Belfast Telegraph

Friday 22 August 2014

Berlin bailout may yet be the best worst-case plan for Ireland’s economy

German Chancellor, Angela Merkel: will she come riding to the rescue of the Republic's stricken economy?

The Germans, it would seem, were thinking about rescuing us before we were thinking of being rescued. Several weeks ago, I was asked by a German correspondent why the German taxpayer should have to bail out Ireland? I confess that I was a bit stuck for an answer.

It had not occurred to me that they would even think of such a thing. The Maastricht Treaty, at the insistence of Germany, specifically forbids it, except for the kind of events the insurance companies call ‘acts of God'.

But among many other strange things, we now see Chancellor Angela Merkel apparently regarding the financial crisis as the equivalent of divine retribution, and therefore not subject to the full rigours of the treaty.

None of this had filtered through to me when I was asked to find some reason why the Germans should rescue the Irish.

It seemed unpatriotic to say there was no reason why they should — although that was my first instinct.

So I came up with what seemed the only area where the interests of Germany and Ireland would coincide on such a matter — the need to prevent the eurozone breaking up.

It looks as if I hit on the right answer. That does appear to be what is making the Germans think the unthinkable — at least where euro area countries are concerned. The dangers look even greater in the new EU, where the risk is that countries could leave the Union altogether.

This week's summit of EU leaders heard claims that the eastern states need new debt worth 30% of GDP this year.

That makes our own 14% of GDP — including replacement of existing debt — look modest by comparison. But only by comparison.

As always with Europe, though, nothing is terribly clear. The summit rejected the Hungarians' idea of a €190bn fund for the eastern economies; where, in countries like Latvia, people are beginning to suffer actual privation.

In the euro area, the idea of ‘federal' bonds issued by a central euro authority, from which countries would take their individual borrowing requirements, has also been ruled out.

All the plans are still hypothetical and all calls for hard cash — even from the commission — have fallen on deaf ears in the major capitals. So it is far from clear that any ‘rescue' will actually take place.

But if it did, the political architecture in which Ireland would find itself would be transformed. Former Taoiseach Garret FitzGerald has already said the country risks losing its independence, which seems a fair description of any likely rescue package. It might partly depend on what it was we were being rescued from. The general assumption is that it would be the fiscal crisis.

Even that can take two forms, however. The Irish Government might be to blame, because it was unable or unwilling to impose enough tax rises and spending cuts to reduce the budget deficit, even to dangerous levels, from the present impossible ones. In that case, any rescuer, be it Berlin or the IMF, would impose the same cutbacks, and a bit more, in return for providing the cash just to pay the public-sector wages and bills.

That is why it is so pointless to resist the necessary measures.

Berlin, though, can be expected to impose more conditions than Washington in such circumstances.There is a widespread German view that the Irish economy is built on sand; its shaky foundations being EU aid and low corporation tax. Some regarded the refusal to rescue Waterford Wedgwood as a sign of this disdain for the Germanic virtue of actually making things.

They may require more than fiscal re-structuring as the price of a bailout.

The other kind of fiscal crisis could occur even if the Government does take stern measures.

There is reasonable circumstantial evidence that the high price of insuring loans to the Irish Government is partly due to speculative trading in those insurance instruments, as well as the actual risk that Ireland might refuse to service its debts.

Unlike going to the bookies, such bets improve the odds for the punter. If Ireland's ‘credit default swaps', become prohibitively expensive, Ireland may be unable to borrow. The bet succeeds.

In such circumstances, though, if the Government had done all that could be expected of it, it should take a tougher line on conditions from would-be rescuers.

All the fiscal rectitude in the world would not save the exchequer if any significant portion of that guarantee were to fall due. As with the fiscal improvidence scenario, we would have to accept whatever terms any rescuers offered.

Suppose, however, that none of these dire outcomes comes to pass? Somehow, we all muddle through. Will it be business as usual in the euro area? It seems unlikely. There is talk that the vulnerable small eastern member states might be offered the protection of euro membership.

That would require much more enforceable budget and credit discipline than the existing rules.

That may come anyway, in an attempt to ensure that existing members such as, ahem, Ireland, Greece and Spain, do not threaten the architecture.

To be any use, though, reform would have to go beyond discipline and restraint. It would have, finally, to put the ‘economic' into economic and monetary union. That means different things to different people. For the French, it is often shorthand for using exchange rates and interest rates to promote growth.

For the Germans, from the beginning, it is a step towards political union. It is not at all clear what that means, either, but we are likely to find out more before this is over. Two big things distinguish the euro area from national monetary unions.

No central government stands behind the currency, and there is no central fund from which regions in difficulty can receive funds.

Neither of these is in prospect, but some limited version of them may be required for the euro area to survive over the long term.

Any such changes would also be accompanied by new limits on member states' freedom of action.

That would present great difficulties for an Irish Government, but could also offer some advantages. Which is more than can be said for the doomsday outcomes.

Brendan Keenan writes for the Irish Independent

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