On May 31st, the country votes on whether to ratify the European Fiscal Compact. The likelihood is that we will ratify it, but failing that, what next?.
The first thing is, all this talk about how the treaty is bad for the social fabric of the country is irrelevant. Talk of social upheaval won’t wash with our creditors. Secondly, while there is a principled argument that governments should have the right to run deficits in certain circumstances, this facility has been grossly abused by Europe. Traditionally, governments borrowed for a number of reasons. They might be at war, investing in infrastructure, or more recently trying to break out of a flat economic cycle. In each case this was front-loading spending from future accounts, and creditors could assume that they would be repaid at some point when the country got its books back in order. The debt mountains amassed by European governments in the past few decades have nothing to do with extraordinary circumstances. Deficits are now being used to finance current spending, even in the good years. France hasn’t balanced the books since the oil shocks in the 1970s. Greece’s and Italy’s public debts were over 100% of GDP even before the crisis hit. Clearly, governments have done a poor job balancing the books, and in the eurozone, all parties have a responsibility to each other not to be overly profligate.
However, most people vote on bread and butter issues, so the real question is: what are the consequences of acceptance or rejection of the treaty? Both sides accept that a Yes vote will mean further cuts to government spending. However, both sides offer wildly divergent views on what a No vote will mean. A number of consequences are possible:
- The EU fronts us the money anyway.
Optimists hope that business will continue as usual. The EU will continue to give us the money we need, and a Europe-wide backlash against austerity will mean that by the time our current bailout program ends in 2013, the troika will be willing to advance further cash. This is, to put it mildly, a dangerous assumption.
It has been argued that we are somehow integral to the euro, that the EU simply cannot afford to cut us loose. Two things would seem to contradict this. The first one is the treatment Greece has received following polls suggesting that radical leftists SYRIZA would get into government. SYRIZA has campaigned on much the same platform as the No camp in Ireland, namely that the costs of kicking Greece out of the euro exceed the costs of subsidising Greece’s defiance, so walking away from the bailout would not prevent further funding. However, no sooner did SYRIZA look like winning a plurality than the prospect of a Greek exit from the single currency began to discussed openly by other European leaders. Essentially, Europe sent a very public message out that Greece’s solvency and membership of the euro were contingent upon its acceptance of the bailout conditions.
Talk of a democratic mandate to end austerity is just that, talk. SYRIZA, despite its promises, is not the master of Greece’s destiny, nor was the previous government forcing austerity on the Greek people out of malice. The reality is that Europe’s weakest economies are dependent on money from the stronger ones, and the notion that people can simply vote away the laws of economics is nonsensical. As a result, the only way that Greece could exit austerity in the near future is through the consent of its creditors, and the EU becoming a full-fledged transfer union.
For northern European countries, the logic is simple. Any exception creates a precedent. Allow the Greeks to get away with flouting their bailout conditions, and it would be politically impossible to force austerity on Spain, Italy, Portugal or Ireland. Each country, having seen how Greece’s blackmail worked, would follow suit. While the bill from funding Greece might be bearable, the cost of funding the whole of Europe south of the Alps would not be. Just as politics have forced Francois Holland to adopt a defiant tone on austerity, so too Angela Merkel cannot be seen to back down. Any transfer union would have to have Germany as the paymaster, so what Merkel says, goes. Even former SYRIZA leader Alekos Alvanos admits that SYRIZA cannot keep Greece in the euro and that this should be made clear to the electorate.
The fact is that, while the EU has to respect our right to reject the treaty, we have to respect their right not to advance us any further money if we do so. The backlash against austerity evidenced by the election of Francois Hollande in France and the CDU’s defeat in Nordrein-Westphalia is not an act of European solidarity. Rather, it is a backlash against austerity in those countries. Voters elected Hollande on a mandate to reverse cuts in France, not to advance money to Greece or Ireland. We cannot expect them to give us additional cash to fund our deficit without guarantees that we will balance the books at some point.
- We get alternative sources of finance.
Of course, if we reject the Treaty, we won’t have to deal with the consequences immediately. Our current bailout covers the next fifteen months, so we probably have some breathing space (emphasis on “probably”, see below). The imperative, in these supposed fifteen months, is to find someone else to give us money. The most obvious candidates are the IMF and the open market.
The IMF is, at best, a maybe. They’ve invested an awful lot in us, so they may be inclined to throw good money after bad. However, they have repeatedly said that bailing out Europe will only be done in concert with the EU, so it would be a difficult about-face for them to do. In any case, the IMF’s conditions for future aid would hardly be less stringent than the EU’s, so this isn’t going to put the brake on austerity anytime soon.
As for the open market, this is unlikely. While in recent months our bond yields have crept down to more bearable levels, this is largely a consequence of having European backing. If we reject the Treaty, the risk associated with our bonds shoots up, as do the yields, Unless we are prepared to pay double-digit rates of interest on our debt, this is unsustainable. In any case, investors will demand as much if not more strenuous efforts to bring our budget into balance.
There is a final alternative, which is to find another sugar daddy. It hasn’t got a lot of play, but it would in theory be possible to try and persuade one of the Middle Eastern sovereign wealth funds, or China or Russia, to invest in our bonds. However, were this to happen, there would likely be political strings attached, and in any case they would demand guarantees of repayment.
- We balance the books
Assuming that we cannot borrow, only one option stands between us and bankruptcy in 2013. We need to bring our budget into immediate balance. This would require a correction of over ten billion euro in one year, far more than any previous budget. The deflationary aspect of this would knock our economy flat, and if we’re voting against the treaty as a blow against austerity, it hardly helps if we need the most austere budget in our history as a result. The situation may never arise, however, because…
- We leave the euro
If we vote No, the fear that we may be unable to repay our debt come 2013 will create knock on effects. Irish banks are heavily exposed to government debt, so the fear that we may be insolvent next year could trigger a bank run. In this situation, the Irish government would be called upon to stand behind its 2008 guarantee of depositors, which we can no longer afford to do. The result would be a disorderly default and probable exit from the euro.
For some in the No camp, this would be no bad thing. The large-scale devaluation that would accompany a return to the punt would lower our labour costs, thereby (ceteris paribus) making us a more attractive investment option. The problem with this is that it focuses exclusively on one narrow aspect of a euro exit, and not the bigger picture.
Consider what happens the day we default and return to the punt. The first thing is we can write off our financial system. Our banks have tens of billions of euro worth of exposure to Irish bonds, and can ill afford another write-down in their assets. Even a relatively minor default would destroy our banks. One of the conditions of accepting the bailout was that the troika became the most senior creditor. In other words, they get paid back first in a default, meaning the bulk of the impact would fall on the other creditors, namely our banks, destroying billions of assets in one go. Meanwhile, with the 2008 guarantee now worthless, savers would rush to withdraw cash from the banks and ship it out of the country. In order to preserve any liquidity in the country the government would have to impose capital controls.
Here at least our task is easier than Greece’s would be, particularly if we got British cooperation in sealing off the island to prevent people moving money out of it. However, capital controls would be such a flagrant violation of the EU’s rules on freedom of movement that we might actually be forced out of the EU altogether, destroying whatever advantages we have to foreign investors and grossly outweighing the cheaper operating environment that devaluation would bring about. Even if this wasn’t the case, we would likely face significant sanctions from Brussels.
Meanwhile, we suddenly have to face a hard currency shortage. While it is true that we have a positive current account balance, in certain areas we are dangerously dependent on imports. The most obvious of these is energy. Our electrical grid is overwhelmingly dependent on imported coal, oil and gas, all of which has to be paid with hard currency. It is unlikely that the ESB and Bord Gais’s suppliers will accept punts for payments originally drafted in euro, meaning that the Central Bank’s two billion of foreign reserves would have to be used to finance energy imports. In order to eke out as much utility as possible from this, we can expect both petrol rationing and rolling blackouts. Meanwhile there would be a crash program to reopen our domestic coal sources in Arigna, Wolfhill and Castlecomer, as well as increase peat production. While this would plug some of the gap, it also means we write off any chance of meeting our emissions commitments under the Kyoto Protocol. Other assets such as the Corrib Gas Field or the shale gas under Lough Allen are years from being ready to produce.
Meanwhile, the government would be forced to impose export controls on food. A plunging punt would dramatically increase the nominal revenues to be made by farmers on exports. Irish consumers would be priced out of the market. In order to avoid food shortages, the government would have to take steps to stop produce leaving Ireland. Conversely, their desperation for hard currency might encourage them to make these controls laxer than needs be.
We can, in all likelihood, kiss our reputation as an attractive investment destination goodbye for a few years. Any foreign investors who held assets in Irish banks will have had their fingers badly burned. Our lack of foreign reserves will create a supply chain crisis, constricting our ability to produce the finished goods which constitute most of our exports. The plunging value of the punt will lead to rapid inflation, stoking wage demands from workers who’ve seen the purchasing power of their wages collapse. It is worth remembering that a devaluation of a currency by 25% is the monetary equivalent of a 25% pay cut, which few people would countenance. Meanwhile, we’re going to be in the EU’s bad books, possibly looking at an exit from the single market. Suddenly all our advantages have evaporated.
This isn’t the end of our problems. Defaults are rarely a clean rupture. More than a decade later, Argentina still finds itself on the receiving end of lawsuits from creditors who took a hit in its default. If our country showed any sign of recovery, our burned creditors will swoop in the hope of recovering some of their losses. As a small open economy, the last thing we can afford to do is have outstanding judgements against the country. Meanwhile, there will be a huge morass of contractual disputes, as parties try to settle contracts originally signed for payment in euro. Divorce, as people know, is never as straightforward or amicable as marriage.
Finally, of course, there’s still the question of how to balance the books. Defaulting locks us out the debt market for the foreseeable future. A plunging currency will lead to spiralling inflation, fuelling public demands for wage and welfare hikes. It is likely that the current government would not be able to survive, meaning a more extreme coalition, most likely led by Sinn Fein, would come to power. Faced with a huge budget gap, two options would remain. Either tough it out with austerity measures beyond our wildest fears, or print money to close the gap. Should we plump for the latter, hyperinflation would be an almost certain consequence, which with a new currency would be catastrophic. It is likely that, in this situation, the euro would remain a de facto currency, and the black market would proliferate.
There are sound grounds of principle to oppose the Fiscal Compact. It constrains future governments from dealing with unforeseen eventualities, and stands square in the face of Keynesian macroeconomics. It may well prove unworkable in the long run, and get torn up. But, in the meantime, from an economic standpoint, No simply isn’t an option. To vote No is to gamble on a complete collapse of the treaty, and the consequences of being wrong are immeasurable.