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Ireland is now white water rafting without any paddles

by Aaron McCormack on September 16, 2011

(c) www.garethmccormack.com

A brief eight months ago Ireland was the only thing that mattered on the world “debt-crisis” stage.  With a unique set of circumstances around sovereign vs banking debt and an impending general election, Ireland was a great source of worry to the European grandees.  We were the first domino in a potential collapse of the Euro.  We had a degree of wriggle room and negotiating power.

Before the Irish election there were moves afoot to create a new political movement in the country that would take as its central (indeed, only) plank the position that Ireland would NOT allow itself to continue on a path towards becoming a debt-servicing agency for bad investment decisions.  Whilst the Irish government was going to have to implement significant budget changes to right the ship, we felt that the best course of action would be to repudiate the banking debt (even if previously guaranteed) and threaten to leave the Euro (though not the EU) if that was necessary.

The desired outcome would be to significantly reduce the debt burden of the Irish – ideally whilst remaining in the Eurozone but, if necessary, by leaving the Euro and adopting the “Icelandic approach”.  This would be a very selfish course of action on the part of the Irish, but one that many people felt was absolutely necessary – despite the part that Irish citizenry themselves played in racking up the banking and government debt.

There were two main reasons why this dramatic course of action would be justifiable – even if it led to Ireland having to leave the Euro (and sparked an onward Euro crisis), saw us locked out of normal credit markets for a time, threatened somewhat our MNC industrial base and triggered a couple of years of austerity and significant local currency weakness.

The first reason is that experts believed, and still believe, that Ireland is still fundamentally insolvent.  The source of the insolvency is the extra debt incurred to fully guarantee the banks and the people receiving that money (bondholders) have not been subjected to the normal rules of capitalism where lenders and borrowers share responsibility and costs for bad investments.  Continuing to have the average Irish joe pay these debts 100cents in the Euro is not at all fair.  Beyond the extra banking debt, the Irish economy is actually in reasonable shape – making the burden on the citizenry doubly unfair.

The second reason is that we believe European leaders’ efforts to safeguard the Euro are fundamentally flawed.  This is continuing to play out.  If the Euro leadership does not take significant and orderly action to restructure the Euro, then the market will do it for them.  It would then be disorderly and much more damaging.  If this is to be an inevitable outcome, then why should leaders in Ireland expose the country to it 100%?

It would have been seen at the time to be a hugely selfish and “ungrateful” act on behalf of the Irish to have threatened to leave the Euro in order to get a radically restructured deal for Ireland.  Especially after all that the EU has done for Ireland in the darker years.  Experts reckon that Ireland needed a deal that would have cut the principal AND the interest rate on loans by about 50% each for the mathematics to work in the long run.  This assumed a reasonable rebound in economic performance globally – something that is far from assured as we all know.

Ireland would still have needed to adopt significant austerity measures and could have ended up facing legal challenges from bondholders.  Ireland may have had to act on its implied threat to leave the Euro (what is the point in having a negotiation stance that carries no credibility?)  That would leave us with a short-term mess and could have threatened the MNC base in Ireland.

Now, however, Ireland seems powerless in the European drama.  Greece is centre-stage in terms of its immediacy.  Italy and Spain are centre-stage in terms of size and scope.  Ireland and Portugal are now footnotes in the debate.   Political leaders in Ireland are on the sidelines of the drama.  They seem to be happier there.  After all, nothing that now ensues will be their fault.

It doesn’t appear to be a study in courage – even if you fundamentally disagree with my take on what Ireland should have done back in March with a new government, an effective referendum on the bailout to back them up and a sense of optimism that our new leaders could make a difference.

So, what can Ireland do if change at the highest level of abstraction is impossible?  The focus has to be on what can be controlled.

Continued cuts in government costs combined with smart revenue raising are needed to get primary finances in good shape.  Given the continued over-optimism of ESRI forecasts it is likely that the current government hasn’t gone far enough in either case.  The trick is to do all this with minimal impact on growth – it is a hard task.

In addition there is a looming threat to the current (and continued) Irish success story around MNCs – particularly those from the USA.  Although it is well documented that a lot of the GDP generated by MNC presence washes through the economy with little value as it moves onward to the Netherlands and the Caymans, many companies still put jobs and investments in Ireland in part because that is where their money sits. (Ireland has a lot of other things going for it, by the way, but don’t underestimate each and every little bit of competitive advantage that can be mustered).

There is a growing clamour in the United States to give corporations a tax holiday on repatriating monies from abroad – Ireland is always named here as a key “culprit” when this issue is discussed – GE, Cisco, Pfizer, Microsoft and others are using Ireland in part to help with their corporate tax position.

The last time the US gave such an amnesty the vast majority of the money went to share buybacks rather than direct investment or job creation (the populist intention behind such a move).  But, nonetheless, in the spirit of the banking stress tests Ireland Inc. needs to think hard about what happens if the US government changes its tax regime and gives US MNCs less reason to want to stay.

Lastly, no sound business leaves itself without a plan B.  Ireland should be planning a contingency for scenarios where the Euro does end up collapsing or changing or restructuring.  If matters get out of hand is the country ready?

We are now passengers rafting in troubled waters with Sarkozy and Merkel, Barroso and Juncker.  We do have to hope that a combination of smart use of the ESF, help from other central banks, stability in troubled countries like Greece or Italy and a fair and following (and surprise) wind in global growth or inflation will get the Eurozone out of its jam.

But “hope” is neither a method nor a solution.  I hope that the Irish government is planning for alternative outcomes.

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