Monday, November 29, 2010

Ireland's failure, the rise of the eurogroup, and Iceland's revenge

Ireland's caretaker government (the governing coalition collapsed as a consequence of the crisis) has accepted an emergency loan from the EU and the IMF worth 85 billion euros. As I predicted in my last post, Ireland is stressing that the money will go to the banks, either directly (45 billion in immediate aid) or indirectly (to cover banking losses that the government converted earlier into public debt).

At the end of the day, Ireland needed cash, and the UK promises of up to 8 billion euros (7 billion pounds) proved too small to be useful.

One element that Irish prime minister Brian Cowen has stressed from beginning to end is that Irish sovereignty will remain intact. The main issue he is concerned about is keeping the Irish corporate tax rate of 12.5 per cent that has brought so many companies to Ireland, and that has won Ireland a lot of hostility from the European continent. Now that the financial service industry has bottomed out, the last thing Ireland wants is the multinationals that moved to Ireland in recent years to pack up shop and leave. There is already an exodus from London toward Geneva and other ports, and Ireland doesn't want to be next.

Three additional points of this deal are worth noting. First, at the same time that the EU and the IMF are providing assistance to Irish banks, whether directly or indirectly, Ireland is raiding the national pension fund of 17 billion euros to ensure that the amount borrowed isn't even greater. This is a matter of grave importance for Ireland's future, as pension funds worldwide have been hit very badly by the double whammy of demographics and  the decline of pension portfolios as a result of the crisis. This is the perfect example of what economists call time inconsistency...and what the rest of us would call borrowing money today and never keeping the promise to pay it back. Because there never is a good time.

This point has been critical in bringing the Irish out into the streets in protest. Why should they pay for bad bets by Irish banks?

Second, Iceland has had it's moment of sweet revenge and has underlined that the Irish government is making a clear choice to subsidise bankers at the expense of the general populace Iceland's President Olafur Grimsson commented this week that his country doesn't have debt like Ireland because it let the banks fail and didn't guarantee bank failures with public money. This will surely prove to be a wiser choice than Ireland's.

Third, this deal was decided by the finance ministers of the eurogroup, who met on Sunday evening to finalise the deal with Ireland. Although it is sensible for these countries to have a formal role in euro zone matters, they do not, primarily because the UK has opposed it since before the euro existed. Instead, it is formally ECOFIN, the Council of Economics and Finance Ministers of the EU, which has this power.
What is happening and why is it so important? The euro zone, not the EU per se, is putting up the money to save its weaker members, and so it stands to reason that its ministers must meet to approve loans. This means that ECOFIN's role within the EU has been sidelined in an important policy area, and that attempts to keep the eurogroup down as a fact of life have failed.

The new EU, which is in the process of forming, will have to find room to accommodate this new reality.

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