Vincent Browne and the Euro

Vincent Browne is one of Ireland's most venerable journalists. He and I will agree on some things and not on others. One area of accord is probably (based on Vincent’s writings to date) the belief that the study of economics is not a science. Note that I did not write “exact science”. It is not a science at all. It is a set of beliefs that are held by individual practitioners and invoked under any and all conditions. Economists are Keynesians, Monetarists or follow the Austrian School in the same way as the devout adhere unquestionably to Mohammed or Christ or L. Ron Hubbard. Economists cannot agree among themselves on the right course of action under any given set of circumstances and they most certainly cannot predict what will happen in the future.

Vincent doesn’t claim, of course, to be an economist although I understand he has standing as a lawyer. His piece (Irish Times Wed Jan 4th 2012), on the possible upcoming referendum on fiscal measures that have been mooted in the context of resolving the debt crises of certain members of the Eurozone, seems to rely on a legal interpretation of the relevant treaties, especially when he claims that no country can be expelled from the Euro zone, and also when he implies that Ireland can veto the proposals and thereby do a “service to all the people of Europe”.

Taking the last point first, we need only look back a short number of weeks to when the British attempted to use their veto to block EU Tobin tax proposals. In short order they found themselves completely circumvented by the other EU states and at the same time pushed noticeably closer to the EU exit door than even the most rabid Euroskeptic could have wished for.

With regard to the existing treaties not allowing a state to be expelled from the Euro, no nations have better illustrated, through history, the adage that there are many ways to skin a cat than the Germans and the French. In the limit, both of these (along with other fiscally responsible states such as Finland and The Netherlands), could themselves opt to leave the single currency and put in place an alternative that would satisfy their requirements. For those left in the rump Euro the effect would be just as devastating as if they were expelled from the original. I cannot tell the future any more than Vincent or an economist can, but history has indicated a high probability that they would be subjected to very high interest rates, including on home mortgages, speculative attacks on the currency that they would not be in a position to defend, an inability to borrow internationally to repay either the amounts owing as a result of the bailouts or for current requirements, and a fall off in Foreign Direct Investment (FDI) due to uncertainty and a lack of confidence in the currency. The rump Euro would also be subject to significant devaluation, which Vincent and others would probably welcome as an aid to exports and tourism, but this also carries a price, and that price is excessive inflation. We would be back, at best, to the situation that pertained in Ireland in the 1970s, when savings and pensions were destroyed and when profiteering was rampant.

Vincent Browne, and all the rest of us, should be very concerned that he might just get what he has wished for.

OMG! A new referendum

There is a growing expectation that there will have to be a referendum in Ireland on EU treaty change, to allow for shared decision making on budgets and taxation by the countries within the Euro zone, which is known as fiscal union. Up to now the Euro zone has only had monetary union, which has meant that member countries have ceded their powers to set interest rates or regulate the money supply to the European Central Bank, but were left free to decide on such matters as taxation rates and whether or not the national budget should be balanced.

For some, like the current government, the need for a new referendum is unwelcome news. It is likely to be divisive and there is no guarantee it will be passed. Because of the attitude of certain of our Euro zone partners, most notably Germany and France, it is looking likely that Ireland’s not agreeing to fiscal union could create serious issues about the actual survival of the Euro as a hard currency and / or the part that Ireland might play in a re-designed European single currency system.

Readers of Stack Six will be aware that we follow an enthusiastic European line here. It is not too much to claim that the development of the European Union and Ireland’s place in it have been the most significant macro events that have occurred during this writer’s lifetime, having been born just a few short years after the end of World War II.

It is easy now to forget the changes that were forced upon the Irish Republic as a condition of entry to what was then known as the Common Market, and which evolved into the European Union. Some examples include: the end of the rule that meant that women had to resign from all Civil Service and many other jobs on getting married; the repeal of legalised discrimination that existed against gays; an end to corporal punishment in schools; a ban on capital punishment; and a general requirement to abide by the anti-discrimination measures of the Treaty of Rome, which set the whole thing off.

Even the NCT car test, which has contributed, along with a zero tolerance for drunk driving, to a halving of the annual rate of road deaths in Ireland since it was introduced in January 2000 [the actual reduction between 1999 (413 deaths) and 2010 (211 deaths), is 49%], was only established in Ireland because of an EU directive. It is easy to argue that we would have moved with the times in regard to these matters anyway but our history does not give any scope for comfort in this regard – we needed that external stimulus.

All relationships suffer from time to time. Those that are worth keeping are also the ones that are worth working on when difficulties arise. Ireland’s membership of the EU falls squarely into this category. An important element of our association with Europe, and a highly desirable facility in its own right, is our use of the Euro as the unit of currency. It has given us significant trade benefits, a defense against speculative attack on what would be our own ‘soft’ currency if we were not part of a currency bloc, very low mortgage rates, elimination of currency exchange costs and risk for travelers and businesses in the rest of the Eurozone, pricing transparency for same, and an additional incentive for US and other foreign direct investment into Ireland.

All of that is worth holding onto.

Democratic deficit - what democratic deficit?

In the beginning there were 17 separate currencies where there is now only one, the Euro. This currency unit was set up as a result of the Maastricht treaty, which was democratically tested in Ireland by means of a referendum. The agreement, voted on and passed by the Irish people, included that the common currency would be monitored by the European Central Bank, now known as the ECB.

Monitoring means, and was always understood to mean, ensuring as far as possible the continued viability of the currency and the setting of the interest rate that would be attached to it, which affects most particularly the rate of inflation in the Euro zone and the exchange rate of the Euro against other global currencies.

Sixteen other states of the European Union have a stake in all of this. They were, and are, entitled to assume that ratification of the Maastricht treaty would mean that all member states would abide by the rules by which the common currency was set up, and that all members would accept the oversight of the ECB, which was specifically charged with that task in the Maastricht treaty.

In the olden days if a country found it had allowed its inflation rate, and therefore its competitiveness, to exceed what was prudent, its currency could be devalued either explicitly, or stealthily by market forces. This solution was not available, and was never going to be available in terms of their economic relationships with the other Euro zone states, to those countries that had signed up for the Euro.

All this was known at the outset. It was understood, or should have been understood, by the economists whose job it is to advise the finance ministers and compliance agencies in the various countries. And the same economists would not exactly need to have been qualified to the level of Nobel Prize winners to be able to come to grips with this principle.

What has now happened is that a number of member states of the Euro zone have taken their eyes off the ball to the extent that they have allowed inflation to increase well beyond the rate that has been achieved in some other Euro countries, most notably Germany, so there is now a serious imbalance in competitiveness within the Euro zone. Not only that, but a number of these same countries have either borrowed more than they can afford to repay or have allowed their banks, as in the case of Ireland, to lend too much, cause a property bubble which has burst, and then have their unsustainable wholesale loans guaranteed by the state.

These developments have a direct and serious bearing on the viability of the Euro. Default on sovereign debt by a Euro member state would be devastating for it. However, those Euro zone countries that have been able to keep their inflation rates and borrowings at acceptable levels, such as Germany, France, The Netherlands and Finland, and are now clamouring for the ECB to do its job and bring pressure to bear on these errant members to rectify the situation by living within their means and in other ways acting responsibly, are being accused of contributing to what has come to be characterised as a “democratic deficit”.

I’m afraid I don’t see it, this democratic deficit. Even when Nicholas Sarkozy lashes out at politicians in Italy and Greece in his frustration at seeing some of their number playing local political games with the Euro crisis, it hardly qualifies as an all-out attack on the sovereignty of that state. It might be a call for all concerned, even at this late stage, to live up to their legal and moral obligations as representatives of a country that freely, and democratically, signed up to the Maastricht treaty, and were happy indeed to take advantage of the very significant trading, foreign direct investment inflow, low interest rates, elimination of currency exchange overhead, reduction of exchange rate risk and the pricing transparency benefits of the monetary union that have been there since its inception, and which the prudent and compliant members would like to see continue. Instead of castigating them, we might take a leaf from their book.

Mr. Fintan O’Toole, c/o The Irish Times newspaper, please take note.

Ireland is not Greece

Mario Draghi, the new president of the European Central Bank, having taken over from Jean-Claude Trichet, has put the current debate about the possibility of Ireland getting a discount on the financial responsibilities it has assumed for the debts of its banks nicely into context.

We are indebted to Laura Noonan of the Irish Independent for asking the question, at Draghi’s first regular monthly press conference as ECB president, as to whether or not the Greek example, where banks with exposure to Greek sovereign debt have been persuaded to take a write-down of 50%, could be used as a precedent for Ireland. His answer was as follows:

“One has to keep in mind that the Greek situation is exceptional and unique - and unique. The sovereign signature, in spite of the recent turmoil, remains a pillar of financial stability, in the Euro zone and in the rest of the world. We are confident that the Irish government could comply with the measures announced, and the Irish government itself said it will do whatever it takes. So one has no reason to doubt about the commitment of the government”

In other words, Ireland has the opportunity to make a serious and very valuable contribution to resolving the current crisis in the Euro zone, and in so doing reassume its position as a member of the core, committed group of European Union member states. It can do this by reinforcing the value that has always been placed on a guarantee by a sovereign state, and in this case one that also happens to be part of the Euro zone. Greece’s misfortune is not that it does not want to do this; it is that it cannot.

Those of the Irish political opposition who are calling for a unilateral default by the government, whether it’s on Anglo Irish bank bonds or on Irish sovereign debt, either do not understand the consequences of what they call for or, much worse, are prepared to cause serious if not fatal damage to the European project, of which the Euro currency is a major component. Theirs is a desire to achieve a short term gain at a cost that represents extremely serious long-term damage. This damage is not even related to the regard or otherwise in which we would be held by our fellow Europeans, but rather to what would result from a grave setback to, or failure of, the European Union. See this previous StackSix entry to get a sense of the material significance of the EU to Ireland.

The historical, political and philosophical importance of it goes much, much deeper than that.

Also see this Financial Times article on "Why it's worth keeping the EU dream alive". Then read the comments for a lively debate on the issue.

The Euro zone rescue deal - "them and us"

The announcement of the Euro zone rescue package, which included a 50% loss on Greek bonds for those banks that held them, led to a number of reactions here in Ireland. One was from Mr. Peter Brown of the Irish Institute of Financial Trading, who said, on the RTE news on Thursday 27th. October:

“If they’re that keen on keeping the Euro intact, Ireland needs a deal”.

Who are “they”, in this context? The ECB? Angela Merkel and Nicholas Sarkozy? The European Commission? Ireland is a member of the ECB and the EU Commission. France and Germany are our comrade states in the entity that has given us massive social, equality and consumer legislation improvements at home and free access to a market of over half a Billion consumers, not to mention significant capital transfers through the EU Common Agricultural Policy and the Structural and Cohesion funds.

Our membership of the Euro zone provides us with protection from speculative raids on what would otherwise be our local currency, such as that which cost the Bank of England an estimated £3.4 billion in 1992. As a result of Irish government attempts to protect the Punt at the time, interest rates on Irish mortgages reached a staggering 16% at one stage.

We have vitally important price stability through the determined and consistent actions of the ECB, although we undo some of that by our own inflationary actions here at home. Our most recent crisis has shown that use of the Euro gives us access to technical and monetary assistance from those other member states, such as Germany, The Netherlands, Finland and France, that have the discipline and experience to be able to deal with low interest rates and increases in the money supply, and to impose adequate regulation on their financial institutions. Our recent property related bubble and its subsequent bursting has shown that we in Ireland are still only in the learning mode with regard to these matters.

An important consideration for travellers is that the Euro gives us the convenience of a common currency as well as valuable transparency in pricing throughout those states that use it.

And being in the Euro zone is yet another asset to go along with our educated workforce, our status as the only English speaking state in the zone and our competitive corporation tax rate to help us attract Foreign Direct Investment (FDI).

In a nutshell, when Mr. Brown talks about “them” he really means us - in order to make good on the implication of his remark, Ireland would have to be prepared to leave the Euro zone and, in so doing, jeopardise the whole EU project. In the light of the benefits we have and can continue to expect from remaining in, this would constitute the greatest example that can be imagined of cutting off one’s nose to spite one’s face.

Fiscal Union

In economics, fiscal matters relate to revenues and expenditures, as opposed to monetary matters, which have to do with the relative value of the currency and all that it depends on, such as interest rates and money supply.

In the Euro zone, which comprises of the 17 EU member states that use the Euro as their unit of exchange, the European Central Bank (ECB) has responsibility for monetary matters. It has declared its primary objective in managing monetary policy to be the control of inflation or, to be more precise, inflation expectations. Each individual Euro zone member state is responsible for its own fiscal policy.

If fiscal policy is about revenues and expenditures, then the most important aspect of this has to be decisions about how taxes are raised, which in turn include questions about the activities that should be taxed and at what rates. The other important element of fiscal policy is how money is spent, which means how national budgets are prepared and executed.

At the extreme, full fiscal union would mean that fiscal strategy in the EU would be centralised, just as monetary policy is at present.

For Ireland, under the current bailout agreement with the ECB and the IMF, there is already an element of what might be called fiscal cooperation in place, as both these bodies now have oversight of Irish budgetary provisions. This, however, falls well short of full fiscal union. The most serious block to fiscal union is the determination of the Irish government to hold on to its favourable corporation tax rate of 12.5%, which has been a significant factor in motivating Multi-national Corporations to locate, and in many cases establish their European headquarters, in Ireland. There are well founded fears that fiscal union would result in a rise of the Irish corporation tax rate to a standard, Euro zone wide, percentage. Many other EU states maintain that the relatively low Irish rate confers an unfair advantage in the attraction of Foreign Direct Investment (FDI).

In addition to the above there are many commentators in Ireland who maintain that fiscal union would mean an effective loss of sovereignty for the Irish state. This is surprising, as we have already, and long since, effectively ceded sovereignty by accepting EU directives under legally binding treaties, by convention named after the cities in which they were formulated such as Rome, Maastricht, Nice, Lisbon and even Dublin, in areas of social policy, anti-discrimination measures, consumer legislation and the penal code, to name but some.