We have seen political dithering of the worst kind, persistently, with the resulting vacuum in terms of policy being taken up by the European Central Bank. It is to its credit that it has at least stepped into the breach.
However, of all of the European institutions it is probably the least democratic, as independent central banks have to be. Every ECB action, no matter how well-meaning, in the absence of political and therefore democratic-based, approaches further undermines the democratic legitimacy of the euro. In any case, ECB intervention in bond markets has at best only a temporary effect, and it is ultimately up to governments to implement policies that restore fiscal discipline.
The action this week has focused on Italy. Heretofore the countries that have found themselves locked out of the financing markets have been ones which were sustainable, non-systemic, and manageable. Italy is simultaneously too big to fail and too big to save. Italian public debt is the third-largest, in absolute terms, in the world. It has to refinance €200 billion in the next year. GDP is the eighth largest in the world. And yet this week we have seen that Italy is, in effect, locked out of the bond markets, at least at anything approaching sensible rates.
We also see this week that, despite there being no formal mechanism for doing so, it has been suggested by leading European officials and politicians that countries can exist outside the eurozone. It is highly probable that an exit by any country would lead to a cascade, resulting in the effective breakup of the euro. What then for Ireland?
The first thing that must be said is: hopefully somewhere in Government there is a plan.
Secondly, in the event of a eurozone break-up, there will be significant winners and losers in Ireland.
The first decision that would have to be made would be whether or not to allow a freely floating currency, which would almost certainly depreciate significantly, or whether they would put in place some form of managed float.
While depreciation would be attractive, in that it would be a boost to exports and assist in putting the country back on a growth path, it would also result in imports becoming more expensive. A third of our imports come from Britain and, in all likelihood, the new Irish punt would be weaker than sterling. It would probably also be weaker than the dollar which, given our extreme dependence on oil, would result in significant increases in petroleum-based products.
We will also have to very quickly move to achieving a primary surplus. The primary surplus, instead of a primary deficit in government finances, would be necessary to pay down the accumulated national debt. When we consider the pain we are going through to reduce the deficit to 3% over four years, it is hard to imagine the wrenching dislocation that would be required to achieve a primary surplus over a couple of years.
Yet that is what would be required. We would have to offer significantly higher rates on our debt to potential investors than is the case even now, not least because they would almost certainly be facing into a much more inflationary environment.
Another area that would mostly see losers would concern external euro-denominated liabilities. External in this context means outside of Ireland. Mortgages, bank loans, any liabilities within Ireland, would be converted to the new punt. It is the liabilities in euro outside Ireland that would be messy. The most likely option would be that these would be denominated into the currency of the country where they are located. Thus, a loan taken out in Germany would have to be converted into deutschemark, which would result in a very significant increase in these liabilities. Conversely, for multinationals with money on deposit in Ireland, any hint that these would be likely to be converted into a weaker currency would result in their being withdrawn. This in turn would exacerbate the existing credit crunch. The only feasible solution would be harsh exchange controls and a degree of financial repression for a time.
It is debatable whether or not Ireland should have joined the euro. At the time I was in favour. I felt that, on balance, European politicians were more likely to behave in an economically sensible manner than Irish politicians, and that the requirement as part of a monetary union for fiscal discipline would be useful for Ireland.
Unfortunately, this faith was misplaced on both sides.