Taking stock

19/07/2012

Michael O'Sullivan: We are likely not yet even halfway through the euro-zone crisis. The latest episode in this soap opera brought a reasonably happy outcome for Ireland but there will be some many more drama’s and tragedies ahead. In this respect any resetting of our bank related national debt is going to be small beer compared to the greater costs that the crisis will inflict on our economy and society. In this respect we have to diligently and very single mindedly for more dramatic options. A comparison of the Iran hostage crisis with ‘Neptune Spear’ is a good way of illustrating the benefits to very careful planning. With Europe in mind, our end goal should be a sustainable debt balance, and sustainable growth after that. Below is the text of an opinion piece I wrote for the Sunday Business Post on this issue.

During Operation Neptune Spear - the US mission to kill Osama bin Laden - its mission leader, vice-admiral Bill McRaven, compiled a thick dossier of the attack options, and nearly all possible responses to scenarios where "something goes wrong".

In the eurozone, something has been going very wrong which is unlikely to be put right by the recent EU summit and the series of meetings that will follow it.

On the plus side, the summit showed that the fallout from the first attempt to fund Spain's banks has been digested, and that the urgency of the situation in the eurozone is forcing the likes of Mario Monti to the fore. However, many pitfalls lie ahead.

The summit has crystallised a north-south political divide. The ESM, the proposed new rescue fund, is simply not big enough to do all of the things that the periphery countries now expect of it. In addition, the creeping mutualisation of periphery debt will soon run into political (German) opposition, and brings few of the benefits - such as market confidence - that formal mutualisation (ie, euro bills) might bring.

The ongoing risk is that, having muddled themselves into a quicksand of unambitiously low growth and near-permanent financial market stress, Europe's politicians may not find an escape from the crisis.

Many economic indicators demonstrate how Europe is being surpassed by Asia, and how, within the eurozone, the core has split from the periphery.

More importantly, global growth is slowing to such an extent that it recently forced unexpected interest rate cuts from central banks in countries as diverse as South Korea, Denmark, Brazil and China.

The realities of low growth and financial market stress continue to lie in the way of Ireland's path to economic recovery and solvency. In effect, we are locked in the eurozone, conscious of the damage its constraints inflict our economy and society but unable to manoeuvre out of it.

The necessary response to the deepening of the eurozone crisis is to adopt a more strategic, independent approach, and one that mirrors McRaven's level of preparedness. This kind of preparedness served Ireland well during the EU summit. However, it must be taken to a radically different level, and be broadened to a range of scenarios.

We must now think through the consequences and limits of a potential review of Ireland's bailout. In the past, there has been a blind willingness to accept the gifts of outsiders as a means of supporting our economy, with little thought of the consequences, Accepting the wisdom and apparent benevolence of others may help us in the short term, but it limits our independence.

The latest promise to 'look again' at Ireland is not the end of our problems, but a narrow opening to a long march back to recovery.

Even if we get a deal on our banking debt, disentangling the financial elements of our sovereign bailout will be extremely difficult. What we now know about the proposed Spanish bailout - and the outline of a possible Irish deal - carries serious timing and implementation risks.

For Ireland, the danger is that the debt write-down associated with a 'look again' option would be too small, and all that the core countries would be prepared to grant us. If we are very lucky, we may be able to reduce our debt burden by 15-20 per cent of GDP.

If so, then a resulting reworking of the bailout may still leave Ireland perilously close to insolvency territory, especially in the face of private sector deleveraging.

A number of policy-makers and commentators have expressed the view that a debt-to-GDP level of close to 90-100 per cent is workable for Ireland. But this will not happen.

For a small, weak, constrained economy in a low-growth, indebted world, a sustainable debt to GDP level would likely be closer to 70 per cent or even less. That is why we need to prepare for scenarios beyond the 'look again' option offered by the EU.

Our policy-makers should analyse and prepare for a range of events that many consider 'unthinkable'. Chief among these is the need to assess the ways in which a restructuring of our sovereign debt could be undertaken. This is a task of multi-layered complexity.

For example, could a restructuring be unilateral or multilateral? What are the consequences for our banking system of these approaches? How would a restructuring affect our relationship with the ECB? What knock-on effects could there be for Italy? Confronting and assessing these issues will bring home the truth of our situation to policy-makers, and will prepare the state for a deepening of the eurozone crisis.

The ensnaring of Spain into a full sovereign bailout, a deeper breakdown in trust between European governments and a very likely Greek exit are other scenarios that require careful consideration by the likes of Portugal and Ireland.

We must also develop our own view of the future of Europe, if only to use it as a roadmap of where not to tread. Eurostat surveys regularly highlight the Irish as being the continent's most pro-European citizens, though there is a temptation to read a certain blindness into this optimism.

Europe, as we consider it, will change dramatically in the next five years. Ultimately, the most positive and necessary outcome of the crisis is a full acceleration towards fiscal, financial and political union. But, under this scenario, the components of our world view of Brussels would be torn apart.

For example, the role of 'our' EU Commissioner would have to change significantly. More invasive fiscal surveillance, a European Parliament with legislative initiative and more concerted moves toward a better coordinated and more active common defence policy are just some other components of our 'world view' that may change.

Viewed in this respect, the result of the last summit is not only a chance for the eurogroup to re-examine Ireland, but for Ireland to re-examine every aspect of its relationship with the eurozone.
Michael O'Sullivan is author of Ireland and the Global Question (Cork University Press)

Posted in: EuropeEurope

Tagged with: eurozoneeu

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