Such are the anguished cries of much of our media and many of our Politicians that it can only be a matter of time until we see the sandwich-boards return to Grafton Street proclaiming the end is nigh.
Sometimes it seems we are only happy when we have something to moan about, and of course there has been lots of subject matter around of late. But all too frequently, haste to show apparent knowledge of complex issues can result in poor analysis, and balance is lost. In a week which saw a big bold rescue scheme for the euro, and coalition Government come to Britain, there were also some reasons to be cautiously upbeat about the future, but you would be forgiven for thinking the opposite.
So to bring balance to what was a momentous week which will shape recovery, ITIC spoke with Economist Jim Power, and here is his balanced view. This ezine is a little longer than usual, but it attempts to deal with complex issues in a manner that is straightforward, and which shows that the week’s events probably had more good new than bad.
When the 10th anniversary of European Monetary Union (EMU) was celebrated a short while ago, the majority consensus was that it had been a resounding success. However, over the past year the single currency area has experienced its first major challenge in the shape of the Greek crisis and the consequent instability in the financial markets of the peripheral European economies, such as Spain, Portugal and Ireland.
In the week ending May 7th, the whole euro project was pulled to the edge of a precipice and its survival started to be questioned in a reasonably serious way for the first time since it commenced back in 1999. Bond markets, from which countries that run fiscal deficits have to borrow, lost faith in the ability of a number of Euro Zone countries to manage their affairs properly and basically refused to lend money to them. In other words, markets effectively seized up. To bring the system back from the precipice required a grand gesture from Brussels and thankfully a grand gesture did emerge in the shape of a radical financial support package worth up to €750 billion, backed up by the EU and the International Monetary Fund (IMF). While it has to be hoped that this package will not be availed of, at least markets now realise that there is a significant lump of money on standby to bail out countries who might at some stage find it difficult to raise money on global bond markets. As a consequence, markets have settled down again, albeit with a still uneasy sense of calm. It is now incumbent on high borrowing countries to do whatever is necessary to reduce borrowing as quickly as possible, and that includes Ireland.
The serious fault lines of the whole euro project have been exposed by the Greek crisis that has emerged since last October. From day one it was always going to be very difficult to manage a currency and monetary union with initially 12 and now 16 very different countries and very different political systems, without a strong system of political and fiscal governance at the centre of the project. In theory, fiscal governance was provided for under the terms of the Stability & Growth pact which was designed to prevent governments from running deficits in excess of 3% of GDP and outstanding government debt in excess of 60% of GDP. While this fiscal discipline is strong in theory, the reality is that it is not backed up by a robust political structure that would make it effective. Hence it has been ignored by some member countries.
The Euro Zone now has a government deficit of around 7% of GDP, but countries like Ireland, Spain, Portugal and Greece are all well above the average, and the prudent countries like Germany are now being asked to bail out the rest. German voters are justifiably not happy about providing financial support to countries that have not behaved prudently. The European Central Bank’s key mandated responsibility is to ensure price stability in the Euro Zone and to preserve the stability of the euro. The Germans are seriously annoyed at the announcement that the ECB would if necessary buy the bonds of Euro Zone countries, in the event of those countries not being in a position to borrow money on capital markets. The French are strong supporters, but the Germans believe it will threaten future price stability. In reality the two key Euro Zone powers, France and Germany, are now quite divided on how the Euro Zone should be managed and this is potentially a recipe for future instability in the zone.
The reality is that for a monetary union to function properly there needs to be much more centralised fiscal policy making and a much more centralised political governance at the centre of Europe. This is not politically popular in most countries as it would imply national governments being forced to cede power to the centre. The EU Commission has laid out plans to exert much greater control over national budgets. This is totally logical and desirable if the single currency is to be truly successful, but unfortunately the logic is lost on some.
While the current economic, financial and political instability and uncertainty is not on the whole positive for anybody in the Euro Zone, there are certain aspects of the crisis that will certainly suit Ireland:
– Up to September 2007 sterling had been quite stable against the euro for some considerable period of time around the 68 pence level. It then fell by over 46% against the euro by the end of 2008, and during 2009 it continued to trade very weakly against the euro. However, against a background of the recent Euro Zone instability, the euro has fallen by almost 9% against sterling since the end of 2009. Furthermore, the euro has lost almost 17% of its value against the dollar since December 2009;
– The euro continues to lose the confidence of markets and is steadily ceding ground to the dollar and sterling. Sterling now has the added advantage of having a government in place that should prove to be relatively stable and which should tackle the serious deficit in the UK public finances. Provided the new government does what needs to be done, sterling could well have the potential to appreciate further against the euro, as could the dollar;
– A weaker euro is unambiguously good news for Irish exporters and for Irish tourism;
– In value terms in 2009, the United Kingdom accounted for 16% of total Irish merchandise exports and the United States accounted for 21%. When combined with the gradual improvement in Irish cost competitiveness, this fall in the value of the euro should give an additional welcome boost to Irish exporters who have been operating in a very challenging environment. The strengthening of sterling will be especially good news for indigenous exporters who have a heavier dependence on the UK market, particularly the very important Agri-food sector;
– Although the Euro Zone economy is gradually recovering as evidence by the increase of 0.2% in first quarter growth, there is still significant spare capacity and a lack of inflationary pressures in the Euro Zone. Consequently, there is no pressure on the ECB to increase official interest rates for the foreseeable future. Furthermore, in an environment of such instability in the Euro zone, the ECB cannot contemplate tightening interest rates, particularly if the countries with serious deficits take measures to reduce them through a combination of public expenditure cutbacks and tax increases. The persistence of low interest rates represents unambiguously positive news for the Irish economy;
– For the tourism sector, recent currency trends represent very good news. In 2009, visitors from Great Britain accounted for 47% of total visitors into Ireland, and the US accounted for almost 13% of total visitors. For visitors from both of those destinations, the recent weakness of the euro will make Ireland a more attractive and competitive location. That is badly needed.
There is an old saying that it is an ill wind that blows no good. The current instability in the Euro Zone is having a negative impact on the euro, but this has the potential to give a significant boost to the export and tourism sectors of the economy. Despite this, it is still very incumbent on Irish policy makers to continue to correct the Exchequer deficit and improve the overall competitiveness of the Irish economy. Both of these conditions are vital for the future prosperity of an Irish economy that is likely to have technically emerged from recession in the first quarter of this year.
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May 13th 2010