Out of the PIIGS nations Ireland gets less attention since the crisis in Greece has focused attention on southern Europe. But econ prof Morgan Kelly takes a look at why Ireland is in trouble and finds the government take-over of failed Irish banks was done in a way that assures Ireland's sovereign debt burden will reach levels similar to Greece.
This debt would probably be manageable, had the Irish government not casually committed itself to absorb all the gambling losses of its banking system. If we assume – optimistically, I believe – that Irish banks eventually lose one third of what they lent to property developers, and one tenth of business loans and mortgages, the net cost to the Irish taxpayer will be nearly one third of GDP.
Adding these bank losses to its national debt will leave Ireland in 2012 with a debt-GDP ratio of 115%. But if we look at the ratio in terms of GNP, which gives a more realistic picture of the Ireland’s discretionary tax base, this is a debt-GNP ratio of 140% – above the ratio that is currently sinking Greece. Even if bank losses are only half as large as we expect, Ireland is still facing a debt-GNP ratio of 125%.
When the banks were taken over the Irish government did not just make whole depositors. The government also bailed out bond holders. That seems incredibly foolish. Why'd they do that?
If Kelly is correct then Ireland faces a future where at some point the market will demand far higher interest rates for Irish sovereign debt than the Irish government can afford to pay. At the same time, the bail-out for Greece just kicked the Greek problem into the future by 2 or 3 years.
I am wondering how the European sovereign debt crisis (and the coming US sovereign debt crisis) will resolve itself. Ross Douthat sees expanding state power in the US and Europe. IN Europe in particular the emotional bonds across nations seem much shallower than the emotional bonds across US states. So I see pretty severe limits in the willingness of the Dutch, Germans, and other more affluent and financially sound European states to bail out the other states.
At the same time, the European Central Bank seems unlikely to inflate away all the debt. Inflation has better prospects in America than in Europe. So default still seems like the most likely outcome in Europe. The question then arises: Default in the euro zone or default while exiting the euro zone? Will Greece, for example, default on its debt and yet still remain in the euro? Or will it default and bring back the drachma currency at the same time?
I also wonder in event of default whose decision will it be on whether Greece leaves the euro? Will the Greek government decide? Or will the Germans and some nations allied with them decide to eject a nation that dares to default? Will the Germans see a default as an opportunity to eject a nation which does not share its economic values with regard to currency soundness and public finance?
The avoidance of either default thru inflation or explicit default seems a very remote possibility. European welfare states already face aging populations and over-promises on entitlements.
|Share |||By Randall Parker at 2010 May 23 09:25 AM Economics Sovereign Crises|