Default and Devaluation: The Only Path for Ireland Now

by: The Ox

This is a very tough article for me to write. Growing up in the west of Ireland, it was always drilled into me that you pay people what you owe. To not do so would be considered shameful beyond belief. Thinking about the future state of Ireland’s finances now, we can easily start to envision something even more shameful than default. The shameful image begins with the Irish population devoting almost every cent of its tax revenues for the next six years towards propping up parasitic lenders such as Anglo Irish (OTC:AGIBY), Bank of Ireland (NYSE:IRE) and Allied Irish Banks (AIB).

The shameful image develops as we envision a generation of some of the best educated graduates in the world leaving their homeland because the Irish economy is not competitive enough globally to provide them with jobs. Who could blame these kids for not sticking around, considering that every spare penny of their tax payments would go towards ensuring that European banks like Royal Bank of Scotland (NYSE:RBS), Danske Bank (OTCPK:DNSKY) and Credit Agricole (OTCPK:CRARY) never have to take a write-off for their reckless loans. Ireland has been down the path of economic imperialism before. It is still part of the national memory that Irish grain crop “surplus” was once exported overseas while the local population were left with rotten potato tubers.

I’m extremely nervous that the current set of Irish politicians will do anything to ensure they stay part of European club, even if that entails a future of indentured servitude for the Irish population. Recently we have had several Irish politicians warning that the bond markets will crucify Ireland forever should it dare to default. Taoiseach Brian Cowen, in his shortsightedness, recently opined that it was unhelpful for Angela Merkel to suggest that bond holders may have to share the painful consequences of reckless lending.

The truth of the matter is that the international bond vigilantes have very short memories. To demonstrate this, we only have to look at Russia, a country that defaulted in 1998, now issuing 20 year bonds at under 5% yield only 12 years later. Or consider Argentina, which by 2006 had its bonds yielding rates very much in line with what were available before the country ran into the financing issues that led to its 2001 default.

But how can Ireland survive without the ECB? Isn’t the country ruined if it doesn’t roll over and do what the core European politicians demand of it? After all, aren’t Irish ATMs only operating courtesy of funding from Brussels?

I have no doubt that without external funding, a run on Irish banks is probably a foregone conclusion. But given the capability of printing punts once again, the Irish government could soon have those same Irish ATM machines churning out a steady supply of “new punts”. These “new punts” would be no Zimbabwean dollar either.

While Ireland, unlike countries such as Norway, does not have massive natural resources with which to back it’s currency, it does have a hell of a lot going for it. To begin with, the country has a very solid legal system, and a homogeneous and cohesive population. Unlike for example, the Greek tax system, Dublin’s tax collection system is very functional and its tax laws are adhered to for the most part. Courtesy of the recent bubble it now has a decent infrastructure and a supply of housing that’s getting cheaper every day.

Ireland’s greatest resource however is its labor force, English-speaking and highly educated. Irish workers were highly sought after by international corporations before the Euro wage base priced them out of completion with India and Eastern Europe. Most importantly, the Irish government still has a reputation for fiscal discipline. It is only two or three months ago remember, that Ireland was acclaimed as the poster child for taking the hard austerity measures needed. Ireland is certainly not Greece, or even Italy in this regard.

Consider this my “cross of gold” speech - the Euro makes no more sense for Ireland now than would sending the U.S. Dollar back to the gold standard. Irish businesses have been crying out for a devaluation for several years now. Devaluation is the one sure way to get this very open, export driven economy back on its feet again. As we are beginning to realize, growth won’t come from austerity and fiscal cutbacks – with the Euro still in place, such measures will only serve to lead the country further into a debt spiral of sinking tax revenues.

Don’t get me wrong, I have no doubt that issuing bonds in Irish punts would be no cake walk. The International bond market would rightly demand a premium of, lets say 400 basis points over comparable German issued bonds. But wouldn’t such a premium be a decent improvement from the 600 plus basis points spread Irish bonds have been trading at recently? An independent Irish currency and economy would also mean that Dublin can dictate its own corporate tax rate, maintaining the coveted 12.5% rate that Brussels is surely at this moment asking to be sacrificed on the altar of a false European cohesion. Surely it would be folly of the worst kind for Cowen to sacrifice independent tax and economic policy for an overpriced and ultimately unsustainable euro-based economy?

In the waning hours of bailout negotiations, I would have this piece of advice for Cowen and his colleagues: You actually have the ECB where you want them. At this point Ireland has nothing to lose, it is already an economic basket case. By comparison, the European core has everything to lose – their whole papered over banking system is at risk. This is no time to go knock-kneed in the face of the Brussels bully boys.

Default may be shameful and highly unpopular within Europe, but the alternative vista of an indefinite period of indentured economic servitude would surely prove more soul destroying.

Disclosure: Author is long the Euro- for now