Ireland is experiencing an extraordinary economic crisis, but do its ties to the EU and Eurozone threaten even the wider bloc?
Crippled from the fallout of a massive housing bust, Ireland is wobbling towards default. A rocketing soverign deficit and the world’s highest levels of per capita private debt mean Ireland’s ability to service its debt is becoming increasingly precarious. But what implications does this have for the wider economic bloc of which Ireland is a part?
Sovereign default is a traumatic event even for unattached nations like Russia in the 90s or Iceland in 2008. It has dramatic implications for that country’s currency and its future ability to borrow. In most cases the defaulting country will absorb the shock, stumble, but eventually carry on. It will wear the badge of a defaultor for a time and its creditors will be more cautious in their future dealings with it.
Can Ireland be allowed to default like this? Ireland is a member of the Eurozone, the 16 nation EU single currency zone. As such its debt obligations affect the standing of the shared currency. A failed member state, even a small one like Ireland, could badly damage the credibility of the currency. Which begs the question of whether the EU could allow a Eurozone member to default? Larger Eurozone members would have to consider coming to Ireland’s aid to avert damage to their own currency. This is the reason why Ireland’s bailout will come from Europe, with Germany reluctantly cleaning up Ireland’s mess.
Ireland’s economy is only 1/50th of the overall Eurozone’s, and could easily be picked up by other members. But the systemic threat comes from the fact that Ireland is not alone among Eurozone members in courting default. Ireland’s position may be the worst, but Greece, Portugal, Spain and Italy all have problems that place them at higher than normal risk of default. Were Ireland to be rescued, these other states may also demand rescue. And that is a bill that the EU cannot easily shoulder.
Such an event could greatly alter the structure of the EU. Consider the following crisis scenario from FT Deutschland; Substitute if you wish Ireland for Greece in the opening act, who the CDS market now rates a higher risk of defaulting.
But that does not mean that a breakdown of the euro area is inconceivable under all scenarios. Let us start with the hypothetical scenario of a Greek payment default. If the German finance minister, as I would expect, were to insist pedantically to apply the no-bail out clause, the crisis could, within hours, spill over to Portugal, Ireland, Spain and Italy, where bond spreads would be shooting up. Hedge funds will suddenly have discovered a good opportunity to make up for previous losses. Finance instruments such as Credit Default Swaps (CDS) are imminently suited to this type of speculation: If you stock up with Portuguese or Italian CDS during one of the panic runs, you stand to make very large profits. This in turn accelerates the domino effect of the crisis, and market interest rates will go up to double-digit rates all over southern Europe. The EU will hold an emergency summit at which it becomes clear that it is too late for a general bailout. This would have worked in the case of Greece or Ireland. But Italy and Spain are simply too big.
The summit would summon experts who tell the prime ministers that there are only two alternatives. Either the euro-area is dissolved with immediate effect. Or, one creates an imminent fiscal union, starting with single the European issuance of all future debt, and the transformation of all existing debt into a single European bond. The member countries would lose the sovereignty over budgetary politics. The finance ministers would receive their daily marching orders from Brussels. This would, of course, require a whole new EU Treaty, which the prime minister would have to agree on almost in real time.
I am not sure how Germany’s political leadership would jump when confronted with such a stark choice. Jean Quatremer, the Brussels correspondent of the French newspaper “Libération”, asked on his blog on Tuesday whether Germany is still a European country? The political instincts of Angela Merkel and Peer Steinbrück have been clearly anti-European during this entire crisis. They have prevented any real economic coordination with persistent reference to the national interest.
Ireland’s calamity has been so great that it must be recused before it threatens the entire European project. What price the EU will extract for its rescue, and how it will change both Ireland and the EU remain to be seen.
Tags: bailout, collapse, crash, debt, default, ecb, economy, eu, euro, europe, eurozone, ireland, rescue, threat
