Ireland’s Catch-22 is a dilemma for EU
FINALLY after 13 days of uninterrupted panic about Irish government debt, the markets retreated yesterday and the cost of holding our debt dropped a little.
The figures for our debt and borrowing have not changed. The only thing that did change was that political leaders made statements clarifying Ireland’s position that the country has not applied for a bailout, that the EU is willing to lend to them if required, that the fund is ready and, most importantly, that debt holders will not lose money.
For the past two weeks Ireland has been caught in a Catch-22 position. Investor fears drove up the cost of debt and, on Thursday, those fears started affecting Italy and Spain, pushing up the cost of their debt also.
“Ireland is the new Greece”, the headlines screamed. And in May when eurozone member states agreed to fund Greece, the hysteria subsided. But it was impossible to deal with the Irish situation the same way. The Greeks needed money and quickly to repay a huge sum of debt. Ireland has enough money to keep the country afloat for the next six months.
How could Ireland seek money from the new EU fund when it did not need it? The €750 billion fund set up by the European Commission, member states and the IMF, has been established with an office in Luxembourg and headed by Klaus Regling, the German economist who drew up one of the reports on Ireland’s banks.
But the Germans insisted that a country could only draw money from the fund as a last resort. It was true that at a 9% interest rate, Ireland was as good as shut out of the markets – but it did not need to access them.
“The phrase Catch-22 neatly captures the situation,” said economist Nicolas Veron of the Brussels-based economics think tank, Bruegel. “This is a classic situation – markets see a solvency problem down the line but it’s not there yet as you have cash to meet your immediate commitments.”
Finally, someone figured that what the markets were scared of was not that Ireland would default now. They do not like the EU agreement, driven by France and Germany, that in future investors and debt holders must take a hit when a country goes bust.
At the summit in Brussels two weeks ago, President of the European Central Bank Jean-Claude Trichet warned that even proposing this now was not a good idea. He said it would scare off investors in sovereign debt and make them build in the cost to what they charged member states for borrowing.
He was right. But Germany and France are not that concerned about the immediate situation, or about the self-inflicted problems of countries silly enough to go on spending sprees with borrowed money. They are talking about the future, about a new bailout mechanism that will replace the current Luxembourg-based fund that has a lifetime of just three years.
But nobody made that sufficiently clear. German Chancellor Angela Merkel was busy talking to her voters, emphasising a point that should be music to the ears of Irish citizens, that in future taxpayers should not have to pick up the entire tab.
Just yesterday the European Commission clarified in simple, direct terms, and confirmed that it would require a Treaty change to deprive private investors of money they had lent to countries borrowing from the current fund.
Detailed talks are said to be going on behind the scenes to arrange a €80bn bailout for Ireland. There appears to be no time frame but even if it is true, this will continue to make investors nervous.
The four-year budget the European Commission is expecting to receive from the Department of Finance before the end of the month will give speculators another chance to say if they believe Ireland can actually reduce it’s budget deficit to 3% of GDP by 2014, as will the 2011 budget to be revealed by Finance Minister Brian Lenihan on December 7.
On Tuesday the finance ministers of the eurozone will discuss the situation. They will be anxious to say that they cannot let the markets dictate eurozone policy – as German Chancellor Merkel pointed out – they and the politicians have different aims.
The fact of the matter is that there is a war being waged between speculators, investors and governments. In the EU, Internal Market Commissioner Michel Barnier is churning out legislation to rein them in, and curtail their ability to bring down companies and countries to win lucrative bets.
Ireland has said it will exclude senior bondholders from suffering losses in its bank resolution strategy but wants to deprive subordinated bondholders – those who took bigger risks and stood to win a bigger return – of up to 80% of what they lent. Investors are fighting it.
But all of this will still not prevent future euro crises, Nicolas Veron warns: “What is happening with Ireland illustrates the larger point that if the EU wants to be in a position to prevent crises, it needs more flexible instruments than it has”.
Eurozone leaders have to ask what will make government bonds, and particularly those of the peripheral economies like Ireland, more attractive to investors in the future.
“The fact of the matter is that a monetary union cannot just be government by strict rules and discipline... there has to be some capacity for political decision-making and solidarity”, said Mr Veron.
This means if healthy countries are to show solidarity, the weaker beneficiaries must be prepared to sacrifice some of their sovereignty, he adds.
“It’s about fiscal federalism. You cannot have a monetary union without some form of fiscal federalism – which is not a phrase anyone likes.” What shape this would take he could not say. “It can take many forms but not a set of rigid rules.”
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