When the Celtic Tiger was reduced to mews - Outside View by Chirag Mehta

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When the Celtic Tiger was reduced to mews
Dec 10, 2010

Despair! That's the one overpowering feeling that hits me as I follow the Irish tale of gloom. Every testimony of a young professional looking at migrating for better (actually, just about any) job opportunities is a story of survival. What can a nation that is experiencing such a drain of its future hope for?

At the bailout press conference you could almost feel the anger, confusion and sense of loss of the Irish people present there. Prime Minister Brian Cowen couldn't tell his people how much the bailout would be, how it would be drawn down, nor how long it would take to get Ireland back on track.

The only thing he could tell them though was that he was not to blame for the current situation.

So who is to blame? Is it the Irish people, who are paying with their jobs, livelihoods, and futures? - Is there an answer to who caused the Celtic Tiger to be reduced to mews?

From the Tiger to the Dodo

An estimated deficit of 32.5% of GDP for 2010!

Total Government debt at 80% of GDP!

Ireland is still badly hit despite efforts to prop up its insolvent banking system.

However, Ireland's underlying problems a are different from those of Portugal, Italy, Greece and Spain (commonly referred to as PIIGS, with the inclusion of Ireland). The root cause of the financial crisis in these nations was unsustainable welfare spending which led to the creation of high and structural public deficits. Uncompetitive factor markets added another blow to their economic woes. These nations opted for deficit spending to artificially increase living standards; used deficits to finance the unemployed, public employees, and pensioners, which in turn served to sustain inflexible labour markets.

Such irresponsible economics was only possible because it was taken for granted that if the situation worsened (as it eventually did), the other Euro nations would step in to prevent the fall of the Euro by bailing these governments out.

However, Ireland was different. The Irish problems were created, not by an excessive welfare system, but by socializing the losses of a privileged banking system.

With one of the lowest corporate tax rates in the Economic and Monetary Union (EMU) - 12.5% - Ireland attracted foreign banks and businesses looking for new territories to expand. As a consequence, Ireland's banking sector boomed. During the good years, credit expansion policies and government backing ensured that the banking sector saw growing profits. However, with time, these credit expansion policies presented Ireland with a should-have-been-expected problem - a housing bubble, which caused Irish banks substantial losses and even insolvency when the bubble finally burst.

Following up on this fiasco, the Irish government guaranteed all Irish bank liabilities, thus socializing the banking industry's losses.
Here's an interesting fact:

The Irish banks are in trouble - If they go down, their lenders will go down too - The lenders to the Irish banks happen to be major banks of other European countries - Thus, the major banks of other European countries are in trouble too - Hence, the pressure on the European Union to bailout Ireland.

The decision was never Ireland's to make

Why not leave Ireland to fight its own battle, you ask? Well, simply because, this is not Ireland's problem alone, it has the entire Euro-zone muddled up in it, and nations are afraid that the instability will spread and create a domino effect where one nation goes down after another.

Consider this -

Euro-zone governments believed that bailing out Ireland would take the pressure off Portugal. Now Portugal is important because they have large investments from Spanish banks.

Hence, if Portugal were to fall, the Spanish banking system would fall along with it.

At this brink, the situation would be uncontrollable. And thus, the pressure on Ireland to accept the bailout.

There are ofcourse other reasons, for instance, the fact that English, French, and German banks had invested important sums in Ireland.

Ironically Ireland's losses wielded enough influence to eat up the capital of European banks and bring down the whole European banking system and its allies - European Governments.
The Irish population was strongly opposed to this bailout. But yet, the government persisted.

How could the Irish government be "convinced" to accept a bailout not supported by its own people? And this, despite claiming to be funded until well into 2011?

A few theories -

Since the crisis, Irish banks have depended on monetary support from the European Central Bank. Without this support, Irish banks would probably go bankrupt, which would spell disaster for the Irish government. The ECB refused to continue its support, when Ireland's government resisted the bailout earlier on.

To add to this, Germany threatened to withdraw its guarantees for over-indebted euro governments, which would ensure that these governments fail given soaring interest rates. This has put Germany in a commanding position leaving no option for other nations.

Someone has to pay the price

The Irish bailout actually weakens the other countries. Governments of the Euro-zone will have to pay higher interest rates for their own debts due to the additional burden caused by the loans to Ireland. Post the bailout announcement, the yields of even German government bonds have increased.

The plight of embattled countries is even worse - not only do they have to repair public finances and fix banks, but they also need to simultaneously restore competitiveness and growth.

Are these bailout mechanisms which will eventually be accompanied by money printing a real solution? Not really. In fact it only increases the problem at hand over the long term. You cannot solve a debt problem by issuing more debt.

Policy makers in the Euro region now face a stark choice: "Press forward with a de facto fiscal union", or, "Confront the risk of defaults and the unravelling of the Euro-zone."

The joke called - Policymaking

The Irish program solves nothing. The international loan will need Ireland to pay an interest rate of 5.8%, in inclusion to the principal repayment that shall commence after a couple of years. This would mean that Ireland will be transferring nearly 10% of its national income as reparations to the bondholders, year after year.

Not accepting the bailout was probably the most correct decision to make for Ireland. Because of the bailout ordinary taxpayers are now responsible to cover bank losses. The bailout money will mainly serve to sustain the living standards of bankers, rather than those of the people of Ireland. Do you remember Germany's experience while preparing for World War I reparations? A similar situation here, which is not politically sustainable at all - a populist backlash is a likely possibility.

Policymakers are not helping the situation in any way, simply prolonging the problems and allowing them to grow bigger by the day. Are there any correction steps taken? Well, not really. In fact they are being inflated into bigger problems for the future.

What a flaw in policymaking! Till the time that such a mockery of economics is existent and allowed, there seems to be only one true form of money - Gold. With the experience of historically keeping value, it probably makes most sense to back your portfolio with gold in times of such reckless money creation. Because, who knows when the next tiger would be poached...

Chirag Mehta is Fund Manager, Commodities for Quantum Mutual Fund and manages the Quantum Gold Fund ETF and the Quantum Gold Savings Fund among others.


The views expressed in this Article are the personal views of the author Chirag Mehta and not views of Quantum Asset Management Company Private Limited(AMC), Quantum Trustee Company Private Limited (Trustee) and Quantum Mutual Fund (Fund). The AMC, Trustee and the Fund may or may not have the same view and DO not endorse this view.

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