The Irish Recovery Plan – Is It Too Late to Default?

Irish Liberty Forum
12.12.2010
By David Howden

Ireland “officially” entered recession over two years ago – September 2008. In the interim period, the country and its citizenry have witnessed one of the most spectacular collapses in modern history. While a series of bailout packages have been introduced over the last two years, it is instructive to see what has been gained, if anything, by such emergency measures.

Two years ago, one of the first early warnings that the bailout funds would not be beneficial occurred on this site. Canny warned that the bailouts would not be effective and could very well exacerbate the very problems to be solved.

Two years later the costs of banking rescues have spiraled, and large public sector borrowing has left the country’s finances in tatters. External debt now runs at 1,305% of Ireland’s GDP, which represents some $535,000 per person. These figures make it the second-most indebted country in the world. With the effectiveness of the past bailouts and loans increasingly scrutinized, one may ask why we keep continuing to throw good after seemingly bad.

At the same time, one may also ask what bailout, if any Ireland has just received. €85 billion is not small change. It is also not without its own costs. The terms of the bailout loans impose a 5.8% rate on this sum of money. Some observers, note it would have to be a strange definition of the word “bailout” to think that making a loan at an interest rate that the distressed Celtic borrower was incurring not even 3 months prior amounts to easing Ireland’s difficulties.

Indeed, some of the more astute point out that this loan actually increases the chances that Ireland will eventually default. This seemingly low interest rate of 5.8% is almost assuredly above the growth rate that one can expect to occur in Ireland’s immediate future. As Ireland’s debt service payments rise faster than their ability to pay, odds (and probably the market’s money) are on Ireland facing increasing difficulties servicing this debt. To conceptualize the fractional problem at hand – Ireland’s odds of default are analogous to a fraction where the numerator (the debt service of 5.8%) rises significantly faster than the denominator (GNP, or ability to repay this loan, perhaps 1-2% maximum). Ireland’s schooling system is still sufficiently effective, I believe, that most school-aged children can read this bailout as a recipe for disaster.

All of this could have been avoided by pursuing the traditional method for dealing with insolvencies – bankruptcy. Ireland could have defaulted two years ago, exited the Eurozone, and tried to rebuild from its evidently collapsed financial and social model. Instead, years of bailouts have prolonged the pain, and worsened the imbalances now all too apparent in the economy. Nobody likes to take their lumps, but getting the inevitable out of the way early allows for an entrepreneurial learning process – the errors of the past are identified, and an unsustainable situation is avoided for the future.

In the comment section to Canny’s 2008 article, one skeptical observer comments: “There were two countries in dire straits at the time the guarantee was brought in, ourselves and Iceland. One government intervened in the market, one didn’t. Which country would you rather be living in right now?” Two years provide an enormous amount of insight to this question.

Two years ago the UK got upset when Iceland decided to let its banking sector default on its obligations (of course, only after it was nationalized – better too late to realize it than never). Icelandic banking debt was 12 times its GDP, an impossible sum for such a small country to repay. Ireland, in contrast, decided to “save” its banking sector by taking on massive public debts. The Fianna Fail party has been willing to stake its reelection on propping up such an unsustainable system with ever-increasing debt levels.

By the end of 2008, Iceland’s entire banking system was decimated and its stock market had fallen more than 95% from its all-time highs of just one year earlier. By allowing its currency, the krona, to devalue (60% again the euro) the government was forced to take austerity measures that other European countries talk loosely about, but lack the moral strength and courage to enact. The decline in the exchange rate opened Icelandic exporters to increasing cost advantages as the crisis worsened.

Ireland, by being tied to the euro and not enacting meaningful fiscal cuts, continued shouldering ever higher amounts of public sector debt. Banking imbalances worsened and innocent Irish citizens – powerless to stop the rush to the abyss – stood helplessly by as Ireland’s downward spiral intensified.

What a difference two years make. While Ireland’s GDP continues to freefall, Iceland’s has stabilized and is showing signs of growth. Real wages have been negative in Ireland since the middle of 2008. After falling sharply over 2008, Icelandic wages have recovered and started showing positive signs of growth in the middle of this year. Inflation in Iceland is also stabilizing, as the devalued krona allows for increased exports and growth in the economy. By taking its lumps early, and severely, Iceland has been able to quickly regain its composure and start the trek back to prosperity. Lord only knows how long Irish people will wait for a similar result.

This is not to say that it is too late for Ireland to following the Icelandic path. A default and exit from the Eurozone and a return to the punt would involve some painful short-term adjustments. It would also allow for two significant beneficial results. First, as trust in the Irish sovereign debt market is negatively affected by such a default the Taoiseach would finally be forced to make austerity cuts that are more than mere lip-service to cutting expenses. Public sector debt would be largely eliminated, and the culprit deficit would be curtailed through the difficulties inherent in borrowing after a default – the Irish government would have to learn to live responsibly within its means. Second, an exit from the Eurozone would allow an exchange rate revaluation (or more correctly, devaluation) which would allow a stagnant economy a chance to recover. If one thinks that relying on IMF/EU/ECB et al. bailout funds (and there ensuing regulations and demands on the Irish citizenry) are more preferable to enticing a business-fueled recovery, I invite you to welcome the European technocrats with open arms. If I had to bet which horse to back in this recovery – the Irish businessperson or a Brussels-based bureaucrat – I think it is clear who offers a sounder plan for recovery.

And so, to revisit the mocking question: “Which country would you want to be living in right now?” I leave that to the Irish people still searching for safe footing as their once proud economy continues falling from grace.

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