Ambrose Evans-Pritchard
Telegraph
November 5, 2010
The uber-strong euro does not help (Photo: PA)
Ireland has been desperately unlucky.
The bond crisis is snowballing out of control before the country has had enough time to let its medical, pharma, IT, and financial services industries (don’t laugh, some of it is doing well) come to the rescue.
Yields on 10-year Irish bonds surged this morning to a post-EMU high of 7.41pc.
Yes, Ireland is fully-funded until April – and has another €12bn in pension reserves that could be tapped in extremis – but that is less reassuring than it looks. The spreads over German Bunds are mimicking the action seen in Greece in the final hours before the dam broke.
Once a confidence crisis takes root in this fashion it starts to contaminate everything, as we are seeing in punitive borrowing costs for Irish banks.
The uber-strong euro does not help. Under the IMF’s rule of thumb, currencies should fall by 1.1pc to offset every 1pc of GDP in fiscal tightening, ceteris paribus. Given that Ireland is going through the most wrenching fiscal squeeze ever conducted in a modern economy – though Greece is catching up – it needs a devaluation to match. Instead, the euro has risen by 18pc against the dollar since June. (less in trade-weighted terms).
UCD professor Karl Whelan, a former Fed economist, told me this morning that there is a “reasonably high probability” that Ireland will have to turn to the EU-IMF even though this will be resisted until the bitter end as a horrible humiliation.
The Fianna Fail government has one last chance to avoid tutelage. He advises draconian cuts of €7bn when the 2011 budget is unveiled in coming days, rather than the €3bn previously agreed.
“Yields on government bonds have priced in a high likelihood of default. If this continues, Ireland may not be able to continue borrowing on the sovereign bond market,” he said in an article posted on The Irish Economy website, a good source for anybody following this Gaelic tragedy.
He rebuts the oft-repeated claim (including by me, I confess) that Ireland had shown admirable courage in getting a grip early. “They have taken far too long to admit the scale of the fiscal problem that we are facing”
His UCD colleague Colm McCarthy said Dublin has until January or February at the latest to return to the bond markets after suspending all auctions when yields exploded. “The €1.5bn not borrowed in October plus the €1.5bn not borrowed in November represent borrowing postponed, not borrowing avoided,” he said in the Irish Independent.
“What if the re-entry to the bond market doesn’t work? The amount required is not offered or the rate of interest demanded is just too high to be affordable. In either case early resort to a bailout would be unavoidable.”
“We cannot do `fiscal stimulus’, nor can we devalue our exchange rate, since we do not have one. It is perfectly reasonable to ask how we got into this mess, to allocate blame and to demand retribution. But no amount of ranting can expand the limited range of choices available to the Government.”
(If I may interject: Ireland got into the mess because real interest rates set by the ECB for German needs were minus 2pc for much of the last decade, with utterly predicitable and calamitous results. Could any Irish government have adopted policies – financial repression, fiscal tightening, etc – to offset such idiotic interest rates? Perhaps, at a stretch. But the unbearable truth is that EMU itself caused this crisis).
Back to Prof McCarthy:
“The only factor the Government can do anything about at this stage is the budget deficit. If they do too little to convince the markets, the game is up and the Irish Government will be unable to finance itself, which means an IMF/European bailout and economic policy dictated from outside the country. How bad would that be?”
That is open to debate.
I notice that Fianna Fail is playing the treason card, insinuating that anybody opposed to Dublin’s economic policies is handing Ireland’s sovereignty to the EU inspectorate. What they really mean is that a bail-out would be political death for Fianna Fail.
Prof Whelan said events may force the outcome. “No Irish government in its right mind would want to go cap in hand to the EU but we have four by-elections coming and the government is going to lose every one of them, so there goes its majority. They might not be able to pass a budget,” he said.
“I think there will have to be a general election by January, and that will cause spreads to explode,” he said.
Greece was able to borrow from the EU at 5pc under its €110bn rescue in April. This rate is no longer available. Prof Whelan said the EU’s charge under the newly-created rescue fund (EFSF) would be more like 6pc. “It would not be a soft-touch,” he said.
The trigger for Ireland’s bond hell this week was of course the Franco-German deal preparing the way for orderly defaults and bondholder haircuts for eurozone states that get into trouble. This shift in policy changes the game entirely. Why would pension funds step into distressed debt markets after they have been told that the EU will, suddenly, no longer stand behind the debt?
Chancellor Merkel’s demands are entirely justified, in the long run. But she is playing with fire by raising the issue of haircuts at this delicate moment when Ireland is battling for its life.
If she keeps upping the ante in this way we may find out soon whether Europe’s rescue €440bn fund can cope with a fast and dangerous escalation. Any need for an Irish bail-out will put Portugal in instant jeopardy, as is already obvious from the latest surge in Portuguese yields.
The EFSF would face the risk of two simultaneous bail-outs from a diminishing number of donors. Contagion would spread instantly to Spain.
On balance, Spain looks strong enough to resist such an ordeal by fire. But don’t bank on it. The economy has not yet stabilized. Unemployment rose again in October for the third month to 4.1m. Car sales fell 38pc. The car association ANFAC said there will have to be a cut in auto production levels unless the car market recovers. The knife is nearing the bone here.
In theory the EFSF could handle a triple rescue for Ireland, Portugal, and Spain. I find it hard to believe that this could possibly work in practice. The rescue fund itself would surely be stripped of its AAA rating unless Germany, France and the residual core put up fresh collateral, which would lead to a political storm in Germany.
Italy would find itself having to raise large sums to meet is share of rescue costs, bringing its public debt back into focus.
A triple bail-out is not credible. There are limits to intra-EMU solidarity, as Angela Merkel showed by dragging her feet for months over Greece, and has shown all too clearly again this week.
The EU bail-out fund is a bluff that cannot safely be called.
