Things are bad in Ireland we know, but could they be getting worse?
Prolific eurozone doomsayer and Telegraph business editor Ambrose Evans-Pritchard cites this warning from economist and former Irish Central bank official David McWilliams as to the degree of stress facing the single currency (our emphasis):
“This is war: countries have to defend themselves,” said David McWilliams, a former official at the Irish central bank.
“It is essential that we go to Europe and say we have a serious problem. We say, either we default or we pull out of Europe,” he told RTE radio.
“If Ireland continues hurtling down this road, which is close to default, the whole of Europe will be badly affected. The credibility of the euro will be badly affected. Then Spain might default, Italy and Greece,” he said.
The conclusion appearing to be that Ireland will either have to default or pull-out of the eurozone altogether, as has been much speculated upon.
But, like former MPC member Willem Buiter has recounted time and time again – pulling out of the eurozone doesn’t really make sense. Not only is it something that was never envisioned under the Maastricht treaty, but it would not actually improve matters for any defaulting euro-zone member. The associated costs, for one, would far outweigh the benefits. Buiter uses the below example to illustrate the point (our emphasis):
Would a eurozone national government faced either with the looming threat of default or with the reality of a default be incentivised to leave the eurozone? Consider the example of a hypothetical country called Hellas. It could not redenominate its existing stock of euro-denominated obligations in its new currency, let’s call it the New Drachma. That itself would constitute a further act of default. If the New Drachma depreciated sharply against the euro, in both nominal and real terms, following the exit of Hellas from the eurozone, the real value of the government debt-to-GDP ratio would rise. In addition, any new funding through the issuance of New Drachma-denominated sovereign bonds would be subject to an exchange rate risk premium, and these bonds would have to be sold in markets that are less deep and liquid that the market for euro-denominated Hellas debt used to be. So the sovereign eurozone quitter and all who sail in her would be clobbered as regards borrowing costs both on the outstanding stock and on the new flows.Therefore:
A eurozone member state faced with the prospect of sovereign default, or just having suffered the indignity of sovereign default, would be immensely relieved to be a member of the eurozone. The last thing it would want to do is give up the financial shelter provided by membership in the eurozone to try and emulate Iceland, New Zealand or the UK.
What’s happening in Ireland, of course, can be seen as a worrisome indicator for the UK. Both countries’ economies were dependent on the housing bubble of the naughties. Both countries have limited export-based industry. Both countries experienced a high influx of low-income workers from new European Union members. And both countries are closely dependent on eachother for trade.
With that in mind, McWilliams, reminds us that the UK can at least let sterling fall – effectively making its problems someone else’s. Ireland’s only solution really is to become an export economy again. Not that easy. This would mean wage reductions, more people on the dole and generally an increasingly pro-longed contraction. Oh dear.
Of course, if sterling devaluation fails to deliver a much desired trade boost (as recent trade data seems to be confirming, those policies may also have to be employed in the UK.
Related links:
Anglo Irish to be nationalised – FT Alphaville
Sovereign stress – FT Alphaville
Buiter goes pamphleteering – FT Alphaville