The Irish and the Germans like and can hold a tune. As Brian Cowan plays Danny Boy to Angela Merkel’s Lilly Marlene, the Beatles’s song “With a Little Help from our Friends”, in which a verse refers to singing out of tune, comes to mind. Within the European Union (EU) and among members of the eurozone, different hymn sheets are being sang from.
The bail-out of the Irish government by a combination of European Union (EU), International Monetary Fund (IMF) and some other EU Member States, reportedly worth around €85bn can be traced to the aftermath of the financial crisis. But, almost as importantly is a fundamental flaw in the design of the single currency system and the consequences of a public wail from the German Chancellor about private investors needing to be prepared for a ‘haircut’. That is, accept a loss of their holdings of government bonds in the eventuality of a default by the issuing government.
Similarly, the French Finance Minister Christine Lagarde railed against the bond markets as ‘irrational’. But that is the point, markets are always irrational otherwise financial crises wouldn’t be endemic to capitalist economies. The bond yields (%) of a number of eurozone economies is shown below.
The impact of their interventions was to increase the yields that markets demand for buying the sovereign debt of a number of European Union Member States. The bond yield is the return (interest payment plus gain capital gain) from the buying and selling bonds). Perhaps these two august European politicians should have been listening to Miles Davis’s “In a Silent Way”.
Other public commentators sing that it is greedy bankers who are causing difficulties for the eurozone system and not the system itself. The former is the ex post outcome of the ex ante weakness of the latter. The eurozone purports to be an optimal currency area, that in the absence of full mobility of capital and labour needs a system of fiscal transfers to compensate for differences in economic flows and development. At the birth of the euro monetary policy was established at the EU level but fiscal policy remained under the control of the eurozone national governments.
The lack of a fiscal equalisation system means that the currency area is not optimal in managing an asymmetrical external shock. That is, how the global financial crisis impacted differently on different currency area members. The euro went through a long period of stability and thus its weaknesses were not exposed. It allowed peripheral economies like Greece, Ireland and Portugal to exploit low and stable interest rates to create a development path that was unbalanced and unstable. It would appear that the system benefits small open economies on the upturn but privileges the larger economies on the downturn.
Fiscal crises always follow financial crises as the states bails out the banking and financial system whose participants engaged in speculative behaviour. In the case of Ireland a low corporation tax rate to attract Foreign Direct Investment (FDI) and a speculative real estate boom had the bankers and politicians leading the chorus of Survivor’s “Eye of the Tiger”:
“It’s the eye of the tiger, it’s the cream of the fight
Risin’ up to the challenge of our rival
And the last known survivor stalks his prey in the night
And he’s watchin’ us all in the eye of the tiger”
to celebrate the rise of the Celtic Tiger economy. Unfortunately in the face of the crisis, the Irish economy turned out to be toothless.
Ireland’s fiscal position deteriorated with a budget surplus to GDP ratio of 2.9% in 2006 to a budget deficit to GDP ratio of 32% at the time of writing. The efforts of the European Central Bank to pump liquidity into the EU banking systems and the European Stabilisation Fund, as well as the new financial regulatory architecture, notwithstanding, the imbalances between the EU’s largest economy and its smaller neighbours is at the heart of resolving the crisis. EU policy makers, however, appear to be fighting historical episodes rather proactively dealing with the almost fatal flaws in the design of the eurozone system.
By negatively reacting to the markets ‘animal spirits” rather than proactively engaging in a sustainable policy path, they are in danger of letting “Babylon Burn” as the eurzone appears to be heading for conflagration.
With friends like these, Ireland may wistfully think about whether Angela Merkel should organise a karaoke night with the 1980s British pop band Haircut 100 in a starring role singing Gloria Gaynor’s “I Will Survive”. Unhappily for many of Ireland’s citizens they may not as pubic expenditure cuts to satisfy fiscal fetishism bite.