Should Ireland default and devalue?

By Felix Salmon
November 19, 2010
Mohamed El-Erian weighs in on Ireland today, and is blunt.

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Mohamed El-Erian weighs in on Ireland today, and is blunt:

What is most desirable is not feasible given the path Europe is embarked on; and, to make things even more complicated, what appears feasible to Europe is not necessarily desirable. As a result, Ireland finds itself stuck in an unstable muddled-middle.

What seems probable in Ireland is a Greece-style bailout. It’s a debt-go-round, basically: the sovereign takes on the bad debts of its banks, becoming less creditworthy itself in the process; and then the EU takes on the debts of the sovereign. Writes El-Erian:

While seemingly exceptional to many, this approach constitutes the path of least resistance. In fact, it is the most feasible. But we should not confuse feasibility with desirability.

At its roots, the approach addresses liquidity but not solvency. It adds to the debt overhang rather than reducing it. And it uses the socially-painful method of income and growth compression as the principal way to promote international competitiveness over time.

This approach hasn’t worked in Greece, which still has sky-high borrowing costs and which is no more internationally competitive now than it was during the bailout. And it’s unlikely to work in Ireland, either.

So what might work? Default and devaluation, basically:

In a wider policy debate, debt restructuring would be considered as a possible pre-emptive option rather than a disorderly inevitability; thought would be given to the possibility of the weakest Euro-zone members taking a type of sabbatical from the club and rejoining on a stronger and more sustainable basis.

These options are still unthinkable politically. But as El-Erian says, the longer they’re put off, the worse the consequences for European growth in general, and the higher the likelihood that the crisis will engulf the entire eurozone. Right now, says, El-Erian, “given the undeniable strength of core Euro-zone countries, anchored by a fiscally sound and economically robust Germany,” it’s possible to structure a default and devaluation in such a way that the country concerned emerges in a strong fiscal position and with a healthy growth outlook. But the longer we wait, the harder that becomes.

I do think that it would be grossly unfair should the lenders to Ireland’s insolvent banks find themselves getting bailed out by Irish and EU taxpayers at 100 cents on the dollar. Is a sovereign debt restructuring the only way to avoid that? I’m not sure. And it’s also politically all but impossible to build a mechanism into the eurozone allowing countries to exit and re-enter again at a more competitive level, now that the currency union has been deliberately designed without that possibility in place.

Essentially, what El-Erian is calling for requires a level of political unity within the eurozone which has rarely existed historically and which certainly doesn’t exit now. Which is why, as he says, “the region as a whole will lose out in terms of both what is desirable and what is feasible.”


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The idea that a country could get in and out of the eurozone is a non-starter, first if a country leaves the euro, it is out of the EU, per prevailing treaties.
But there is worse, technically the euro payment system has become highly integrated and centralised, and Ireland has the second highest level of integration in the zone as measured by the percentage of transactions going through the system,(80% far higher than Greece at 50%), so if Ireland decided to get out the euro over a weekend, what happens on monday morning? => something much worse than Argentina 2002, at least they had their own computers.

Posted by alea | Report as abusive

Alea; very good to know, thanks.

Posted by ARJTurgot | Report as abusive

Does Ireland have a particular uncompetitive exchange rate within the euro? It’s unit labour costs since 2000 have risen about in line with the area as a whole, and while clearly they have risen against Germany over that period, they haven’t since 2004, and are only about 10% higher than they were in 1999.

Posted by mjturner | Report as abusive

Is this only me or anyone else here smells something fishy about this article and the one it talks about??

Because both of them talk exactly like what the all doomsayers did back in March while shorting the Euro, other Greek related assets and made a boatload of money.

Seriously, there’s no way the EU’s gonna let any of their members default. People can write a research paper about the effect of it and everyone would say no no and no.

The PIMCO Erian guy says whatever he wants because we all know what he’s doing behind the scene to make money out of this crisis on Irish related assets, but a Reuters employee supporting him??

Seriously, Reuters has got to fire this Felix Salmon guy..

Posted by trevorh | Report as abusive

The risk to the eurozone is not a peripheral country leaving. It is Germany leaving, because its departure won’t cause a bank run at home or leave European bank loan books in tatters. That is the alternative to Germany (kicking and screaming) leading further integration and the pooling of member fiscal policies. I’m not sure ‘muddling through’ is sustainable given the two-and-a-half years remaining on the IMF/ECB Greece bailout package.

Posted by JameDiBiasio | Report as abusive

Obviously none of you believe in the free market! The bond holders should take their losses as any investor should. Bailouts are only prolonging the pain. At the centre of this stupidity is the EU and the Euro which neither politically nor fiscally serves the interest of the Irish. Amazing to me why they signed up to the Lisbon treaty. Outside of trade and free movement of people, the EU serves no purpose. And for the two reasons I outlined, if Ireland belonged to the EEA, they could have those benefits without all the silly bureaucracy and waste!

Posted by thurstjo63 | Report as abusive

@ Alea- glad to know existing treaties can’t be changed.
@ Alea- glad to know existing computer software can’t be changed.

Any other reasons?

Posted by johnhhaskell | Report as abusive

Where did I say that treaties can’t be changed or software can’t be changed? My point is that none of these can be done over a weekend. It takes years to change treaties in the EU, and Ireland is not in a position to switch currency without the full cooperation of the EU since its payment systems is entirely out of its control. Eurozone countries have given up monetary sovereignty (that was the point of the euro btw), and there is no easy and cost-free way to change that quickly.

Posted by alea | Report as abusive

Alea, I think we’re pretty much in agreement. No one’s saying that this kind of thing would be easy or cost-free, in fact El-Erian’s saying that it would be much harder than the current course of action. The point is that right now there’s enough time to orchestrate it. If you leave it till the last minute, then a chaotic devaluation would be, well, chaotic.

Well we know from King Bill’s monthly missives that sensible Pimco favored Bunds over the debt of reckless periphery countries.

It seems they might as well have loaded up on Irish and Greek debt. D’oh!

As for the Germans, how does it feel to have the national balance sheet deflowered by some unelected bureaucrats? Probably not much better than in America, where our national balance sheet, already debauched, is further molested by some elected bureaucrats.

Posted by DanHess | Report as abusive

first sensible suggestion since this whole fiasco blew up. Ireland could join the USA instead !

Posted by phrage | Report as abusive

Ireland in the USA? I like the idea! They would complement each other nicely in some ways.

But first would have to negotiate the corporate tax rate. Should it be 12.5% or 35%? That’s a pretty big difference!

Posted by TFF | Report as abusive

Simple isn’t it. I’ve now seen how in France they have learnt how Spain, Portugal Ireland, Greece and the other profligate members of the Euro club have been spending like crazy/. France is now in the race to spend like mad, to get assets built before the inevitable Euro crash.
It will result in a) Germany refusing to go along with this nonsense, b) all profligate countries as mentioned above having to sack civil servants and curtail lavish spending, c0 yes a major revaluation of the EURO to a realistic level against Sterling, Canadian Dollar, US Dollar, Rouble, Reminbi, Yen and Australian Dollar. forget the rest.
I guess this will happen late 2011/early 2012, SO GET READY.

Posted by zart | Report as abusive

What would happen if you give a credit card to a teenager?
Most likely, the teenager would first lie to you about being prudent, then end up in default.
So, whos fault would that be – yours or your teenager?
Germany and France knew all too well what a monster they are creating.
So now everyone is pointing they angry finger at Ireland. How come? France and Germany started this mess. They have to figure out how to clean it up.

Posted by anonym0us | Report as abusive

Honestly, unless individual sovereignty is abolished (which will never happen without riots and war) and a single government rules all of Europe with a single budget (another fairy tale that will never come true), the concept of a single currency is simply unworkable.

So, perhaps the Euro should disintegrate and let individual countries have their old currencies back. The bail outs cannot continue forever. While payments and trade have clearly been easier under the Euro, who honestly ever believed a single currency would ever work without control of individual EU nations’ budgets? Would France dictate the annual budgets for Italy? Should Germany tell Greece their annual budget is too large? Of course not. So why then should Germany bail out anyone, simply because she has managed her balance sheets properly?

Let’s face it – the modern notion of a single currency working without complete control of all of annual budgets is simply ridiculous.

Posted by JoeyDawson | Report as abusive