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News : EU Economy Last Updated: Feb 23, 2010 - 6:57:29 AM

Ireland, Greece and leaving the euro
By Michael Hennigan, Founder and Editor of Finfacts
Feb 22, 2010 - 3:53:09 AM

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Green: EU countries using the euro: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain

Mauve: EU countries not using the euro

The economic travails of Ireland and Greece have provoked a debate on the wisdom of the two most vulnerable members of the infamous PIGS (Portugal, Ireland, Greece and Spain) grouping of Eurozone members, on leaving the euro.

On Sunday, in an article in The Sunday Independent, economist and Group Business Editor of Independent Newspapers, Brendan Keenan, pointed out that both Ireland and Greece are largely dependent on foreign lenders to fund their public debt and suggested that if an exports boost did not follow from devaluation, leaving the euro could result in a more dire situation for a country than it had faced within the EMU (European Monetary Union). He says it depends on how sensitive a country's exports are to internal costs, and whether those costs rise quickly because of the increase in imported costs from the cheaper currency. Keenan concludes that those countries which think the balance of advantage for them lies with euro membership will have to tailor their policies to achieve growth within the single currency. Ireland has not yet done so. "We should worry less about debt and defaults and more about enhancing the economy itself," he says.

Also on Sunday, in The Sunday Business Post, economist David McWilliams, donned the mantle of the Great Depression era economist, John Maynard Keynes, who had been considered an "eccentric" when he had opposed Britain returning to the Gold Standard in the 1920s. McWilliams writes that the gradual questioning of economic orthodoxies takes time. It might take years of needless underperformance where unemployment remains incredibly high, real interest rates do too and defaults are the norm, not the exception. "Ultimately, the old way - in our case, adherence to the euro - is thrown out. The only question economic historians of the future will ask is why didn’t we act earlier and prevent all the pain," he writes and concludes that even suggesting such ideas as quitting the euro is heresy. But so too - back in 2002 - was forecasting that we were in a credit/ housing bubble, after which houses would collapse in value and banks would fail. He says: "if we do what is logical, there is nothing to stop this country growing rapidly again very soon."

According to Ron Chernow in his book, The House of Morgan, in 1923, former US Treasury official and then JP Morgan partner, Russell Leffingwell, warned that "Keynes...is flirting with strange Gods and proposing to abandon the gold standard forever and to substitute a managed currency...it is better to have some standard than to turn our affairs over to the wisdom of publicist-economists for management."

While Keynes liked public attention he was closer to academic economics as modern day celebrity economics is to what could be termed pub-stool economics i.e propose economic fixes without having to do the graft on implementation scenarios and building a credible case.

David McWilliams proposes a momentous decision but does not bother credibly analysing how a new currency would be implemented without crashing the economy. He also shies away from the issue of overdue structural reform without which any benefit from devaluation would soon be fritted away. It's as if he is reluctant to alienate part of his public audience.  We have an unreformed public sector and a sheltered private sector where charges are not responding to market forces. Meanwhile the other celebrity economist George Lee proposed his own menu of economic fixes after his resignation. Even though he denied he advocated leaving the euro following the publication of an interview with the Sunday Independent, the newspaper reported that he proposed "we should take the fight to Europe and claw back our economic-control instruments -- which include our own currency, the deficit, the ability to print our own money and setting our own interest rates." 

Speaking to the Sunday Independent, Lee said: "If Europe is not prepared to help us, we should cut the corporation tax rate even further and take in as much money as we want, and if it is a problem for Europe then so be it. Why should we help them out when they are not going to help us out. We are doing all this because we decided we should cut to increase competitiveness and Europe tells us to do this too."

Ólafur Ragnar Grímsson, the president of Iceland, remarked to Simon Carswell of the Irish Times, at the World Economic Forum in Davos, Switzerland, last month that the Irish people might be interested in how the devaluation of Iceland’s currency has made the export sector “much more profitable in a matter of weeks.”

“This has been an extremely good year for the fishing sector - - the fishermen are getting higher salaries than ever before,”he said.

The fishing sector is responsible for more than 50% of Iceland's goods exports while in Ireland, US-owned pharmaceutical and medical device firms have such a role and the import content is high.

Besides, about 90% of goods and services exports are made by foreign-owned firms and the majority of the trade is intra-company.

A country like Argentina could benefit from a devaluation as most of its trade is in commodities - - minerals, grain and beef  - - selling at world prices.

How devaluation, higher imports costs; a possible wage spiral triggered by higher mortgage rates and an inevitable period of economic dislocation, would help the likes of Intel is an unknown.

The Eurozone is Ireland's biggest market and it has been largely unexploited by indigenous Irish firms.

Exports to emerging markets are insignificant.

Goods exports to China in 2008 were lower than to Switzerland while total trade with India was valued at €440m.

The role of Irish firms in Asia is insignificant.

As for the devaluation of the pound sterling, in theory it should help British manufacturing but the sector is much smaller than Germany's and the rise in import prices is threatening a return to inflation.

Last month, George Provopoulos governor of the Bank of Greece, wrote in the Financial Times: "Those who argue that Greece will wind up leaving the Eurozone believe it lacks the will to slash the structural fiscal deficit and to implement the cost adjustments and structural reforms needed to restore competitiveness. They argue that a devaluation of a new national currency would be like waving a magic wand, thereby restoring competitiveness. But would it?

During the 1980s, Greece had another twin-deficit problem (large and unsustainable fiscal and external imbalances) and its own national currency, the drachma. It waved the magic wand twice, with large devaluations of the drachma in 1983 and in 1985, but in the absence of long-lasting structural adjustment and sustained fiscal contraction. The devaluations were followed by higher wage growth and inflation, with no sustained improvement in competitiveness. Speculative attacks against the drachma were avoided only because of strict controls on capital flows, an option that is no longer feasible or desirable. The twin-deficit problem remained. So much for the magic wand of currency devaluation."

Provopoulos asked if Greece were to neglect these lessons and adopt a new national currency, what would an exit from the Eurozone imply? Here are some likely consequences he detailed:

  • Any devaluation of the new currency would increase the cost of imports, raising inflation.
  • Monetary policy would lack the credibility established by the European Central Bank. As a result, inflation expectations would rise.
  • Expectations of further devaluations would arise, increasing both currency-risk and country-risk premiums.
  • The above factors would push up nominal interest rates, leading to higher costs of servicing the public debt and undermining fiscal adjustment, thereby taking resources away from other, productive areas.
  • The costs of converting currencies with the remaining members of the Eurozone would be re-introduced, inhibiting trade and investment.
  • The exchange-rate uncertainty with the euro area would increase the costs of conducting business, further deterring trade and investment.
  • Existing euro-denominated debt would become foreign-currency debt. Any devaluation of the new domestic currency against the euro would increase the debt burden.
  • Greece would no longer benefit from the economies of scale, including the enlargement of the foreign exchange market, which decreases the volatility of prices in that market, derived from sharing the euro.

Moody's credit rating agency has estimated that 15.1% of Greece's 2010 revenues will go on servicing its debt. Currently, Greece must pay 334 (3.34%) basis points more than Germany, to borrow money -- up from a gap of just 8 basis points in 2005.

The badly misgoverned countries during the boom  are now expecting German bailouts.

"How does Germany have the cheek to denounce us over our finances when it has still not paid compensation for Greece's war victims?" Margaritis Tzimas, of the conservative New Democracy party, demanded in an address to parliament. "There are still Greeks weeping for their lost brothers."

It's easy to shift the blame elsewhere but even so, Germany has for years been the chief banker of the EU's budget. 

David McWilliams and George Lee were not the only economists who warned about the Irish credit and housing bubbles and those stands against conventional wisdom do not give them credibility now on euro proposals.

Brendan Keenan was also no cheerleader of the bubble and I could make the same claim myself, in representing Finfacts. We at Finfacts took a principled stand even though we had no guarantee of income from anyone.

The EMU will come through its current troubles with an improved monitoring system and a competitive Ireland has a market bigger than that of America's on our doorstep with no currency concerns impeding trade.

Apparently painless choices can be fed to the economically illiterate in Ireland; we can cut corporation tax without any response from other countries; the only native English speaking country in the currency area with an offshore financial centre that has trebled employment since the launch of the euro, will prosper with a debased currency; ditto for foreign direct investment; ditto for all the significant PLCs on the Irish Stock Exchange, which have a majority of their shareholdings held overseas and there is no need for structural reform as devaluation will take care of competitiveness  - - even though not a scintilla of data is presented to support the case. Besides, savers will embrace the new currency and there will be no inflation problem despite surging import prices, double-digit interest rates and compensating wage claims. As for servicing the inflated foreign debt, that and so many other issues remain as known unknowns, never mind the unknown unknowns.

The challenge for the celebrity economists is to produce substance to complement communication skills. George Lee wanted to influence policy as a member of Dáil Éireann but wasn't motivated to produce one policy paper himself. As for questioning of what is termed economic orthodoxies, such as staying in the euro, surely there should be more substance in arguing the contrary case than has heretofore been provided?  Without that, the argument hasn't a shred of credibility.

Finally, developing new markets for finished goods may seem easy from the comfort of an armchair. It's far from it and price is only one factor.

Europe from the European Space Agency's Envisat satellite

Finfacts articles:

Building an indigenous Irish exporting base; Being prepared for a hard slog and the sheltered workshop that is RTÉ

Davy says Ireland was never a wealthy country; High income in 2000-2008 largely wasted

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