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Brendan Keenan: Ireland has to stick with euro herd to avoid global predators

Back when all this trouble started, what seems like half a lifetime ago, I suggested early action to try to stay close to the herd. The predators seek out the wounded member.

Ireland turned out to be too badly wounded to avoid being pulled down, but things have not gone well with the herd either.

Reading last week's slew of reports on the global economy, it was hard to avoid the conclusion that the whole ecological balance between predators and prey -- between lenders and borrowers -- has been upset badly, and dangerously.

For instance, which two countries share the dubious distinction with Greece and Ireland of needing budgetary adjustments of more than 10pc of GDP?

It's not Portugal and Spain, the other inhabitants of the famous financial sty. It's Japan and the United States of America.

Financial markets

The largest and third-largest economies in the world, that is. Indeed, given China's still limited engagement with global financial markets, they are still, arguably, number one and two.

Looking at some of the dozens of charts which pepper these reports, one might think Ireland was back in the herd, except that it is a different herd.

There is a particularly striking one showing the countries most vulnerable to any rise in the cost of government borrowing.

These four countries in question need the average interest rate on their debt to stay below 5pc to avoid interest payments exceeding 20pc of tax revenues.

The IMF chooses the 20pc figure because it is rare for a country's interest bill to exceed this level.

For the past 30 years, the average interest cost in advanced economies has been less than 10pc of tax revenues.

Interest burden

The 20pc might therefore be taken as the point at which an interest burden becomes "unsustainable" although there is no precise measurement and, in the past, Greece and Ireland have both carried such burdens for a time.

It is at this point that the Big Two and the Little Two part company. Banks, investors, even other governments, will lend to the USA for 30 years for around 3pc.

Japanese debt is equally cheap, although it is mostly Japanese households which do the lending. The other two in this select group, as we know, cannot borrow at all.

The IMF explains this paradox by citing global demand for US government bonds, however low the interest, as a reserve asset.

Although US deficits are a key component of the global problem, investors want US bonds as a protection against the problem.

This looks distinctly flaky. There is "potential for severe dislocations if investors were to take fright at some point in the future," the IMF says.

Here in Ireland, we now know not to be taken in by the mild language of IMF reports. That is a serious warning.

This uncertainty about the future behaviour of global financial markets is the background to the efforts of Europe, and in particular the Eurozone, to deal with its particular problems.

Those efforts seem as confused as ever. Having persuaded markets that their loans to the likes of Greece and Ireland were safe until 2013, but that anything might happen after that, German ministers were suggesting last week that a renegotiation of Greek debt could be imminent, and might be no bad thing.

As an entity, the Eurozone has much healthier public finances than the USA. But it is not an entity in the same way.

Both the markets and Europe's leaders, stress the responsibility of national governments and national taxpayers.

Ironically, attention has been shifting to the shaky finances of the American States, which must be added to the difficulties of the federal government.

But the federal government is there. Political weakness and confusion, more than deficits, are at the core of the Eurozone's fiscal difficulties.

By the time you read this, we may know whether Greece is about to restructure its debts.

Even the financial markets were not expecting that just yet. Policy is still evolving but in an extraordinarily haphazard fashion and with no very clear objective.

In a key passage, the IMF sets out how it thinks a European rescue scheme should work.

There are persistent reports about differences between the fund and the EU over the actions taken to date, and this is probably as good a guide as any as to what the arguments are about.

Interest rates

"To be effective, these (rescue) facilities require sufficient scale and flexibility and should lend at interest rates low enough to support debt affordability, subject to strict conditionality."

The italics are mine, but they make the point. The IMF may be frustrated at the marginal €500bn size of the EU bailout funds, and puzzled at how indebted countries are supposed to be put right with 6pc interest rates, but these arguments will surely tell in the end.

There is a common European cause here. Despite some wishful thinking in many Eurozone capitals, it is in everyone's interest that the euro herd should stick together; certainly until the global position is more stable -- and that is some years away.

It is also very much in the interests of the countries which have been shut out of bond markets -- or who may be shut out -- that this is dealt with at a European level.

For one thing, the IMF would not have the resources on its own to provide the level of funds which even Ireland, Greece and Portugal need.

Whatever the difficulties of dealing with our euro partners, coming to emergency arrangements on this scale with the IMF -- which in effect means the USA -- stretches the bounds of imagination to the limit.

Of course, a lenders' strike on Spain, not to mention Italy, would exhaust the present EU rescue arrangements.

It is devoutly to be wished that no such crisis erupts but, theoretically, the Eurozone could deal even with that.

The proposals from the Breugel thinktank for "blue" and "red" bonds, aka "federal" and "state" bonds, would be one way to approach such a crisis.

Challenge

Let's hope we don't find out whether the European system is up to such a revolutionary challenge.

Instead, we must hope that it is up to the existing one. Ireland is one of the causes of this crisis, but its own actions will also play a key role in deciding how things turn out.

Having been bailed out, we are back in a confused and frightened Eurozone herd. If it turns on itself, only the predators will win.

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