Saturday, November 20, 2010
It cannot be denied that Ireland has lost its status as a sovereign nation. Thanks to its disastrous entanglement with the euro, it has lost any independence in domestic, foreign and above all economic policy. The Irish nation is the creature of Brussels and the European Central Bank. The Irish prime minister has effectively been turned into a pro-consul despatched to Dublin from Brussels. Brian Lenihan, the finance minister, is like an overseas manager of a Brussels subsidiary. For those of us who love Ireland, this is miserable and demeaning – but it needs to be borne in mind that a similar fate awaits a number of other European countries. Greece already does what it is told by the IMF and the ECB; the same will shortly apply to Portugal and in due course Spain.
But how long before the merry-go-round stops? How long before France, Germany and the UK lose the capacity to finance these bailouts? How long before the contagion reaches these core countries of the European system? How long before public outrage makes it impossible for a government to acquiesce to institutions like the World Bank, the IMF and ECB? And when it does stop, what happens then?
Ireland could be the next Lehman Brothers. That's what has the markets worried. If Irish leaders refuse to accept a bailout from the EU's new European Financial Stability Facility (EFSF), then bondholders will be forced to take haircuts on their investments which will leave banks in Germany and France short of capital. Bonds yields will rise sharply slowing activity in the credit markets. An Irish default will trigger hundreds of billions of dollars in credit default swaps (CDS), which will push weaker counterparties into bankruptcy and domino through the financial system. Contagion will spread to Portugal, Greece, Spain and Italy widening bond yields and forcing governments to increase their borrowing at the ECB. Business activity will sputter, unemployment will rise, and growth will shrink. It will be a second financial meltdown.
But no one believes that will happen. Most people think that Ireland will take its medicine and spare bondholders any losses. Irish leaders would rather accept a decade of EU-imposed austerity measures and the loss of sovereignty, then leave the euro and start fresh. It's disappointing. The euro is not designed to meet the needs of the smaller, less industrialized countries like Ireland. They need their own, flexible currency to ease the effects of cyclical downturns. But Irish leaders are still captivated by the idea of a united Europe. So they will cast aside the independence they earned through centuries of struggle for a pipedream and the elusive promise of prosperity.
At present, the Irish government is underwriting the toxic debts of its main banks. Unfortunately, those debts far exceed the revenues of the state. According to BBC's Robert Peston, the liabilities are equivalent to an oppressive 700% of GDP when banking, public sector and private sector debts are added together. So far, the ECB has helped to keep Irish banks operating by providing 130 billion euros of emergency liquidity. But the wholesale markets no longer accept Irish debt as collateral and bond yields are in nosebleed territory. Irish politicians still maintain they have sufficient funds to get through the middle of next year, but that does not include funding for the banks. In fact, if the ECB stopped lending to the banks today, the system would crash overnight.
So the situation is tense and getting tenser. Even so, everyone expects Ireland's Finance Minister Brian Lenihan to cave in and accept a bailout. That will shift all the losses onto Irish taxpayers.