"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Monday, September 27, 2010

Fears of Irish Default Intensify

From the Financial Times:

Markets fear Ireland is another Greece

So soon after Greece’s economic crisis erupted earlier this year, one cannot but help getting a déjà vu. Markets have begun to ask questions about Ireland’s solvency, but European policymakers appear to be in the same sort of denial as were their Greek counterparts. This denial may be the prelude to the same sort of grave policy mistakes that characterised last May’s Greek bail-out package from the International Monetary Fund and European Union...

The most important point made by the article (emphasis mine):

But the elephant in the room being glossed over by European policymakers is how extraordinarily difficult it is to make large budget adjustments within the straitjacket of eurozone membership, since that straitjacket precludes the possibility of currency devaluation to boost exports as an offset to fiscal tightening.

article ends with:

If Greece’s bail-out earlier this year offers any guide, one must expect that European policymakers will try to paper over Ireland’s solvency problems with a heavy dose of IMF-EU financing. This might buy useful breathing room for a European banking system overexposed to its periphery. But it would hardly be in Ireland’s best interest since, in the absence of debt restructuring and of a euro exit, IMF-imposed austerity runs the real risk of plunging Ireland deeper into depression and deflation.

If it is indeed inevitable that, in the end, Ireland will be forced to renege on its government’s debt obligations and to exit the euro, from an Irish perspective it is better that it be done quickly without pointlessly prolonging pain and saddling the country with a mountain of official debt. For at least that route might offer Ireland some prospect of recovering from its present economic depression.
My view:

As I have written before, Austerity will not be the path to national solvency.  If anything, I believe that austerity measures in the medium term, will worsen the economic situation of the EU Periphery countries.  As I have said before, Greece is going through a severe debt deflation period.  Businesses are closing, people are spending less and being taxed more (rightfully so, but the timing isn't convenient), and Greece is not alone.  The issue is not one of efficient government - that is, Ireland's government is more efficient than's Greece's so Ireland should be fine.  The issue is debt levels - how much, and who holds the debt.

Ireland has the highest external debt to gdp of any other nation - bar none.  And here's the issue with that:  external debt is like a vacuum - it sucks up money out of the national economy because payment is made to creditors abroad.  The stats below are from year end 2009:

(click on image to enlarge  - source of image and good article)

A further issue the EU is facing is the currency race to the bottom.  Looks like Bernanke was able to spook the markets better than the EU could regarding future monetary printing.  The US Dollar has fallen a lot in value against the Euro and gold recently.  In terms of trade, the US benefits.  The EU Periphery, could use some Euro debasement right now.  (And I'm sure Germany would be happy too.)

But in the end, it won't matter.  Bad enough the debts are too cumbersome, the EU is making it more difficult for the periphery to manage those debts.  As Michael Hudson has said:  "debts that can't be paid, won't be paid."

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