In an attempt to reverse a recent, rapid deterioration of investor confidence, the government of Ireland today released new estimates of the costs of rescuing its sickened banking sector. You might want to sit down because the numbers are pretty ugly. Nationalized Anglo Irish Bank, the biggest source of investor concern, will require, in total, as much as $47 billion in capital, in a worst-case scenario, significantly more than earlier projections (though the bank has received most of that sum already.) In all, the government's support for the banks will reach 20% of GDP this year. That's going to slaughter the nation's financial position, propelling the budget deficit to 32% of GDP in 2010 and government debt to almost 99% of GDP.
The announcement comes at an especially sensitive moment for Ireland. The yields on its sovereign bonds have been rising for weeks, recently hitting record highs, as investors continue to fret over the government's future solvency. Yet the hope of the Irish government is that coming clean on the extent of its banking bailout will remove uncertainty and bolster investor confidence. Finance Minister Brian Lenihan was clearly using the announcement as an opportunity to show the government's firm resolve to fix its financial house. Here's what he said in a statement:
Greater certainty on the final costs of repairing the banking system in Ireland will provide reassurance to investors on the capacity of the Irish State to accommodate these costs within the Government's overall framework for the restoration of Ireland's public finances to long-term sustainability"¦The overall level of State support to our banking system remains manageable and can be accommodated in the Government's fiscal plans in the coming years. It is imperative that we remain focused on our major challenge which is to ensure that our public finances are returned to a stable and sustainable path. We must continue the fiscal consolidation we have embarked upon. This is the only course to follow if we are to ensure the future economic wellbeing of our society.
Markets always prefer more information to continuing speculation and uncertainty, and in that spirit, the fact that Ireland has outlined the scale of its bank bailout could help improve investor sentiment "“ in the short term. Beyond that, I'm not so sure.
Though the bailout is huge, it really came as little surprise to investors, who had been expecting amounts along those lines. In early trading after the announcement, Irish bonds strengthened slightly. But the bailout announcement also shows the monumental challenge the Irish government faces in repairing the economy. Though Ireland is probably not facing insolvency in the near term "“ the government made clear in its announcement that it has ample funds through mid-2011 "“ solving the country's financial crisis will be a Herculean task.
Lenihan said his government remains determined to reduce the budget deficit to less than 3% of GDP by 2014. That already tough job will be made even more difficult due to the poor condition of the economy, which is still contracting. Lenihan and his fellow policymakers find themselves in an awful bind. With debt rising, and the government's borrowing costs with it, Lenihan's has little choice but to keep cutting the budget deficit, even as the real economy stagnates. He warned that further austerity measures will come in 2011. But imposing even greater austerity will only further dampen economic growth, inflicting even more suffering on the Irish populace and making the budget deficit harder to fill. So the government has no easy way out of the crisis.
And that means further uncertainty for investors. Today's bank bailout announcement added some clarity to Ireland's financial situation, but has done little to actually solve it. That means investors are likely to remain skittish about Ireland for some time to come.
Ireland isn't alone. Governments throughout the Eurozone are facing the same dilemma "“ they're under similar pressure to cut deficits even though in many countries the recovery from the Great Recession remains fragile. Moody's downgraded Spain's sovereign rating, citing low growth prospects and poor competitiveness. Yields on Portuguese bonds have been rising along with Ireland's in recent weeks, due to a political dispute over new austerity measures.
So the bottom line in Europe remains as it has for several months: We're looking at problems so severe in the region's weaker economies that they will take years to resolve. And that means a sense of crisis in the Eurozone may well continue. Steps like the one Ireland took today are a step forward, but only a step.
Unlike the United States, Canada, Japan, China, Australia et al, Ireland is not Monetarily Sovereign. In essence, it is on a "euro standard" and so, cannot control its money supply.
There is nothing Ireland can do, on its own, to solve its financial problems. The post is correct that, . . . imposing even greater austerity will only further dampen economic growth, inflicting even more suffering on the Irish populace and making the budget deficit harder to fill. So the government has no easy way out of the crisis."
The only solution for Ireland, and indeed for all of the EU nations (except the U.K., which is monetarily sovereign), is for the EU to create euros and dole them out to the member nations.
In a 2005 speech at the UMKC, I said, ". . . because of the Euro, no European nation can control its own money supply. The Euro is the worst economic idea since the recession-era, Smoot-Hawley Tariff. The economies of European nations are doomed by the Euro."
Nothing has happened to change my prediction.
Rodger Malcolm Mitchell
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