Depression will last generations
Our leaders must act to prevent bank failure which will set Europe back decades, writes James Fitzsimons
Published 27/11/2011 | 05:00
The Government is working with the lights out and its budgetary strategy will plunge us into a depression that will last for generations.
The budget fundamentals are not right. Our modest expectations for economic growth have been proven to be unachievable. Even the IMF and ratings agencies revised their expectations. All indications are Europe is heading back into a recession and even depression. Nobody took the tough decisions when it could have made a difference. Even the Troika hasn't realised that things have moved on since last year. They face more problems in their own countries than we do here.
Last week Germany failed to raise €6bn at bond auctions; €3.6bn is all it could get. It's not just about financial markets any more. In September the purchasing managers index fell too. All the indications are pointing to a recession. It's not that big business has run out of money. It has scaled back production in response to falling demand and will sit it out until politicians come to their senses. As politicians are removed, there is no guarantee the economists who are taking over will do any better.
Consumer demand across Europe has fallen too. They won't spend with so much uncertainty as to their future. Eurocrats could be responsible for the collapse of the euro and the break-up of the European Union if they don't act soon. Our Government is so preoccupied with trying to impress its paymasters in the Troika it hasn't even noticed how things have changed.
Banks continue to be at the root cause of all our financial problems. They still control the purse strings. When Mario Draghi took over as president of the European Central Bank he surprised everyone by immediately cutting interest rates. Without fundamental changes to how banks operate, falling interest rates and recapitalisation will be wasted. Financial regulation is being used to justify reckless banking decisions while it pays lip service to protecting the consumer.
There was public outrage when Irish banks refused to pass on the ECB interest rate cuts. There is a three per cent differential between mortgage interest rates at the main Irish
banks. One reason for the difference is the risk profile of the borrower. While the banks got this wrong in so many cases, they never pay for their mistakes. Moral hazard is used to avoid providing commercial solutions to these basic financial problems. Why can't a borrower who was penalised with higher interest rates be rewarded with a refund of the charges when the loan is paid off? Instead, those who pay back what they owe are burdened with the debts of those who do not. This is at the heart of consumer frustration whether their loans are impaired or not.
European banks found it difficult to satisfy the capital adequacy requirements imposed on them in advance of stress testing last summer. Out of 90 banks, about one-third either failed, or barely satisfied the requirements. In an attempt to appease financial markets the constraints are even greater for the next round of tests. Our deteriorating financial circumstances may force one of the bigger banks to fail in Europe.
Bank failure is looking more likely as the key political players dither. If even one goes under it is likely there will be panic as financial markets take back their funds. Depositors will rush to withdraw their savings too and there will be a run on the banks across Europe. Once mass hysteria sets in nothing will prevent the collapse. In the circumstances, the 17 Euro countries will be forced to split up. The currency might even be abandoned. Nobody wants that, but we are running out of time to save it.
While the bag is not tied, the cat is still in it. But it won't stay that way for long. The EU has failed to come up with a cohesive plan to calm financial markets, or restore consumer confidence. The pressure on European banks to beef up their own balance sheets is creating a credit squeeze in countries outside the EU, as European banks repatriate their funds.
The Irish Government proposes rolling out €100m of soft loans for business. We really need €100bn for businesses and consumers so they can restructure what they already have. If financial stability is regained, consumer confidence will be restored. Demand will rise as spending accelerates. Circulating capital will increase the overall money supply. Then we might avoid a full-blown depression.
If the Eurocrats faced up to the European banking crisis three years ago they could have issued eurobonds before financial markets became so hostile. We could have avoided the double-digit interest rates demanded of some eurozone countries such as Greece and even ourselves.
The Germans want to have their cake and eat it. They want low inflation and the benefit of a stable currency for their exports. But they are not willing to accept the higher interest rates that eurobonds would impose on them. There are too many countries in the EU to maintain control. It might be easier for them to abandon the euro and start all over again.
To the Germans we must be like unruly children. While a frustrated parent might give a child what it wants even if it is not in its best interest, the Germans are steadfast in their resolve to avoid this. While they might accept that we in Ireland have learned our lesson, they don't trust the rest. The dysfunctional behaviour in Euroland may be the main problem. But it suited those who capitalised on the madness too. The Germans won't accept that they are part of the problem. While they won't take the medicine, there will be no cure.
The EU is already divided based on currency. Survival may depend on a slimmed- down EU. It was never so unstable as it is now. They are working overtime in Leinster House to honour agreements that are already redundant. We need to set our own course until the Germans and French come up with something better! This doesn't mean we abandon the austerity measures, but this time they need to be in our own best interest.
James Fitzsimons is an independent financial adviser specialising in tax and financial planning.