“A disorderly break-up of the currency zone does remain a serious risk,” warns Dan O’Brien. Despite relative calm for the past three months, “there are all sorts of things that could go wrong. Things could blow up in different countries [such as Greece, Portugal, Spain, Italy and Ireland] that could reignite the crisis.”
Overall, Ireland’s fiscal policy has been “highly contractionary” for quite a while. “In the good times, it’s expansionary and in the bad times it’s contractionary (i.e.) a pro-cyclical fiscal policy which is exactly not what you want to do,” O’Brien tells eolas.
Ireland has strong economic fundamentals such as “a good business climate, decent levels of education, reasonable infrastructure, access to the European market and a good position geographically in the trans-Atlantic economy.” However, its high level of debt (estimated at 108 per cent of GDP at end of 2011) is “a boulder pinning the economy down.”
Another weakness is its “disastrous banking system which is not able to do what a banking system should do which is provide credit,” O’Brien contends. In addition, Ireland has “a major problem with low-skilled former construction workers, a weak state labour market policy that could help those people [if stronger], and an indigenous entrepreneurial culture that is not as dynamic as might be needed to generate employment that would help drive the economy back to recovery.”
While commentators such as Teagasc have claimed that the agriculture sector will help boost the economy, as prices for most farm produce are rising, O’Brien believes their projections are “totally overblown.” He points to employment in agriculture which has “declined very sharply over the past four to five years (after the construction sector).”
Jobs in the agri sector declined from 97,200 in 2009 to 84,900 in 2010 and were up again to 85,800 in 2011. Construction jobs fell from 155,400 in 2009 to 125,300 in 2010 and 105,700 in 2011.
“If there are good things happening in the agriculture sector, it’s not showing up in jobs,” he reflects.
On the other hand, exports are a bright spot. Last year, they were up four per cent to €93 billion (from €89.2 billion in 2010). The growth was driven by chemicals and pharmaceuticals.
The Fiscal Compact Treaty will have “next to no” impact on the current fiscal crisis, O’Brien contends. “Debt has to come down, budgets have to be tightened; all that has to happen anyway whether or not this compact existed.” It is, he reflects: “largely a political cover for Germany in particular so that a treaty exists rather than just secondary legislation at an EU level. They can wave it at their voters and say: ‘We are absolutely sure that the peripherals will not get into trouble again.’” The EU economic governance six-pack is much more significant, O’Brien contends. It strengthened the Stability and Growth Mechanism by threatening to fine any member state which does not take adequate measures (outlined by the Commission) to ensure their budget deficits are below 3 per cent of GDP and that their government debt is below (or reducing towards) 60 per cent of GDP.
The compact and the six-pack are “necessary,” in his view.
“We need to be live to risks. Such external checks and balances are a good thing because, over the years, many governments have shown that they ignore risks, they look at scenarios that are too rosy in terms of revenue-raising and they have a tendency to overspend. We’ve seen a general rise in public indebtedness in the recent decades and that simply can’t go on.”
Uncertainty around the euro overshadows everything and “is a big weakness” in Ireland, according to the analyst.
Saving the euro
It is “still plausible” that the euro will hold together, according to O’Brien. Speaking at an eolas seminar on the euro crisis, he said that the provision of three-year funding to the banking system by the European Central Bank “has had a major impact in terms of lowering the cost of sovereign funding [and has] helped to recapitalise the banking system by stealth.”
“There’s massive profit to be made in borrowing at 1 per cent and buying a sovereign bond that yields 5 or 6 per cent. It’s a money-making machine,” he told delegates.
Greater liberalisation and structural reforms in southern European countries could “help boost economic growth,” O’Brien predicted.
The ECB can do more by directing its Security Markets Programme and monetising debt, O’Brien suggested. Although, that was “very much a last resort and there are all sorts of legal difficulties.”
Another option would be to “turn the bail-out funds into banks with banking licences.” This would mean that “the EFSF or the ESM [could] go and tap the ECB.” While that has not been done to date, “it’s a possibility,” O’Brien claimed.
Ultimately, the European Union could become a fiscal union. “It seems to me that in the euro zone as a whole, the position is better than both the UK and the US, and indeed Japan, in terms of external balance and fiscal balance. [However], there’s a weakest link problem. When you don’t have a fiscal union or a monetary union, you are always going to have a weakest link problem … The only way you are going to deal with that is by creating a fiscal union,” he stated, predicting this could happen in 10 to 20 years’ time.
A second scenario is a partial break-up of the euro zone, with Greece being ejected.
Greece is clearly a sectional case in many ways: economically, politically, socially it’s very difficult to see things improving,” O’Brien remarked. “It’s very much a border-line failed state.” While “legally, there is no mechanism to remove a country from the euro zone, O’Brien adds: “My view is, if a crisis becomes sufficiently grave, a way will be found around legal constraints.” This “nightmare scenario” would have significant knock-on effects on the weaker peripheral countries: Portugal, Ireland, Spain and Italy.
“There would almost certainly be a bank-run, the shut-down of banks, capital controls. Citizens in other member states would look on and [decide] to eject the other peripheral countries,” he predicted.
Retaining the core
Thirdly, O’Brien suggested the possibility of retaining a core euro zone, and the removal of weaker, under-performing member states.
“If you are going to have surgery, it’s best to cut all of the bad stuff out at the same time,” he said.
While he sees the rationale for such a move, O’Brien concedes that “the consequences would be absolutely devastating.” The core countries in northern Europe would probably not survive the enormous default that would result from cutting away the Mediterranean countries “and for that reason I think it won’t happen,” O’Brien told delegates. However, he included this option because “this crisis is of such a magnitude I don’t think anything can be ruled out.”
Finally, the euro zone could “fall apart.” O’Brien concluded: “Since the crisis broke out two years ago, it really did feel that this crisis was not going to be controlled, that within days or weeks there was going to be a meltdown. [For] three months now, that hasn’t been the case and that’s very welcome but it cannot be taken for granted.”
Tags: Future of the euro