Analysis and Commentary on Irish Banking and Eurozone Stability - An Economist's View.
Wednesday, 7 December 2011
A Necessary Divorce
By Ray Kinsella
Tuesday, December 06, 2011
Economic conditions laid down by the troika are stalling the recovery and hurting the Irish people, but it is still not too late to take drastic action, argues Ray Kinsella
THE measures included in Budget 2012 have been well trialled. They take place against the backdrop of yet more meetings between France and Germany in the lead up to Friday’s make-or-break euro summit.
The subtitle of this summit could be "this time it’s personal". Finally, Germany and France are pushing with brutal self-interest their version of full fiscal and political union as the only way forward. In a eurozone where "subsidiary" was once a core principle, the views of Ireland and other countries count for nothing. Power and hegemony are what it is about.
But it would be very short-sighted to ignore the timing of Budget 2012 and of the euro summit. They both take place in the lead-up to Christmas. Christianity is about hope and transformational change, yet hope is what is conspicuously absent from our budgetary process. The issue of transformational change doesn’t even arise — all economic and financial indicators continue to point south.
We need the context of Christmas, not just to cope with the effects of self-destructive policies that have been imposed on Ireland: We also need this context to understand how corporate capitalism seduced a generation into a wilderness of austerity and a debt burden that cannot be repaid. We need the image of a family, on the outside, looking in at a political elite that does not understand just how separated it is from the lives of the people. In Spain, to take one example, over 40% of young people are unemployed.
Budget 2012 will devastate Irish business and the economy. In terms of domestic demand, investment has collapsed. The retail sector’s frail state is reflected in the unprecedented "sales" which have all the hallmarks of desperation. Raising VAT damages an employment-intensive sector which is already under huge pressure. But that is only one example. The budget will further push up costs for businesses and for families in desperate straits.
The budget is the latest in a series dictated by the troika. Our European partners, whose financial systems we are helping safeguard, bought control over our future for the knockdown price of just over e30 billion. An economy, with a capacity for innovation stretching back 5,000 years to Newgrange, is held hostage to a eurozone budgetary strategy that is demonstrably failing.
Look at the most recent EU forecasts for 2011. In Ireland, CSO data on growth and numbers on the Live Register confirm the state of an economy traumatised by the three previous budgets based on "troikanomics". Why are we inflicting more of the same on an economy blessed with resources and with spare capacity that would make one weep?
Budget 2012 is a highly regressive and divisive exercise in short-termism. The focus is on squeezing the life out of what remains of the economy. A great detail of spin is being used to justify this approach. It has no substance. Budget 2012 shows, as never before, how the policy mindset of a country can be captured.
This is a hard thing to say: Budget 2012 has been drawn up and will be enforced in the eurozone by individuals with one thing in common — they all have jobs. Only those who have talents they cannot put to use and commitments (especially at Christmas) they cannot meet can understand the pernicious nonsense being talked about the virtues of belt-tightening as a substitute for national development as the key to restoring solvency.
Over the past three years, I have argued that the adjustment strategy adopted post-2008 was wholly imbalanced; that the only sustainable approach was to adjust over a sensible timeframe (2020); that the emphasis needed to be on growing our way back to national solvency.
In September 2010, I argued that IMF intervention would be inevitable unless we changed course. Alongside others, I argued against the terms of the bailout. Last year I argued we were "stumbling toward default". This spring, with so many windows of opportunity having closed, I made the case for a managed exit from the eurozone as the only viable option to prevent the economy being swallowed by a vicious circle of contracting demand, a massive credit squeeze and policy-induced recession.
There is another point.
Developments in the eurozone in the past year — the flat-lining of growth, sovereign credit downgrades, the fact that Sweden, which voted against eurozone entry in 2003, can now borrow more cheaply than Germany — demonstrate to anyone with an open mind that the terms of the bailout is impelling Ireland into a cul de sac.
TDs across the political spectrum know this to be true. Many simply do not believe what they’re being asked to approve in the budget. Faced with this, appeals are being made to "loyalty", a word prone to stalking Dáil Éireann.
It is not acceptable to argue "we have no choice". We have always had choices — even though the cost of exercising those choices becomes greater with each opportunity we let slip through our hands. The truth is we bottled it.
Nor is it respectful of a Dáil to whom our Constitution, forged of vision and heroic sacrifices, has been entrusted, to shrug its shoulders and acquiesce in the emasculation of democracy. This is why our unreconstructed political system commands little respect in the country. What do we have left to fall back on if, as both markets and respected analysts expect, the eurozone implodes and political instability becomes a very real threat? If the Bank of England and the British Financial Services Authority counsel their institutions to prepare for this eventuality, why do we persist, with bowed heads, with a discredited bailout?
A disorderly collapse of the eurozone is likely to occur sooner rather then later. Recent summits have produced nothing except the continued erosion of ECB independence and proposals for a European Stability Fund Mechanism (ESFS) — a bailout fund for large eurozone countries in trouble — whose design and funding arrangements have all but collapsed. In the wake of this, there has been an air of barely concealed, quiet desperation. Spreads remain stubbornly high, even in the wake of Italy’s change of government. Both the ESFS and even Germany are encountering market resistance to funding requests.
All of the choreography set out in recent speeches by German chancellor Angela Merkel and French president Nicolas Sarkozy is of a pre-emptive move to full political union. It is entirely proper to conceive of a role for the ECB that is different to the one set out in the treaty by which it was established.
However, that is not what exists now. What is there now is an institution the mandate, function and independence of which are being subverted by a model of monetary union that was structurally and politically flawed from the outset. It is wrong and has done terminal damage to manipulate the ECB mandate into compensating for these flaws. France, with its intolerance of Ireland’s corporate tax rate, effectively wants the ECB to resort to the printing presses to bail it out when the markets come knocking on its door.
For Ireland, fiscal union — of which the bailout was a precursor — is a precursor to full political union. This means Germany and France would draft monitor and enforce Ireland’s fiscal policies, including its corporation tax rate. When I argued during the Lisbon 1 campaign that this was on the line, it was largely dismissed. We know better now and we know how much store can be put in "binding commitments" from our "partners". What is even worse is that Budget 2012 imposes cuts on our third-level sector as our corporate tax regime has been put on notice by Mr Sarkozy, as part of the fabric of fiscal and political union. It was not supposed to be like this.
At present, Denmark, Sweden, or Britain can adjust their exchange rate to gain competitiveness and thereby ease pressure on their labour markets.
Not so Ireland. We are a member of a "one-size-fits-all" monetary union that lacks a fiscal transfer system but instead has a malign adjustment process which exacerbates the underlying structural problems stifling growth.
We should be clear about what surrendering what remains of our budgetary autonomy means. It means that the opening up of the economy in the 1960s would not have happened. It would mean that the Irish Financial Services Centre would not have happened; it means that, as matters stand, our capitol corporate tax rate is living on borrowed time.
In return for all of this, the Merkel/Sarkozy drive for political union offers "direct elections for a President of Europe". Are the suffering people of Europe really expected to see this as something of substance? In our country, we have seen, up close and personal, how little respect there is for the wishes of the electorate.
The Dáil should vote against this budget. It should negotiate a managed exit from the eurozone, both in our own national interest and for a catalyst for the eurozone to face up to its internal inconsistencies and rebuild itself. We have now reached a stage where the threat of default hangs over a growing number of eurozone countries, including Ireland.
We need a government of national unity, because the disunity, factionalism, begrudgery and bitterness that are increasingly evident in our national life are the greatest obstacles to Ireland’s self-belief; and to understand that change from within is infinitely better than adjustments being imposed from outside by those who know little of Ireland’s potential and, quite frankly, care even less.
Christmas seems a good time to take our courage in our hands and leave a blighted eurozone and reclaim a future for our children.
The greatest short-term threat confronting the eurozone is of a self-inflicted economic ice age. Economic growth has slowed to the brink of recession, largely because of policy-induced austerity measures. Eurozone banks are now conflicted by the regulatory requirement to dispose of assets in order to meet higher capital requirements. This means even less lending available for businesses, especially in the present high-risk economic and financial environment.
Meanwhile, non-euro banks are deliberately reducing their lending to eurozone countries. But, most telling of all, inter-bank lending is freezing up — just as it did in 2008. There is, once again, a meltdown in trust, reflected in the unwillingness of banks to lend to their peer banks within the eurozone. In this environment there is only so much that the ECB can do. Printing money, against diminishing quality collateral, is not sustainable in the medium-term and also carries a serious threat of inflation.
These developments will put even more pressure on the public finances of eurozone members, as well as on the already weak balance-sheets of banks. The possibility of a bank run, necessitating ECB intervention, is real. This is the eurozone’s negative vortex within which it — and Ireland because of its adherence to the — bailout is trapped. The EU summit must find a way through on Friday.
*Economist Ray Kinsella is professor of banking and finance at the UCD Michael Smurfit Graduate School of Business