This government doesn’t have that luxury.

      In terms of energy policy we have the facile Huhne babbling on about wind power producing the energy we need. That is absolute rubbish! Look outside right now, there is snow on the ground, the temperatures are at the lowest they have been for ages, and there IS NO WIND. Huhne’s windmills are not turning at the time of the year when we need the energy they are supposed to be producing most. The man is a (fool-ed).

      I am afraid folks we have infants running the show.

    2. Lindsay McDougall
      December 21, 2010

      I TOLD YOU SO.

      Everyone who can should read an article by by Ambrose evans-Pritchard on page B3 of today’s Daily Telegraph (Tuesday, december 21, 2010), entitled “Pimco says ‘untenable’ policies will lead to eurozone break-up”.

      Who are Pimco? They are the world’s biggest bond fund. Andrew Bosomworth, head of Pimco’s portfolio management in Europe, is quoted at length:

      – Greece, Ireland and Portugal should step outside the eurozone temporarily [!], devalue and restructure their debts unless the currency bloc agrees to a radical change of course. They cannot get back on their feet without either their own currency or large transfer payments, he told German newspaper Die Welt.

      – The bond fund argues that the EU strategy of forcing heavily indebted countries to undergo draconian fiscal austerity without offsetting stimulus is
      unworkable. The austerity policies are stifling the growth needed to stabilise debt levels.

      – Pimco also gave warning that the bond vigilantes have lost faith in the policy and are trying to liquidate their holdings of peripheral EMU faster than the European Central Bank can buy the debt, causing a relentless rise in yields, and a vicious circle.

      THINGS FALL APART. THE CENTRE CANNOT HOLD.

      Please, Mr Redwood, put out an appeal for the PIIGS to leave the eurozone while there is still time for it to be done in an orderly manner. We, on our part, will have to relearn the words escudo, punt, lira, drachma and peseta.

  7. Gary
    December 20, 2010

    So the market is saying it is increasingly unlikely that Ireland will be able to pay its creditors. More good money thrown after bad. Tory leadership answering only to the bankers.

  8. Rob Hay
    December 20, 2010

    If I were an Irish politician (awful prospect) I’d be threatening to pull out of the Euro and default unless I was offered a very good deal. The current arrangement simply protects foreign investors and does nothing for Ireland. Iceland defaulted and is in better shape then Greece or Ireland.

  9. Norman Dee
    December 20, 2010

    No resolution of these problems are possible when they are to be underwriten by a political agenda, the European commission needs to acknowledge that the Euro has failed and to find the least painful way out for all it’s members. Instead we are watching a disaster unwind, and everyone except the commission will pay the price, they will just raise their salaries to allow for the inevitable inflation.
    We must cut all monetary ties with them or get sucked down in the inevitable vortex

  10. StrongholdBarricades
    December 20, 2010

    So at a time of falling tax receipts etc, it seems strange that once again Ireland is almost encouraging emmigration

    Surely, however, this will only lead to those who probably already have a job and wanting to leave actually benefitting and causing further issues in Ireland?

    On top of which, is their economy actually capable of encouraging the necessary entrepreneurial growth when previous policy has revolved around corporation tax “beggar they neighbour”?

  11. Acorn
    December 20, 2010

    I had not realised that 62% of the countries’ foreign currency reserves are held in US Dollars and 27% in Euros. Also how many countries actually peg their own currencies to those two currencies. I assume that this makes the stability of the Euro somewhat more important than realised.

    I have read that WW2 had little affect on the global banking system at the time. Central Banks appeared to be operating in some form of parallel universe, with the Swiss trebling their assets. I expect the same is happening now. Some things can only be known to God and Central Bankers. Even fewer things can only be known to Central Bankers 🙂
    http://www.voxeu.org/index.php?q=node/5945

  12. Seymour Major
    December 20, 2010

    the Irish government defended the attractive Corporation Tax rate, which helps a bit

    How can the Irish use the low Corporation tax to grow when it looks likely to becoming ensnared by the European financial stability mechanism in 2013 and with Germany almost certainly likely to call the shots on tax harmonisation. I think the days of the Irish being able to attract business by this route are numbered unless the UK can find a way to parachute Ireland out of the Eurozone.

  13. Neil Craig
    December 20, 2010

    In all the talk about getting out of recession it is worth making absolutely clear that there is no general recession. The IMF have said that this year we will see growth in the world economy of 4.8%. Britain could easily be part of that if (A) our political classes were not solidly Luddite criminalising new tech wealth production & (B) we were out from under the probably even more parasitic EU bosses.

    Ending this disaster starts with recognising what the problem is & who has to be fired.

  14. waramess
    December 20, 2010

    Bail out the Irish? Why? What will they do with the money? How will they repay?
    Will the Irish use the money to bail out their banks? Are they bailing out their banks to ensure the stability of the EU banks who have lent them money?
    Why oh why should the average Irish citizen be required to accommodate such reckless actions?

    Bail out the Irish? No sir, let the Irish banks go bust and let each country of the EU sort out their own banks who might be distressed by having lent to the Irish banks, if they are so inclined.

    Bailing out the Irish is a great deception leveled on the British and Irish citizens by the EU.

    The Irish should deliver a short sharp message that the EU is not a club for Germans and French; the buggers must sort out their own messes and dream up deceptive stories to tell their own citizens which might of course include the story that they must save their banks because they are too big to fail.

  15. John Wood
    December 20, 2010

    Why should Ireland always ‘need to borrow money’?

    If they keep borrowing money then they end up deeper in debt and have to keep paying back ever more of their GDP in interest. They can’t even inflate their way out as most stock (including GBs) is now index linked.

    I know that to a lender the best situation to have is a borrower who can never reduce their capital but can keep servicing the interest (until they default), but surely the politicians in the country know in their hearts that continuous borrowing leads to self destruction. Or are they only interested in the next general election?

    In the UK this has happened. Labour spent and borrowed to make things appear that we had never had it so good – and in effect buy at least one election and nearly buy a second. Now it’s time for cold turkey – we have seen the reactions from the hoi polloi and most of the ‘cuts haven’t happened yet.

    Bread and circuses AD2011 rather than AD211

  16. Andrew Nicholas
    December 20, 2010

    Just as a matter of interest, Ralph Musgrave, Hong Kong uses the Hong Kong dollar not the US dollar. A very different animal and, I suspect, likely to be considerably stronger than its US counterepart in the century to come

  17. EJT
    December 20, 2010

    Dr. Merkel ( or Mrs. Dr. to go all German )

  18. Javelin
    December 20, 2010

    I’ve noted on this site that I believe if any country breaks the Euro is will be Italy. The reason is that the Italian Government, corporates and banking system are all weak.

    I see Italy having a perfect storm of under capitalised banks (based on housing – like Spain and Ireland) plus an under-taxed population (like Greece), plus strong tradition of protestors (like France).

    Winston was right Italy is the soft underbelly of Europe.

    1. Javelin
      December 20, 2010

      OK, here’s some evidence for why I think Italy will break the Euro

      “Italian Banks` Refinancing Costs Soar” – debt is expensive

      http://www.bloomberg.com/news/2010-12-02/italian-banks-refinancing-costs-soar-on-contagion-concern-nation-s-debts.html

      “Italian Banks on the Ropes” – they are under capitalised

      http://www.ft.com/cms/s/0/af4ff9c8-df9b-11df-bed9-00144feabdc0.html#axzz18fF547m7

      Italy top tax dodger in EU (E159 billion) – 54.5% of taxes being paid below what they legally should be

      http://www.presstv.ir/detail/155361.html

      Riots in Rome

      http://www.guardian.co.uk/world/2010/dec/15/italy-rome-riots-police

      “Minister blames Rome riots on Professionals of Violence”

      http://www.ft.com/cms/s/0/c89357e4-09f9-11e0-9bb4-00144feabdc0.html?ftcamp=rss#axzz18fGEYuhe

  19. Johnny Zero
    December 20, 2010

    This Sovereign Bond Crisis of confidence and new risk levels of a sovereign default affects all of us who have Pension Funds too. If the thinking is now, that the possibility of default is real for the PIGS in the near future ( before 2013) then there is little point investing in Bond Funds, That only leaves cash offering 1 or 2% or Equities. This could mean that a major investment in Equities will now be undertaken by Investors in 2011 creating yet another bubble. If this is the case and gold continues its rise ( 30% in 2010) then we shall have another major crisis if no growth comes out of the EU Zone soon.

  20. Gary
    December 20, 2010

    The state and city (stretched finances -ed) in the USA is IMO, shocking. Exposed by Meredith Whitney(the one who exposed the bank bust), and aired on 60 Minutes within the past week, the overwhelming theme is : “There is no money”. This theme is surely happening in Europe too :

  21. Alte Fritz
    December 20, 2010

    The question of splitting the Euro has been mentioned, but it seems a very strange notion. If you split a currency, then you have two currencies, but each of those must retain the attributes strengths and weaknesses of any currency. Surely Ireland has no more in common with Portugal or Spain or Italy than with Germany?

    This looks like much more than a two pipe problemproblem.

    1. Ross J Warren
      December 20, 2010

      How on earth could the Euro be split in twain and still be the Euro?

      I agree its a nonsense, what is proposed a northern and a southern euro?

      If Germany isn’t willing to act to prop up the single currency then it would be better to say so, and dissolve it now before the whole of Europe is dragged under.

      For a short period then we could have several “euros” all moving up or down according to the perception of the markets. After a short transition other names could be found. The sad part is that Ireland has been ruined and it seems there is very little chance that it will recover any time soon.

      This mess has been made worse by the reluctance of Germany to act in the spirit that is essential in a “single currency”.

      The only good that has come out of this whole mess is that nobody is now seriously talking about Britain adopting the single currency. A currency I might add that is unlikely to outlast a single crisis.

  22. Denis Cooper
    December 20, 2010

    In May the French Minister for Europe, Pierre Lellouche, told the FT that EU leaders had made “de facto” changes to the EU treaties when they agreed to a bail-out package for Greece:

    ” “It is an enormous change,” Mr Lellouche said. “It explains some of the reticence. It is expressly forbidden in the treaties by the famous no bail-out clause. De facto, we have changed the treaty,” he added.” ”

    As those national politicians assembled as the EU heads of state and government had no lawful authority to make any such changes to treaties which had been duly approved by their respective national parliaments, down to the last comma, what Lellouche referred to as “de facto” changes could only be arbitrary breaches of those treaties – which the EU nonetheless insists on exalting as its “primary legislation”, and comparable to the national constitutional law of each of its member states.

    Now another senior French minister (and previously a noted lawyer) Christine Lagarde, has even more openly admitted the total illegality of the bail-outs under the treaties:

    http://openeurope.org.uk/media-centre/summary.aspx?id=1249

    “French Finance Minister: “We violated all the rules” to rescue the euro

    Monday, December 20, 2010

    In an interview with the WSJ, French Economy Minister Christine Lagarde has said, “We violated all the rules because we wanted to close ranks and really rescue the euro zone.” She said, “The Treaty of Lisbon was very straightforward. No bailing out,” adding that the Greek and Irish rescues, as well as the creation of the bailout fund, were “major transgressions” of the Treaty.”

    Note that Lagarde acknowledges the illegality, which she would certainly not have done if she believed the cover story that the bail-outs could be legalised through the Article 122.2 TFEU loophole which is officially claimed as the legal basis for the European Stabilisation Mechanism:

    http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/10/173

    Brown and Cameron have both been complicit in these blatant breaches of the EU treaties, and as those treaties were approved by Act of Parliament prior to final ratification they are guilty not only of breaking EU law but, far more importantly, breaking our national law.

    Which takes us back to 1688, the very first grievance in the Declaration of Rights and Article I of the Bill of Rights which is still on the statute book and in legal force:

    http://www.statutelaw.gov.uk/legResults.aspx?&activeTextDocId=1518621

    “That the pretended Power of Suspending of Laws or the Execution of Laws by Regall Authority without Consent of Parlyament is illegall.”

  23. Bazman
    December 20, 2010

    Where are all them Tory farmers who where out blocking the motorways and protesting over the price of fuel nowadays? Especially when VAT goes up next year.

  24. Bernard Otway
    December 20, 2010

    This whole nonsense started out when Kissinger asked who the President spoke to in Europe,
    unfortunately they believed him and decided there had to be ONE voice and set about creating it,through the monetary side leading to political union,only trouble is the American President speaks ONLY English,but Europe speaks ,English,French,German ,Dutch,Italian,Spanish,
    Portuguese,Slovakian,Swedish,Danish oh s..t I can,t go on.Kissinger (was wrong on this -ed).

  25. BobE
    December 20, 2010

    Inflation needs to rocket up. This will devalue the debts. The poorest will pay, again. (What bets are 12% by the end of 2011?).

  26. Lindsay McDougall
    December 21, 2010

    Contrast the situations of Ireland and Iceland. The folly of the Icelandic banks was so great (for a small country) that their banks owed 900% of GDP. Naturally, it was a question of “Can’t pay, won’t pay”, so the Icelandic government allowed their privately owned banks to fail. They had a severe recession and GDP contracted by 11% but they cancelled a lot of debt owed to Johnny Foreigner and could devalue. They are past the worst, the Icelandic economy is growing again, and they are beginning to pay off their sovereign debt. Iceland has agreed to pay a lot of debt owed to UK but only by negotiating a reduction in the interest to just over 3%. This is a partial default by another name.

    The Euro situation is turning into a Greek tragedy (Ouch! Sorry about that). The PIIGS can’t devalue and for historical reasons Germany won’t tolerate an inflationary currency. If Angela Merkel agrees to a loose monetary policy by the ECB in order to finance the fiscal deficits of the PIIGS, she is finished – and she knows it. I’m sorry to bore you all again but the only solution is for the PIIGS to leave the Euro zone, devalue and run a loose monetary policy. This is in Britain’s interest – better to have the money owed to us paid in clipped coinage than not paid at all. Greece and Portugal won’t mind too much. Ireland and Spain would have to swallow their pride but they will eventually recognise how dire the alternative is. Italy will be a real problem – one of the original Six, the home of the Church of Rome and the Treaty of Rome. It’s almost unthinkable for Italy to leave the Euro zone. But what is their alternative?

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