What’s new pussycat (Celtic tiger edition)?

Back in May when Greece was in the process of getting its “bailout” I kept wondering why it had to be that Greece would accept such harsh conditions when it held an ace up its sleeve. The proposed package of austerity, which would make the economy worse, was only an issue as long as Greece felt it needed to stay on the euro. Greece once had drachmas, and could have them again. That alone would have been better for Greece by allowing them the flexibility of devaluation. There might have been some termoil in the transition but with people rioting on the streets it is hard to see how it could have been much worse.

At the time, going off the euro was not seen as a legitimate option, and the main reason was that it could have potentially led to the breakdown of the euro itself. Which is the ace. If Greece had threatened to leave the euro, it would have had much better bargaining power to seek a major write-down of its euro-denominated debt in exchange for staying.

It is worth noting, since reporters for the mainstream media outlets don’t seem to get it, that these so-called “bailouts” or “rescue packages” are not for the people of the afflicted country, but their creditors. That “bailout” is not a grant but an increase in the debt that people are eventually going to have to pay, on top of the fiscal austerity they must accept. There are two sides to any transaction, and why creditors should be fully protected rather the other way around is a choice, a bad one.

But this dynamic plays itself out time and again in previous financial crises, especially where the IMF has been involved. The 1997-98 Asian crisis was a fairly egregious case of feted economies all of a sudden made out to be demons in need of harsh economic medicine.

So as the game has moved on to Ireland, how’s that rescue package working, Greece? Are investors so much more confident that financial flows to Greece have restarted, unemployment is falling and the economy is recovering? Uh, no.

Yet now we see Ireland in the crosshairs. The Irish people (I do have Irish blood, but I swear its not affecting my position on this) are going to undergo a wave of cuts and pay back higher debts well into the future so that Irish creditors can get out relatively unscathed (principal intact, anyway, according to one report). Ireland should not accept this bad deal, and instead give the euro the finger unless they come up with a much better offer. This is a nation that spent much of its history fighting English colonization; why roll over so easily to Euro-colonization?

Dean Baker has a recent commentary that describes the real alternative model for Ireland: Argentina. So let me just quote him:

[E]ven a relatively small country like Ireland has options. Specifically, they could drop out of the euro and default on their debt. This is hardly a first best option, but if the alternative is an indefinite stint of double-digit unemployment, then leaving the euro and default look much more attractive.The ECB and the IMF will insist that this is the road to disaster, but their credibility on this point is near zero. There is an obvious precedent. Back in the 2001, the IMF was pushing Argentina to pursue ever more stringent austerity measures. Like Ireland, Argentina had also been a poster child of the neoliberal crew before it ran into difficulties.

But the IMF can turn quickly. Its austerity programme lowered GDP by almost 10% and pushed the unemployment rate well into the double digits. By the end of the 2001, it was politically impossible for the Argentine government to agree to more austerity. As a result, it broke the supposedly unbreakable link between its currency and the dollar and defaulted on its debt.

The immediate effect was to make the economy worse, but by the second half of 2002, the economy was again growing. This was the start of five and a half years of solid growth, until the world economic crisis eventually took its toll in 2009.

The IMF, meanwhile, did everything it could to sabotage Argentina, which became known as the “A word”. It even used bogus projections that consistently under-predicted Argentina’s growth in the hope of undermining confidence.

Ireland should study the lessons of Argentina. Breaking from the euro would have consequences, but it is becoming increasingly likely that the pain from the break is less than the pain of staying in. Furthermore, simply raising the issue is likely to make the ECB and IMF take a more moderate position.


  • The one big downside might be that if Ireland calls it quits then so will Portugal and Spain have to given what their financing costs would look like after Ireland bailed. This should be of no concern to the Irish. If it is, it is certainly the wrong way to leverage solidarity.

  • There is a good piece by Martin Wolf on this, Andrew Jackson and I exchanged about it on facebook.
    Ireland is a classic Minsky case of runaway asset prices (land and housing), growing debt, current account deficit, followed by price drops, and bankruptcy; then the banks who had borrowed from the European Central Bank, found themselves in liquidity crisis, moving to solvency problems, as the mortgages come back and derivatives written on top go under.
    The downturn plus the austerity programmes kicks the government budget deficit up sharply, and unless they can sell bonds to China, the Irish government looks unable to issue new debt. Why? As you point out the banks are not buying.
    The solution lies with re-doing the EU monetary pact, and reforming the ECB which has a deflationary bias.
    Exiting the Euro, and ending dollarization of the Argentine Peso are hardly comparable. Dollarization imperilled the national credit of Argentina in order to protect the fixed exchange rate. Ending that experiment made sense. The default was traumatic but courageous. Entering into a regional deal (Mersour) made more sense than linking to the dollar.
    The Eurozone is a serious challenge to U.S. dollar imperialism. Three big players (China, Russia, France, plus Brazil) want a new international currency unit to replace the dollar.
    Is Dean Baker going to suggest the U.S. ditch the greenback in order to deal with the dollar over-hang abroad? I somehow doubt it.
    Though with the President of the World Bank talking about how gold holds its value, anything is possible, nobody is going to leave the Eurozone, unless it is provoked. Germany does not want to feed the PIGS, it may have no choice.

  • Dean Baker, as usual, is the only one radical enough to make the obvious suggestion: the eurozone squeezes financially strapped countries, and does grave harm to their citizens, and so should be disbanded. Even Paul Krugman, who has been so astute on the causes of the recent financial calamity, won’t pursue this unavoidable conclusion; other economists avoid it as well. The question is: why?

    There is an enormous commitment to the euro on the part of its most prosperous proponents, particularly– and sometimes exclusively–Germany. The roots of this commitment are historical, but the arguments for its continued existence are mostly, I think, emotional and intellectually dubious.

    The economists and financiers of the eurozone are the least credible on this question. George Soros, who loudly supported the euro in the late 1980s and early 1990s, recently–and self-servingly, of course– blamed the euro, and the ECB, for the prolonged economic crises in Ireland, Spain and Portugal. His hypocrisy on this matter notwithstanding, very few economists are willing, publicly, to revisit their judgements and opinions from the time of the euro’s inception. Who wants to admit they’re wrong, especially when the consequences of their commitment to the eurozone have proven to be so catastrophic?

    Marc writes this: “At the time, going off the euro was not seen as a legitimate option, and the main reason was that it could have potentially led to the breakdown of the euro itself.”

    Political support for the euro is understandable, but sentences like this one are meant to provide economists with cover. Dropping the euro was most certainly discussed at the time, but it wasn’t supported by eurozone economists not because it would have meant the end of the euro (some, after all, are hoping for, and predicting, this very thing), but because it would have led to widespread condemnation and questioning of the very economists who supported its creation in the first place.

  • Anthony, for some informed background on the Euro and what it means in the context of two world wars involving the participants, you could look at the Five Books feature by Barry Eichengreen, which starts with Tony Judt, and his masterly Postwar.
    The real problems are in Haiti not Europe. The American economy has more structural shortcomings than the Club Med countries of the Eurozone I would say. Finance capitalism is broken, who knows how the next crisis will work out. Arun has a good post on securitization and what that implies for the continuing mortgage meltdown.

  • The euro was flawed from the beginning because there is no European Treasury to deficit spend and support economic growth when needed. European countries are in effect very similar to Canadian provinces in that they have no control over their currencies and as a result can become insolvent, hence the current problems. This is not possible for the US, Canada, the UK, Japan, to name a few. Interestingly the euro can be seen as the culmination of monetarism – leave most economic intervention to monetary policy and reduce or eliminate fiscal policy.

    Pre-euro, some 150 European economists pointed out the basic flaw, essentially that the use of the same currency by countries that have large export surpluses while others are running large export deficits is unsustainable in the absence of a common Treasury to balance the member countries’ economies. This is what happens in Canada for instance when the federal government deficit spends to maintain demand.

    In the end political motives overrode the economic objections in Europe and the ill-advised euro went ahead. The political concerns were understandable given the history of Europe, but as is now clear the euro was an economic mistake.

    The euro is now being maintained by the ability of the European Central Bank to buy member country bonds. The ECB sets harsh and probably unsustainable fiscal conditions in exchange. In effect the ECB is playing the role of a european quasi-treasury but in a deflationary way which is the reverse of what is needed.

    Exiting the euro may be the best option for some countries rather than face many years of depression but it also means exiting the European Union, something not to be taken lightly.

  • I’m not sure if I think the Euro is really needed as a US dollar challenger any more. It seems countries are starting to simply do trade in their own and each other’s currencies. Russia and China apparently have officially decided to do their trading in rubles and yuan. Currency conversion and hedging, like trading in general, is so automated nowadays that perhaps there’s a lot less need for an “international” currency.

  • I am with Keith on this. I strikes me as both Keith and Krugman have pointed out their is a deep structural flaw in the way the Euro was rolled-out: essentially a federal currency without concomitant federal spending capacity. That matched with significant differences in the regional economies and as Keith points out significantly different models of development (i.e., Germany’s export led quasi merchantalist surplus strategy) means that the Euro actually removes flexibility from the Euro area.

    Further the Germans have proven that they prefer moral lectures rather than serious collective solutions (as in they prefer austerity). It is hard not conclude that the Germans are running the Euro show for their benefit in a way that is not much different than dollar imperialism.

  • The Europeans have had exchange rate stability as a goal since the mid-seventies, the snake in the tunnel period, through the EMS, and now the Euro. Free floating national rates make no sense in such a small area. They are only an invitation to speculation.
    The cost of exiting the Euro could best be borne by Germany; the other are paying premiums of between 250 and 400 basis points which is not that excessive. Compared to pre-Euro it is a bargain. Going it alone after a panic run to the exit would make future borrowing prohibitively expensive.
    What makes people think Canada runs counter-cyclical fiscal policy? After the 95 budget the provinces were on their own. The Feds were squeezing everyone with their surpluses, for which the counterpart was consumer debt increases.
    The Maastricht treaty was badly flawed, the Eurozone has to have better rules on government access to credit. In Canada the provinces have not had access to the Bank of Canada since the 1930s, though lending to them was one of the objectives of creating the Bank of Canada. Giving the European nations access to the ECB was a step forward.
    The repo window of the European Bank helped the European banks make bad loans, that is the problem: banking policy not the Euro per se.
    If the Eurozone is running a current account surplus it can re-cycle to countries in deficit. That is what happened in the Marshall Plan period of exchange controls, right up to convertibility in 1958, European countries shared scare reserves.
    The EU has regional transfer payments in place, a common tariff, and a budget. The problem is that the Euro rules promote deflation, which is not the solution for Greece or Ireland.The German model does not translate outside Germany.
    The American economists who have opposed the Euro from day one, still want it to go away. It is not going away, regardless of what they write. The EU banking and finance models need to be rethought. Canadians familiar with John Crow were vocal critics of the ECB operating mandate, but not of monetary integration. Why would France and Germany invoice trade in greenbacks, make payments to each other in greenbacks, and hold large quantities of greenbacks in effect providing a permanent loan to the U.S.
    The loans to the U.S. made by all countries, banks, companies, and individuals holding U.S. dollar deposits, financed the Vietnam, Iraq, and Afghan wars, the takeover of companies around the world, and the U.S. current account deficit. For Europeans this made no sense, to Americans it makes sense. When you oppose the Euro you are voting for continued dollar domination wether you want it or not.
    My sense is that the flooding of the world currency markets with dollars by the Fed (QE2) is not going to help the 15 million U.S. unemployed, or anybody else, except maybe the speculators betting against bonds from Ireland, Spain, and Portugal.
    I repeat read Martin Wolf from last Wed.

  • I agree with Duncan that the US reaps huge benefits from the fact countries are willing to accumulate vast quantities of US treasury securities. Since the US does not allow much of these to be converted into US physical assets and is able to produce as many $ as it wishes, these accumulations are in effect largely valueless. And indeed they do allow the US to pay for its empire for free contrary to the UK, for example, that couldn’t afford its empire after world war 2 under the prevailing gold standard. The US went off the gold standard in the early 70s because it wasn’t sustainable for them and then discovered how amazingly well this worked (for them). Take a look at Superimperialism by Michael Hudson on this topic. Note I am not advocating a return to the gold standard.

    With respect to the euro, the trade deficit countries are unable to devalue their currencies to balance trade because they share the euro. So they must deflate to lower prices internally relative to the surplus countries. That means years of depression for them unless Germany in particular balances trade with them, an unlikely prospect it seems.

    Speculation happens when currencies are pegged in some way. The speculators try to break the peg by depleting the victim’s foreign currency reserves. They sell an overvalued currency until finally it drops and reap a profit from the difference. High leverage produces high profit. Free floating currencies don’t offer that opportunity. Floating can be a problem for some countries if they are highly dependent on food imports and prices go up if their courrency goes down. For wealthy countries currrency fluctuations can indeed cause problems for exporters or importers, but speculation isn’t a problem.

    It could be a good thing for European countries to have the same currency but it requires either similar economies or an effective transfer mechanism in a crisis neither of which they have. Under current arrangement the euro is not a viable replacement for the US$.

    With respect to Canada, last year we had a counter-cyclical federal deficit of about 4% of gdp and this year 3% of gdp. It is inadequate but it is not insignificant.

  • Addendum to my previous comment.

    I realize I didn’t make an important element clear in my previous comment. I focused on the trade imbalance problem which is indeed serious. I’d like to emphasize again that the basic euro flaw is euro countries don’t have a treasury that can run large deficits to support aggregate demand in the event of a serious recession, backed by a central bank. They have the bank but not the treasury that can run the required deficits at whatever level is necessary and yet not face insolvency.

    The Maastricht Treaty ostensibly limits deficits to 3% of gdp. Of course this has been grossly disregarded during the current crisis but is still held up as a target. To get public finances back in line with this needless target, bone-crushing austerity is being implemented in a variety of countries.

    What is inexorably pushing the euro to break-up under current circumstances is that re-instituting a free-floating sovereign currency allows countries to pump up their economies by running large fiscal deficits and alleviate high levels of unemployment. In order to eliminate the risk of insolvency those countries require a central bank able to meet all liabilities if necessary. The newly issued currencies would drop in value but human suffering would be greatly reduced. It is also a fairer solution because costs would be borne by everyone in the country through the lower currency (and what that implies), not only the unemployed. It would help redress trade imbalances as well.

    Redrafting European Monetary Union arrangements would be preferable but that seems to be very difficult politically.

  • To Duncan via Barry Eichengreen

    “It pains me to say this. I’m probably the most pro-euro economist on my side of the Atlantic. Not because I think the euro area is the perfect monetary union, but because I have always thought that a Europe of scores of national currencies would be even less stable. I’m also a believer in the larger European project. But given this abject failure of European and German leadership, I am going to have to rethink my position.

    The Irish “program” solves exactly nothing – it simply kicks the can down the road. A public debt that will now top out at around 130 per cent of GDP has not been reduced by a single cent. The interest payments that the Irish sovereign will have to make have not been reduced by a single cent, given the rate of 5.8% on the international loan. After a couple of years, not just interest but also principal is supposed to begin to be repaid. Ireland will be transferring nearly 10 per cent of its national income as reparations to the bondholders, year after painful year.”

    Yep good thing the Irish are not suffering under dollar imperialism. I guess they can always immigrate to Quebec. Me I am moving to Armagh QC in anticipation of the second great wave.

  • Travis, as you will remember, Ireland’s problems were with British Imperialism, not American. The problems were severe in the 19th century, including famine, and many did immigrate to Quebec. The voyage had an unhappy ending for many who perished on an Island in the St. Lawrence. The Bishop of Quebec invited the population to take in the orphans, and hundreds ended up being adopted. To rid themselves of the English, the Irish had a revolution; and ended up quasi-independent, with an Irish pound (the equivalent of a Can. dollar). They were happy to drop that for the Euro.
    We are witnessing a panic. Investment grade government debt is being shorted all over the Eurozone. The issue is that big European banks which hold the debt could well start going under.
    Eichengreen is right the Irish “bailout” does not deal with the Irish debt servicing problems, but once you have said that, what have you said ? The problem will not be solved by leaving the Eurozone, it will be made worse.
    The deflationist bias of the ECB, plus the absence of a discount window for government debt, while commercial banks over-borrowed from the repo facility, have created a severe crisis for financial capitalism. The major players are still Anglo-American, pro-market people, none of whom have a stake in helping out banks on the continent.Within that mindset, nobody knows what to do next, except try and profit from the troubles of others.
    The obvious measures, a FTT or a bank tax, put forward by Sarko and Brown were nixed by the U.S. (with a big assist from Harper) prior to the G 8/20 in Toronto. I argued on rabble.ca this week that nationalization of the banks is what should happen. I am not holding my breath. By the way, CUPE proposed this in in the early 1980s, I drafted the brief to the House Finance Committee; we were not accorded a warm welcome.

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