EU Economy
Germany faces debt tsunami; Economist says Greece should quit Euro; Irish clamour for default
By Michael Hennigan, Founder and Editor of Finfacts
May 9, 2011 - 7:11 AM

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Germany is threatened by a debt tsunami, a leading German economist will say in a lecture on Monday evening. The same economist said in a Sunday newspaper interview that Greece should quit the euro. Meanwhile, Morgan Kelly, a professor of economics at University College Dublin, has won a lot of attention for his latest bleak analysis of Ireland's economic outlook but his drastic prescriptions are without consideration of downsides. There are no volunteers among his colleagues never mind elsewhere, for huge pay cuts.

Prof. Hans-Werner Sinn, president of the Ifo Institute for Economic Research at the University of Munich, on Monday night at the Humboldt University, Berlin, will examine the build-up and risks of the current euro crisis and show how the threatening tsunami can be averted.

Sinn has said Germany is still enjoying the economic upswing, but all around the euro a gigantic debt tsunami is building up. The GIPS states of Greece, Ireland, Portugal and also, in part, Spain cannot only not refinance their own government bonds, also their foreign trade debts are now being assumed and deferred by the European Central Bank (so-called Target2 claims).

Over the years the southern European countries have lived beyond their means and now they are being subsidised with additional billions. The time bomb of the swelling amount of liabilities of now €1.5trn is ticking. Of this Germany will have to cover €400bn, with a growing trend.

Sinn said the German Bundestag has long recognised the explosiveness of the European Stability Mechanism (ESM) and is insisting on its own budgetary powers. More and more members of parliament are declaring their unwillingness to carry the additional liability risks. Legislation on the introduction of the ESM will be brought before the Bundestag this summer.

At the week-end, Prof. Sinn said Greece will be unable to solve its debt crisis if it keeps the euro currency. The German public, too, is upset over the billions being spent to keep Greece afloat.

"If Greece were to exit the euro, it would be able to devalue its currency and thus become competitive once again," Sinn said in the Sunday edition of the Frankfurter Allgemeine newspaper.

He said Greece was heading for a banking crisis whether it kept the euro or not. If the country remained with the euro, the economist said that there would be no way to rescue the economy in the long run.

"If Greece decides to attempt a so-called internal devaluation - - that is by cutting salaries and prices within the country - - it would risk setting off civil war," Sinn said. "Greece is heading for economic crisis in either scenario. But if it stays in the Eurozone, Athens will kill off the companies that make up its economy."

Private Eurozone meeting

Prime Minister George Papandreou of Greece on Saturday attacked “rumour and speculation” after Germany's Der Spiegel magazine reported that Athens was threatening to leave the Eurozone in order to bargain for easier terms on its huge debt obligations.

“Markets continue to have doubts and we have scheduled our next steps for 2012,” said Greek finance minister George Papaconstantinou who commented in reference to his discussions in Luxembourg on Friday night with the finance ministers of Germany, France, Italy, and Spain. ECB President Jean-Claude Trichet, European commissioner for Economic Affairs Olli Rehn and Eurogroup president Jean-Claude Juncker also attended.

“We will either go out to markets or use the recent decision by the EU Council that allows the European fund to buy Greek bonds. That was what the discussion was about,”  Papaconstantinou said.

With the prospect of a second Greek bailout rising, George Osborne Britain’s chancellor of the exchequer, told the BBC that participation in the Irish bailout was a “special case.” Britain did not wish to take part in any “second bailout” of Greece, he added.

Meanwhile, a survey published on Sunday showed that the German people were still opposed the bailout of Greece a year ago.

German daily Welt am Sonntag showed that only one in five Germans believed the bailout was acceptable. Forty-seven percent of those asked said the move was "false," and 33% were undecided.

Ireland

On Saturday in an article in The Irish Times, Prof. Morgan Kelly said: "At a stroke, the Irish Government can halve its debt to a survivable €110bn. The ECB can do nothing to the Irish banks in retaliation without triggering a catastrophic panic in Spain and across the rest of Europe. The only way Europe can respond is by cutting off funding to the Irish Government.

So the second strand of national survival is to bring the Government budget immediately into balance. The reason for governments to run deficits in recessions is to smooth out temporary dips in economic activity. However, our current slump is not temporary: Ireland bet everything that house prices would rise forever, and lost. To borrow so that senior civil servants like me can continue to enjoy salaries twice as much as our European counterparts makes no sense, macroeconomic or otherwise."

It is likely that Ireland would have to negotiate a restructuring of debt in 2013 when the current EU-IMF bailout deal ends.

The country has no shortage of hurlers on the ditch who make radical proposals but do not have to detail their prescriptions and the downsides.

To cut the budget deficit of €18bn at stroke would be a drastic step but by having collapsed banks the whole SME sector would be a risk. 

On RTÉ radio’s This Week on Sunday, Minister for Communications Pat Rabbitte  said he agreed with Kelly’s analysis of how Ireland got into its current difficulties.

“The piece is a powerful horror polemic,” he said.

“I don’t dispute most of the analysis but I do dispute the prescription.” He said people had a “ghoulish fascination” with Prof Kelly’s analysis but they needed to look at the “prescription”.

The “implications of Morgan Kelly’s prescription which is that we bring the public finances into kilter as quickly as possible” would mean cutting €17bn or €18bn in one budget.

This would result in “serious cuts in pay, in pensions, increases in taxes, cuts in the public capital programme.”

There were already critics in the Dáil he said who “throw around default like confetti.” Some
“think we can land oil on Dalkey head and that will solve all the problems.”

Prof. Patrick Honohan, governor of the Central Bank, said sustainability of Ireland’s debt depended on its economic growth prospects.

“If things don’t go well in terms of economic growth it will be much more difficult . . . in that case there will be a problem and in order to cope with that situation we need to think of better financial arrangements with Europe,” he said. “We need to think of risk-sharing arrangements that would ensure that the growth will come right.”

While defending the EU-IMF deal, he said that Ireland has a number of cards to play.

“We have a number of cards . . . there is a right time to play your most important card.”

None of Kelly's admirers could address how the prescriptions could work in almost 400 posts on the Irish economy Blog.

Irish Economy Blog: Morgan Kelly

I challenged academics to make specific proposals on cutting the budget deficit; there were none.

Emotion is not a strategy and we had a Civil War, because for some emotion trumped facts.


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