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| From: Irish Political Review: Editorials |
| Date: January, 2011 |
| By: Editorial |
Economic Mindgames |
| To Default or Not to Default? that is the question facing the Irish democracy at present. Should Ireland become the first Euro-zone country to renege on its debts? The bank debt in question has largely been incurred by private institutions of the capitalist system, which made plenty money for themselves when times were good—which adds a piquancy to the choice ahead. As Irish Congress of Trade Unions General Secretary David Begg has pointed out, the Banks have been reckless. The net foreign debt of the Irish banking sector was 10% of Gross Domestic Product in 2003. By 2008 it had risen to 60%. And he adds: "They lied about their exposure" (Irish Times, 13.12.10). When the world financial crisis sapped investor confidence, and cut off the supply of funds to banks across the world, the Irish banks threatened to become insolvent as private institutions. If market forces had been left to themselves, the banks would have gone under. Ireland would have lost its banking system and thus a major element of its sovereignty. The problems were created in the private sector, but the society as a whole would have suffered if a remedy had not been found. Brian Lenihan was right to step in and offer a guarantee to all creditors, a guarantee that was partially renewed in November. That guarantee bought relative security for a couple of years. In a volatile situation, as exists in the financial world today, there are no lasting solutions—even for big and powerful economies, as Barack Obama has found out. A small, open economy like the Irish can only survive by dealing creatively with the crisis of the moment. Finance Minister Lenihan has shown considerable talent in doing this. While the Bank Guarantee worked for a while, as the world crisis continued to cause instability, international investors lost confidence in the collateral that the Irish banks were offering for their loans. That is to say, the banks were not able to go on borrowing funds. Again Ireland was threatened with the loss of its banking system. And again the Government acted with flair, to establish the National Assets Management Agency, to take the largest loans from the banks. As has been explained in this magazine, it is not just non-performing loans that have been stripped from the banks. The collateral offered by the borrowers has been taken too, and also loans to the same borrower that are not in trouble. The whole thing has been very complicated, as customers may have had loans from various banks in Ireland and elsewhere. In effect, where a customer has been unable to maintain scheduled payments in respect of one large loan, the whole of his portfolio with any participating banks has been taken on by NAMA. It has thus been made more difficult for them to avoid their liabilities. It is a creative solution and one that will probably pay off in the long run. Along with establishing NAMA the State has been obliged to put money into the banks, and become a major shareholder. Then, when that failed to settle international markets, Lenihan took steps enabling him to close two of the most troubled institutions, Anglo-Irish Bank and Irish Nationwide (not related to British Nationwide, which has remained a mutual institution). He has also taken other wide-ranging powers, such as downsizing the two largest banks, and imposing large losses on subordinated (as opposed to senior) Bondholders. Immediately the Irish Times criticised him for not taking such steps a couple of years ago, instead of offering the Bank Guarantee. This kind of mechanistic thinking is widespread amongst those who have no understanding of how government works. The fact is that, at any given point, the situation must be handled according to the circumstances of the time. An action, which may be right in one situation, could be damaging in another. Two years ago the situation was entirely different. Begg says the Government made a "crucial mistake" by guaranteeing that debt to bank investors (Bond-holders) and equating "banking debt with sovereign debt". Presumably he feels that market forces should have been allowed to take their course and is not concerned about the knock-on effects. The demand that the Bond-holders should be burned is currently coming both from the left and the right of the political spectrum. While the motives of the Left are transparent, if misguided, the same can not be said for those who advocate such a move, while continuing to espouse the capitalist/globalist system. Sovereign debt is public debt, money borrowed by the State for investment and sometimes to make up shortfalls in tax revenues. But it is hard to see how Ireland could have done otherwise than equate Bank Debt with Sovereign debt. In any case, it is utopian to believe that investor confidence in Sovereign Debt would have been unaffected by a Default on bank debt. If the banks had been allowed to smash up, not only would Ireland have been without a banking system of its own, it would also have found it far more expensive to borrow Sovereign Debt. What are the implications of not having a Banking system? It means that Ireland becomes dependent on foreign banks to look after its financial affairs. These banks would have headquarters in the City of London, New York etc. They certainly would not conduct their operations for the benefit of their Irish customers or to build up the Irish economy. In the days when Irish financial affairs were managed from London, Irish savings were channelled to the City of London and built up the British economy. A pre-condition for Irish prosperity was the move by Charles Haughey to put an end to this state of affairs. There is a further consideration. An Irish Bank Default, quite apart from damaging Ireland, would have serious effects right across the European Union. The implications of allowing the Irish Banks to go under would be far-reaching. A default would bring about a domino effect which would spread right across Europe. A decision to walk away from the indebtness problem would not just be felt in Ireland alone. The exposure of European Banks to Irish debt is (in dollars): France 50.1 billion The source for these figures is the Bank for International Settlements and they appeared in the Financial Times of 2nd December. These banks are not just exposed to Irish debt. The banks of every country are mutually exposed to large quantities of debt. An Irish default on bank debt would start an avalanche which would eventually engulf even the strongest European economy. In the immediate post-Default period, Ireland would find it very difficult to borrow the money it needs to maintain its social services at the present generous level, a level more generous than that of most other European countries. Fianna Fail may have given the developers tax breaks worth millions, but he gave the working class billions. While the Default shock therapy treatment might or might not kill the patient, the political and economic system would be savagely damaged with no alternative system in prospect. There could be no gradual change to a different way of doing things. In prospect would be a time of severe economic hardship. A Default is a leap into the unknown: anything could happen. Most societies only choose to take such a course when there is no other practical alternative. In 1919 the German Sparticists led by Karl Liebknecht and Rosa Luxembourg tried to pull down the institutions of the German State. The disorder did not produce their ideal, on the contrary. It is one thing to leap into the unknown as a coherent society, organised around a far-sighted and competent political leadership. It is quite another to make that jump with political parties at the helm that are routinely competent at best, and which display little of the broader vision of their founders. It might be added that those who advocate Default also tend to have contempt for De Valera's vision of a frugal, self-sufficient society, content with simple pleasures. They want the fruits of globalism but do not want to pay the asking price. The way that Eamon de Valera did not make it onto the short list of Greatest Irishmen earlier this year does not suggest that there is a democratic readiness to give up the consumerist way and rediscover the traditional cultural heritage in word, music and dance. The two main Opposition Parties suggest that there is another way of dealing with the crisis—or rather two, but incompatible, other ways. Given that an Irish Default on bank debt would have such a dire effect, what are we to make of the fact that it is advocated in quarters where one would expect probity and conservatism? A Default has been pushed by the Financial Times, and promoted by the Irish Times. And it is not just advocated: it is sold with spurious arguments that do not bear even a cursory examination. Wolfgang Münchau, Associate Editor of the Financial Times, contributed a very prominent Opinion Piece in the Irish Times of 2nd December. The provocative title was Will It Work No. What Can Ireland Do? Remove The Bank Guarantee And Default. And the message was given a big coloured banner headline on the front page of the Irish Times, as well as featuring inside. The point of the wordy headline was to make an impression on those who would give just a cursory glance at the article. These are the methods of agitprop and they sit curiously in what claims to be a serious journal. The Irish Times has consistently undermined the Government's attempts to stabilise the economic situation. Under the guise of a spurious 'balance', it publishes sharply-written negative articles while, somehow, the rebutting pieces never make the same impact. The negative articles are picked up by the world media and the rebuttals are not. And it is not just internationally that this tactic undermines what is essentially a sound economy. Irish investors, too, are persuaded to take their money abroad. Some are even fearful of keeping their money in Euros—as though Stering or the Dollar offered a safer alternative!! The situation that the Bank Guarantee was established to prevent is being gradually brought about by chipping away at investor confidence and stoking up fears of collapse. The more Default is talked about, the more money leaves the country, or fails to come in. But what of Münchau's certainty that the IMF/EU Bail-out will not work? What quality of argument does he deploy? The tone of the piece is ex cathedra: opinions are simply laid down from the Financial Times papal chair. But a closer look shows that what there is in the way of supporting argument is weak, to say the least. Mr. Münchau's core argument is that the rate of interest Ireland will pay on the EU/IMF bail-out facility is greater than the likely rate of growth of the Irish economy. By availing of the bailout, Ireland's debts will become larger in proportion to the economy, while the ability to repay diminishes. Ergo: without a Default, Ireland faces a downward economic spiral. Here is his essential point: "The markets… are correct. At an interest rate of 5.8%, the loan from the European Financial Stability Facility will at best plug a temporary funding gap. It will not improve—and quite possibly worsen—Ireland's underlying solvency position. The interest rate is very likely to be higher than Ireland's nominal annual growth during the period of the loan. And that means the real value of the debt will increase…" But this argument relies on comparing two things that are different in kind. One is the rate of interest on a loan facility. The other is the growth in the size of the economy. The juxtaposition of the two percentages may make an unwary reader believe that Ireland is diminishing its GDP by around 3.8% per annum by availing of the loan facility—the amount of the repayment, less the amount of growth—which of course it is not doing. How come none of the professional economists have pointed to this conceptual flaw in Mr. Münchau's argumentation? Moreover, under the rescue scheme, Ireland may borrow up to €85 billion over seven years, at a maximum rate of 5.8%. It is not borrowing the whole amount in the first year. So it is not faced with paying 5.8% of €85 billion up front, 4.9 billion, as an unwary reader may conclude. Also, €17 billion out of the €85 billion is coming from Ireland's own resources. So in fact the part of the bail-out fund which is in the form of an external funding facility amounts to €67.5 billion. The firepower given by the IMF/EU facility will bolster the Stuate Guarantee and enable our banks to obtain cheaper funding on the international markets. Some of the loan facility may be used to plug a hole in the current account of the State, faced as it is with lower taxation revenues. Münchau dismisses as worthless a loan facility that enables Ireland to plug a spending gap. But is it so worthless? Without the loan, Ireland might have had to default. With the loan, it can conduct an orderly retrenchment of its public spending and bring about a reform of the banking system. And the EU/IMF funding facility, by keeping the show on the road, gives the opportunity to avail of any better international situation that may come down the road. And if the international situation does not improve—then Ireland's problems will be a drop in the ocean! Globalist Capitalism will have reached the end of the road, and all bets will be off. The loan facility means Ireland can meet its funding needs now. That is the present all-important problem. The problem of repayment of the loan is quite different. And it is not insurmountable, as Münchau attempts to convey. He suggests that repaying the loan would decrease the size of the Irish economy, because the interest rate payable on the loan is so high. But there is no iron law which says that the Irish economy has to grow every year, or that it cannot get smaller. In fact the annual Irish Gross Domestic Product—the total value of all things produced in an economy for a year—grew by 6% in 2007, the last of several years of growth so strong that it has been the marvel of Europe. The GDP got smaller by 3% in 2008 and by 7% in 2009. That decline stabilised in 2010, being perhaps 1%. The expectation is that 2011 will see 2% growth. Let us look at the facts not in percentage terms, but in real figures. The GDP in 2009was around €160 billion. The figure for 2010 will not be that different. The current account deficit, the shortfall in annual revenues coming into the Government will be around €18.5 billion. And the EU/IMF loan facility enables the Government to borrow below what the market was charging for this amount. If all of this money is borrowed at this rate, the interest would come to €1.1 billion. But if the nominal rate of growth does come to 2%, we are looking at an increase in the size of the economy of €3.2 billion. So the repayment on this amount is certainly repayable. And Ireland would have money left over! It might be noted that monies which have been made available to the Banks from the European Central Bank up to the present have carried an interest rate of just 1%! Let us also note that Ireland is coming from a very positive underlying situation: in 2008-10 Ireland had the third highest Gross Domestic Product of the EU. It was the biggest exporting country in the EU, taken as a percentage of GDP. In 2008 its debt to GDP ratio was the fifth lowest in Europe. And its National Debt still compares favourably with that of other European countries. There is plenty of scope for taking on additional debt to meet present difficulties without bankrupting the country. As befits a Financial Times propagandist, Münchau ignores the real economy. But Ireland's economy is doing quite well at present. Farmers have had an excellent year and there is good world demand for their produce. On top of that, firms from around the world are continuing to move their headquarters to Dublin for accounting purposes in order to avail of the favourable Corporate Tax. So far, Corporation Tax yields for 2010 have come in above expectations. Manufacturing output in the foreign-owned multi-national sector in this country is up 15%. Output in the indigenous manufacturing sector is up 6%. Mr. Münchau does a sleight of hand with regard to this matter of growth of the economy. He is suggesting that loan repayments must come out of growth in the economy or risk a long-term downward economic spiral. But why is that? The GDP measures the extent size of commercial activity in a society: it says nothing about the wealth of the country as a whole. What is the size and weight of the whole economy that has accumulated down the decades? That is not talked of. Plenty of money and resources remain in the country. If it came to crunch-time, existing loans could be repaid by a modest levy on all the wealth in the country. Ireland is anything but poor: it is one of the wealthiest countries in the European Union. Using economic hocus-pocus, the Financial Times is simply attempting to demoralise the national will of the country to take care of its own affairs. It acted in the same vein in November when it voted Brian Lenihan the worst Finance Minister in Europe. It considered Germany's Wolfgang Schäuble the best. How do you judge best and worst as between such different societies? It must be taken that the criteria applied relate to the Anglo mania for further globalisation. The nearer Germany moves to Boston, the happier the paper will be. And the black mark against Lenihan is because he has been pursuing Irish interests in a single-minded manner. Schäuble is best from the British viewpoint because he has been a globalising Finance Minister, implementing the break up of the national social structure of the German economy decided on, under British influence, by Chancellor Merkel and her predecessors.  By complete contrast to the Finanacial Times, John Fitzgerald, a Professor at the ESRI (Economic & Social Research Institute), has made a complete analysis of the EU/IMF bailouts: "This focus on the interest rate on actual borrowing from the EU/IMF fund has distracted from the value of the facility to Ireland. As with any overdraft, in the case of the EU/IMF facility, Ireland will pay interest when it draws down funds. It will be recalled that Finance Minister Lenihan punished the markets in November, when interest rates shot up, by refusing to borrow money. He said the state had enough in hand. Bucking the market has a cost, and that is holding cash in hand. The trickier the situation, the more of a cash cushion has to be held. Now the Government has a guarantee in its pocket, an assurance that it will not have to pay more than 5.8% to borrow money in the years ahead. So it can run down its insurance money. But there is another advantage to having that bail-out money there as a last resort facility. Governments have long-term commitments and they like to borrow long-term. However, the international financial situation has got so difficult that investors have got nervous. Borrowing money for long periods of time has got very expensive. However, investors are not so chary about lending money for short periods. As Fitzgerald explains, because that bail-out fund is there, the Government need not worry about the long-term capital markets—it can use short-term money: "Under normal circumstances, the bulk of the borrowing by the state is undertaken with bonds repayable seven to ten years in advance. Two per cent! What does Mr. Münchau say to that!? He doesn't of course. He is playing his own game. Far from Ireland being pulled down by 5.8% punitive interest rates from the EU and IMF, the situation is that it is liberated to borrow money in the cheapest market. The bailout money acts as a kind of collateral making it possible to borrow more cheaply elsewhere. Mr. Fitzgerald also makes some remarks about the growth rate of the Irish economy. He rejects the "external commentators" who predict 1% growth or less in coming years. He suggests there will be "significant growth" in 2011. As he points out, the reduction in spending power as a result of Budget cut-backs has less of an effect in the economy as might be expected: because Ireland imports a lot of what it consumes, reduced consumer spending power affects the countries which export to Ireland more than Irish manufacturing itself. As he says: "While this does not make the budget cuts any easier to endure, it will limit their consequences for the domestic economy". (As a slight aside here it might be added that having large numbers employed in the public service is a benefit, not a drain on the country. Goods and services produced by the public sector help to keep money in the country because they are paid out of taxation. If the tax take were lower, a high proportion of the money saved would be spent on imported goods, foreign holidays and the like, taking money out of the country. As labour follows capital, money spent abroad diminishes employment and development in Ireland. The main thing required of those in public service is that they should be bound by a good ethic of service to the country: numbers should not be an issue.) The making of various arrangements to assist Euro-zone countries to resist the onslaught of speculators shows that there are at least some forces in Europe that understand that solidarity is needed at this time. All of this paints a very different economic picture than that being pushed by the Financial Times, with its junior partner in Ireland. John Fitzgerald points out that one of the dangers ahead "lies outside our hands": it being "the instability in the European financial system". But of course Ireland is a part of that financial system. It can be seen that it is for anything but the good of Ireland that the Financial Times advocates a Default. Big game is being hunted here and Ireland is but the tethered goat. There is a strategic heave in progress against the Euro. The Dollar, with Sterling at its heels, does not want a third—and potentially sounder—currency establish itself. Gold has gone as an objective way of holding reserves of money and there is no alternative system in place. The Dollar and Sterling act as surrogates, but both America and Britain use inflation as an instrument of monetary policy. At present the world subsidises America—and Britain too—by having to hold their monetary reserves in currency and financial instruments that are constantly diminishing in value. The world must subsidise America and Britain as things stand. Not surprisingly, it is on the look-out for an alternative. And if the Euro goes bust, there is no other candidate. And, if the Euro fails to establish itself with reserve currency status, the prospect of a third power-bloc goes with it. It must be said that, while Europe has been painfully subservient to America and Britain in international affairs, its very existence as a coherent unit presents the possibility of it re-discovering its political self. America supported the formation of the European Union as a counter to the Warsaw Bloc and Communist political economy. Now that the danger from an alternative way of arranging public affairs has passed, the existence of a united Europe is of no particular benefit—on the contrary. Dealing with countries on an individual basis presents far greater benefit to pursuing American economic and power objectives. It is a curious fact that the financial crisis, made in America, is being turned to good account to further American and British strategic interests as against Europe. And these geo-political objectives are being advanced by the voracious feeding of myriads of piranha fish, all speculating on the Euro becoming a weak currency. Germany is making a monumental mistake in failing to see the real nature of the game that is being played out. It is experiencing some Schadenfreude as it sees prodigal spendthrifts being brought low. It believes that profligate European countries are being punished by the just men of the market. It thinks that it can play out the financial game as if it were gin rummy, using intelligence and a modicum of luck. The crisis is a good opportunity to impose fiscal good manners on the lesser brethren. So it is holding back on the money assistance it makes available to those under market pressure, complaining of the few extra billions in cost to itself. But Chancellor Merkel is not playing gin rummy: it is fight-to-the-death poker that is being played. And to win in that kind of game you need Darwinian instincts—it's all or nothing. If Merkel loses this game, it will not just be a few billions that she loses: there will be a European banking crisis which engulfs large and small. It is poker and as long as she continues to hazard small stakes, she will lose. She is just feeding the blood-lust of the piranha fish. The only way to win in high-stakes poker is to be menacing and bet everything you have. Not only must she gamble with money, she needs to cut off the life-blood of financial lending to the speculators. She needs to re-establish Europe as an unfriendly place for the financial manipulators. Half-measures will not do it. The biggest and most savage will win. All this gives us some perspective on our friendly shark, Mr. Münchau, who kindly advises Ireland to throw the European finance system into chaos, but still stay in the Euro! He ends his piece saying: "…in such a scenario [of default]… Should Ireland stay in the Euro zone? I would say yes it should… The smart choice is to default in the euro zone. It is going to happen, sooner or later." There is a German folk-tale about Baron Münchhausen, who goes around the country telling tall tales. Perhaps the Financial Times associate Editor is related to him. To think that there would still be a stable Euro-zone after an Irish default is to stretch credibility. And if Ireland set off a European banking crisis, would the zone wish to retain Ireland as a member? An Irish default would surely bring Ireland under the wing of its "good friend" (to use British Chancellor George Osborne's term of endearment), Mr. Sterling. C O N T E N T S |