Thursday, May 10, 2012

Decision Time

In a piece labeled “News Analysis” in The International Herald Tribune (access limited by pay wall) on April 28, Landon Thomas Jr. wrote that austerity has failed in Ireland (along with Greece and Portugal). That news might come as a surprise to Lars Christensen, chief market analyst of Denmark’s Danske Bank, which owns National Irish Bank in Ireland.

In an interview posted on web site this past weekend, Christensen declared that austerity is working in Ireland but that the European Central Bank needs to do more to spur growth. He recommended more monetary easing, i.e. printing more money. This might make sense for Ireland, but it probably isn’t going to happen because Ireland does not control its own currency. The ECB isn’t likely to grow the money supply because it would likely result in inflation in Germany. And that is the heart of the dilemma for countries in the euro zone. There is no one-size-fits-all monetary policy that is optimal for all its members.

The euro zone is a subset of the European Union and, in the wake of the bailouts for Greece, Ireland and Portugal, a co-existing overlapping subset has been formed. It can be thought of as the bailout zone. Members are offered bailout help but in exchange for giving up some control over their own budgets. For Ireland to join, its constitution requires a referendum, which will be held at the end this month.

At first, it looked like the referendum on the new treaty was a shoo-in to pass because it was seen essentially as an offer of free money. But as people have had time to think about it, they can see it’s a bit more complicated than that. While it can mean more money for the country, it also potentially means increased austerity imposed by foreigners. As I wrote to a friend the other day, it’s basically a choice between either both a carrot and a stick or no carrot and no stick.

The two major parties (Fine Gael in government, Fianna Fáil in opposition) are campaigning in favor of the treaty because, well, they always reflexively support anything to do with Europe. The campaign against the treaty is led by a surging Sinn Féin, which is the modern face of the old IRA. There was an interesting crack in Fianna Fáil solidarity the other day when one of its TDs (parliament members), Éamon Ó Cuiv, came out against the treaty. While the rift was patched by having Ó Cuiv agree not to actively campaign against the treaty, his stance is significant symbolically because he is a grandson of party founder and Irish liberation icon Eamon de Valera. If nothing else, it reminds people to wonder, what would Dev think of handing away more and more Irish sovereignty? A good guess: probably not very much.

The problem with the “austerity” that is being imposed in Ireland, Greece and Portugal is that, in each case, it amounts to a compromise that will make no partisan policy wonk happy. Everyone agrees that cutting spending does no particular good without also doing something about economic growth. But in each case, the spending cuts are accompanied by tax hikes which will predictably depress growth. (This is also President Obama’s position in the U.S.) But it takes a huge leap of faith to do one (either cut spending or raise taxes) but not both. And, barring an electoral landslide for one side or the other, it is politically impossible.

It is completely unhelpful but completely true to say, things would have been a lot easier if political leaders would have avoided this situation in the first place. But they didn’t (except in Germany), so there is going to be pain. The best the politicians can do is to make sure the pain isn’t in vain.

I’m not overly optimistic, but a first step might be to listen to Lars Christensen. A second step might then be to carefully consider whether it would help for some of these countries to take back ownership of their own currency.

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