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Saturday, Nov. 27, 2010
The luck of the Irish
In the aftermath of Ireland's decision to seek a rescue from the European Union and International Monetary Fund, two questions linger. The first is why wasn't this crisis anticipated. The second is which country is next. The European Union has struggled to contain its members' economic difficulties; thus far it has failed. There is little hope that Ireland's troubles will be the union's last.
During the 1990s, a roaring economy earned Ireland the name of the "Celtic Tiger." GDP growth averaged 8.4 percent from 1994 to 1999, a product of both a rebound from depression in the preceding decade and the application of reform policies that awakened a slumbering economy. One of Europe's poorest countries was transformed into one of its showcases.
Boom begat excess. Low interest rates fueled excessive lending, inflating an asset bubble in real estate. As that bubble deflated, courtesy of the global slump two years ago, banks struggled as collateral for loans disappeared. The government, which had relied on property taxes for a substantial part of its revenue inflows, was similarly constricted just when it needed even more money to shore up its faltering banks.
Experts reckon that the Irish bank bailout could reach as high as 60 billion euro; only a month ago, the total was estimated at "only" 46 billion euro. In recent weeks, Dublin has partly nationalized the Bank of Ireland and almost completely taken over Allied Irish Bank, adding to the government's bill. Ireland's deficit now stands at 32 percent of GDP, a weighty burden. Credit agencies have downgraded the Dublin government's rating, making it even more expensive to raise money on international markets.
Ireland has turned to the European Union and the International Monetary Fund for help, requesting a $115 billion rescue package. Assistance will be conditioned on Ireland getting its house in order. Prime Minister Brian Cowen has proposed a four-year plan that will include $20 billion in spending cuts and new taxes; 40 percent of the total would come into effect next year. Needed though this medicine may be, the austerity package, which includes deep cuts in unemployment benefits, government programs and welfare payments, follows two years of belt-tightening.
Predictably, there have been calls for Mr. Cowen's resignation. Wisely, he has refused. The country cannot be leaderless now. He has promised to step down early next year, after pushing the austerity budget through the legislature in early December. Passage is not guaranteed, however. The Green Party, the junior partner in the ruling coalition, has said it will support the budget but it wants new elections. The opposition smells blood, and members of Mr. Cowen's party are worried about how they will fare in a ballot after this budget is passed. There is opprobrium across the political spectrum for the prime minister who denied till the last minute the need for a bailout.
While new elections are needed to restore confidence in the government, it is not clear that a new government would honor the tough measures that are on the table. The consequences of a failure to do so are potentially huge.
While governments insisted that they could handle the storm generated by the 2008 global downturn, economists warned that Europe's "PIIGS" — Portugal, Italy, Ireland, Greece and Spain — were vulnerable. Greece proved them right when it experienced a financial crisis earlier this year, necessitating a bailout of $140 billion. A loss of confidence created a domino effect, pushing Ireland over the brink. A similar process is already at work in Portugal, where the government faces similar deficits. Portuguese Prime Minister Jose Socrates said that his country "has no need for any aid." Again, the banks are betting otherwise, suggesting that a bailout is only a matter of time.
Confidence (or the lack thereof) is not the only source of contagion. European banks lend throughout Europe and the evaporation of assets transmits economic weakness. The Bank of International Settlements reported that Ireland owed $139 billion to German banks and $132 billion to British banks at the end of June. Most banks have refused to detail their exposure; while that may make sense today, it does not build confidence. Thus Ireland's woes, like those of Greece, become Europe's, too.
Ireland represents just 2 percent of Europe's GDP; Portugal is smaller still. Spain, on the other hand, is the ninth largest economy in the world, and number four among the 16 euro nations. While Spanish officials insist their economy is stable, economists believe that the banking sector is more fragile than is generally known. European banking exposure to Portugal and Spain is reckoned in the hundreds of billions of dollars. Sound familiar?
A bailout of Spain would likely bankrupt the European Union's $1 trillion fund, set up on the aftermath of Greece's travails (and by the way, Greece may yet need more help). That would raise questions about the viability of the euro itself. German Chancellor Angela Merkel goes further, warning that "if the euro fails, Europe fails." The stakes could not be higher as Ireland's politicians try to restore the shine to the Emerald Isle.