Monday 22 July 2019

Cold facts of how we could be 'Iceland inside the euro'

Could the unthinkable come to pass here? Could Ireland default on its sovereign debt? The answer is yes. Such a disaster is now quite possible. In the same way as a family can end up losing the house, the car, everything, a country, too, can fail to make its repayments. At the moment, such thoughts are heresy; but so, too, was questioning the property boom a mere four or five years ago.

Back in 2003 or 2004 when people questioned the property boom and its driver, the debt splurge by the bankers, we were ridiculed and dismissed. We were labelled mavericks. We were told that it was "dangerous" to even suggest such things because we might "talk down the economy".

I remember being labelled "unpatriotic" by a politician in 2004 following an appearance on 'Prime Time' when I described the property market as a "scam" operated by "an unholy alliance of bankers and property developers".

We now know that this is exactly what it was, it was a scam perpetrated by a small minority who made fortunes, aided and abetted by a frenzied population caught in a mania and presided over by Fianna Fail. It is extraordinary that the party which lays claim to the Rising, could end up advocating property purchases in Bulgaria using borrowed money as the highest form of national patriotism, but that's where we got to!

So the moral of that tawdry story is that "thinking the unthinkable" while not popular, is necessary. If we are forewarned, we are forearmed. Make no mistake about it; it is entirely possible that Ireland will default on its sovereign debts. We are hurtling in that direction. Foreign investors are on notice and last week, they demanded a huge interest rate premium from Ireland before they gave us cash. We paid 4.7pc to borrow money on Thursday last. In contrast, Germany paid 3.2pc. This implies an Irish interest rate premium of over 40pc for two states that are in the same currency union. So lenders are worried that Ireland will not be able to pay its way.

Surely you will assert that there is a big difference between being worried and turning off the taps altogether? Well yes, you are right, but consider what has happened here. If you look at things objectively, Ireland should be in a much better position than practically any European country. Our national debt is extremely low, our budget deficit projections are very poor; but so, too, are many countries and in contrast to the rest of the EU, Ireland seems to be concerned about government spending and is talking about putting in place a series of cutbacks. So why, in the eyes of foreign lenders, should we be any more delinquent than the others?

The answer is that although the State behaved itself in the boom and did not borrow, the rest of us went mad. We borrowed for every hare-brained property scheme imaginable. Our banks and the bosses, who are still in their jobs, destroyed the national balance sheet by borrowing money abroad to fund this nonsense. We also decided to pay ourselves better than all our competitors, not because we were more productive but because we were more profligate. The geniuses at the Department of Finance creamed off tax revenues from the top of this frothy borrowed brew, mistaking an overdraft for a tax bonanza.

When this borrowing splurge stopped abruptly last year because the credit markets shut down, the Government was faced with the choice: does it allow the banks to collapse because they were so borrowed that they couldn't finance themselves or does it guarantee the banks, buy time and see whether it can put a plan B in place? Had the Government allowed banks to go bust in October, there would have been a run on the other banks, leading to a collapse of the system and we would have been "Iceland inside the euro".

But amazingly it didn't put plan B into action, it never came up with a plan B and now the banks are again in dire straits. Although the guarantee means that they might not default, their delinquency has contaminated the sovereign debt and now the market thinks that the banks will bring the State down with them.

Consider the position of Anglo. If Anglo goes bust, because people withdraw their deposits, the State will have to write a large cheque. That cheque could be as big as €30bn if the assets in the bank's balance sheet are as bad as many fear. Will Ireland be able to write this cheque? Will we be able, at short notice, to borrow that much cash? Furthermore, will Irish workers stick around to pay the tax associated with such a rise in our national debt?

After all, we the Irish citizens are volunteers, not prisoners and can emigrate to escape the pleasure of paying higher taxes for developers' greed. Therefore, it is not hard to envisage a situation where we default, particularly as we can't even finance day-to-day expenditure without borrowing for God's sake!

Bad and all as it might sound, if we were to default, we would not be unique. To see what can happen to delinquent borrowers in a monetary union, we have to turn the clocks back and re-read a bit of financial history.

It is 1975; flares, Richie Ryan, Eddie Gallagher and the Horslips are in the news. The US is in recession. The Detroit car industry, like today, is going to the wall. The oil price shock is still reverberating around the world and the ensuing recession has weakened the Ford administration more than Watergate.

More importantly, in light of Ireland's current predicament, New York City in 1975 was in crisis and on the verge of default.

Lenders simply stopped lending to the Big Apple. Years of profligacy, which were financed in good times, suddenly caused investors to panic. New York City was about to default on its bonds and Gerald Ford told the city to "drop dead" when it asked for a bailout. Ford argued that the US government would never contemplate bailing out New York, as it would undermine the credibility of the dollar. However, in a 'volte face' of epic proportions, Ford blinked first and the City was bailed out with a federal loan.

To avoid a similar situation threatening the euro, the Commission imposed the 3pc budget deficit rule on all euro countries so that no country could undermine the currency. What would happen if we were to test this? Would the EU bail us out rather than countenance a sovereign default that might destabilise the euro? Could we renegotiate Lisbon along such lines? Could we go to the ECB and look for a bailout?

This might be better for us and for the EU as a whole, however politically unethical it might seem. After all, do they want an "Iceland inside the euro"? That's what it looks like they are going to get! We've tested Europe's patience once, are we about to do it again in a much more dramatic fashion?

I am not suggesting that we should resort to political blackmail, but if you have ever seen a bankrupt man trying to save his skin, you know that he'll do, say or sell anything. Similarly, a country facing default will behave accordingly.

That's just the way it goes!

www.davidmcwilliams.ie dmcwilliams@independent.ie

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