Euro crisis – Act II: the consequences of an Irish default

The Irish bailout shows that Greece was just the first act of the ongoing euro crisis. It is now almost certain that Ireland will accept an EU/IMF rescue package to calm down financial markets. In this second act of this euro area tragedy, however, the UK is likely to be a leading player as well. Indeed, the British government offered direct rescue funds to Ireland as British banks hold many Irish government bonds. The already troubled and largely state-owned RBS is a major lender to Ireland.

Of course, the Irish case is very different from the Greek one. Greece had accumulated huge public debt, cheated with official deficit data and had increased wages much above what was justified by productivity. While the latter is also true for Ireland, its government actually significantly reduced public debt until the financial crisis started. Yet, at the same time, Irish banks had accumulated unsustainable private receivables financed by foreign debt. During the crisis, the Irish government nationalised these “toxic” banking assets. Government debt rocketed as a result and this is the key reason for the second act of the euro area crisis.   

Now it would appear that the Irish bank assets are to be “supranationalised” at European level. Euro-area taxpayers and also British taxpayers will bear the risk and perhaps the costs. And there are at least two further problems with the quasi-bailout. Firstly, a rescue package for Ireland will potentially increase moral hazard for (not only) Irish banks but also for governments throughout Europe. Secondly, the political resolve in Ireland to undertake radical reform programmes and severe budget cuts may in practice be weakened by the rescue funds. This could weaken the necessary structural adjustment and threaten the Irish recovery.

However, there is a more important point. If Greece and Ireland are unable to repay the rescue package and guarantees become payable, public debt in the rescue-providing countries will increase. Then Irish and Greek debt will have to be paid back in the “donor” countries by spending cuts, tax increases or higher inflation. Not only will the banks and lenders to Ireland or Greece have to bear the costs but all taxpayers in the UK or Germany. A European transfer union would be established through the back-door.

The third act of the tragedy is already looming with Portugal as the next candidate for default.

Don’t forget, it’s not the Irish Government that’s insolvent, it’s Ireland’s banks.The public gave the banks eye-watering amounts of money to bail the banks out.Now, it’s only fair that the public should pay it all back.

How many eurozone countries have to be bailed out (contrary to the Treaty of Maastricht) before it becomes clear that the eurozone itself cannot survive without political union? Many years ago Sir Donald McDougall pointed out that unless central taxes in the EU were significantly increased (from about 1% of GDP to at least 6% or 7%), then it would become ‘a low growth high unemployment club’. Each of the seven federal states he examined required a central budget of at least 20% of GDP.No doubt those who run the EU would like to use the crisis to centralise fiscal management. If they did so, it would be an ideal opportunity for the United Kingdom to make its excuses and leave.

It’s a contagion that is going to continue to spread because that bad debt is just being passed along and added to as well. Really is stunning how bad it is heading. Shouldn’t be a surprise in the face of this how the central banks are becoming the biggest buyers of gold bullion now.

Could somebody please tell me, who are these debts owed to?If they include pension funds, then why did my father’s pension rights not pass to me as a hereditament, or else revert to the Crown as a life interest?

Michael – the answer is probably “no” in detail, but in principle it is broadly as follows. The Irish banks have funded lending (especially property lending) by taking deposits, wholesale funding, issuing bonds, securitisation and so on. Some of these debts will have been parcelled up and passed round the banking system but there must be a household at the end of them – such as your father’s pension fund. It is mind boggling what might happen if my advice in the next blog post was followed, but I think it should be followed. Except for insured depositors, these losses should accrue to the persons who ultimately hold the instruments.

Last month Mervyn King made a speech in which he characterised fractional-reserve banking as ‘alchemy’.In 1404 King Henry IV (1367-1413), passed a law which prohibited alchemy. It is also the shortest Act on the statute book. Has it ever been repealed?“It is ordained and established that none from henceforth shall use to multiply gold or silver nor use the craft of multiplication and if any the same do and be thereof attaint, that he shall incur the pain of felony.” (Capital punishment and forfeiture of all property to the Crown).

Former Fed governor Frederic Mishkin recently said: “the Federal Reserve is undergoing what he is calling an unprecedented level of attacks caused by its inability to articulate a clear message regarding its multitrillion-dollar monetary policies.” Inability to articulate a clear message? A clear message? This idiot thinks that the Fed’s problem is its PR skill, rather than its actions. The Fed’s message is loud and clear: bail out bankster buddies at the expense of the country.

I think the government should resign now even before the budget is passed. Let the people vote. Reduction of basic wage? They unemployed will love that they are finding it very hard to make ends meet at present. The question is though is how long will it take for the basic prices to drop (incl coal).

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