Author: John McHale

Comparing Iceland and Ireland

Dan O’Brien completes his excellent two-part comparison of the Irish and Icelandic economic crises in the Business section of today’s Irish Times.   Today’s instalment is available here; last week’s here.

Update: Paul Krugman responds here.

Some conclusions (it is important to read the articles for full context):

The first conclusion is that the size of the bubbles in the two economies – rather than anything that happened when or after they burst – was the main determinant in explaining the magnitude of the two calamities.

. . .

The second stand-out fact from a comprehensive comparison between the two economies – in this case since the bursting of the bubbles – has been the role of exports in contributing to recovery. . . . [T]here has not been a significant difference in export performance between Ireland and Iceland.

This is not at all what one would have expected. While being part of the euro protected Ireland from even greater instability during the worst of the crisis, the downside of being locked in to a single currency is that devaluation is unavailable as an option to rapidly regain competitiveness and make adjustment to the shock easier to deal with.

Iceland suffered all the downside of having its own currency, but far less of the upside. Iceland’s export performance has been nowhere near as strong as one would have expected following a 50 per cent devaluation, while Ireland’s has been better than could even have been hoped for.

And the absence of an export boost from exchange rate depreciation has not been confined to Iceland alone. Another neighbour has been similarly disappointed, as the chart illustrates. Despite the weakening of sterling, British exports remain below pre-crisis levels.

No currency regime is perfect and all have positives and negatives. Although things may very well change, at this juncture the benefits for Ireland of being part of a much larger single currency have been considerably greater than the benefits to Iceland of having its own currency.

But the most important policy lesson from all this, it would seem, is that policy actors must be far more willing to make calls on whether bubbles exist and to take measures to deflate them if they conclude that they exist. Of course, this is not easy as there is no way of knowing for sure whether growth is sustainable or mere froth. But given all that has happened, the case for pre-emptive pricking of suspected bubbles appears incontestable.

Irish Remedy for Hard Times: Leaving

The Wall Street Journal carries an extensive article on Irish emigration.

Stirring it

The FT’s Lex proposes a grand bargain.

Fuzzy Banking Maths

In an otherwise interesting opinion piece in the Irish Times, Elaine Byrne takes a lurch into banking matters in the closing paragraphs.

The elephant in the room is default. It was reported on Wednesday that since the last week of January, Irish banks have issued €18.35 billion worth of government-guaranteed debt.

This suggests that the banks may effectively be issuing sovereign paper with the approval of the Government, the Central Bank and the ECB. In other words, the banks have effectively increased Ireland’s public debt by about 11.5 per cent of GDP in the last few weeks.

Since they are unlikely to be able to repay this debt any time soon, a future government will have to. To appreciate just how extraordinary this is, €18.35 billion of government-guaranteed debt is more than half the entire tax revenue for 2010 at €31 billion.

This kind of arithmetic – certainly not limited to Elaine – is unnecessarily raising fears and adding to confusion.

The central question is how the actual and contingent liabilities of the Irish State are affected by these auto-bond issues.  As I noted yesterday, the State is now effectively on the hook for the losses of the banking system, which amounts to saying the liabilities of the system are explicitly or implicitly guaranteed.  When funds (liabilities) leave the system they have to be replaced.   The main source of replacement is now the ECB/CBI.   Thankfully the ECB appears willing to provide the funds, but requires a government guarantee because of a shortage of eligible collateral.   When it comes down to it, the auto-issue of bonds is just a way of providing the guarantee while staying within the ECB’s rules.  One form of guaranteed liability is being replaced by another and the effective liability of the State has really not changed.   Things are bad enough without double-counting arithmetic. 

Burning Bond Holders

The dominant view on this site seems to be that the new government should play hardball with regard to senior bondholders.   While I sympathise with the fury over the inequity of bailing out private creditors, I have reluctantly come to a different conclusion.    In the interests of debate, I give below a stripped-down overview of my reasoning.    I’m sure people will tell me where I’m wrong.

Cutting to the essentials, the State is now effectively on the hook for: (i) bank losses beyond their capital; (ii) any losses on capital the State itself has injected; and (iii) and the eventual losses on NAMA.    The ECB/CBI will provide the necessary liquidity/funding to meet all ongoing obligations to creditors.   In return, they require a shrinking of bank liabilities (to reduce their exposure) and an eschewal of loss imposition on senior bondholders given concerns over balance sheet contagion and eurozone precedents.   (Arthur Beesley reports on eye-opening estimates by Seamus Coffey on the ownership of the Irish bank bonds.)

There is a growing chorus that Ireland should insist on imposing losses on (at least) unguaranteed seniors.   This comes down to gambling the ECB won’t significantly pull the liquidity/funding support, and indeed that we should take the further risk that the fiscal components of the bailout deal will not be withdrawn.

I think most of us agree that the original blanket guarantee was a shocking mistake, and also that in ordinary circumstances losses should be imposed – Danish style – on unguaranteed bank creditors.

I think the difference in views comes down to how we see the obligations of the ECB.   If we think the ECB is simply doing its job with its liquidity/funding support, then demands to protect bondholders do seem indefensible.    (By the way, the dictatorial language used by Commissioner Rehn earlier in the week barring such loss imposition was both undiplomatic and, I thought, extremely unhelpful.)  But  if we see the ECB as going beyond its ordinary lender of last resort obligations to small set of banks within the eurozone, then proportional additional conditions do not seem unwarranted.   I think people should take a close look at what the ECB/CBI are giving, as well as what they are demanding.  From where I sit, the ECB’s willingness to act as long-term lender of last resort does qualify as extraordinary support.