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Time To Think The Unthinkable?...

Is it time to start thinking the unthinkable?

If our membership of the eurozone was the cause of our woes, perhaps leaving the club would help fix things...


AS the Greek financial crisis continues to worsen and shows signs of spreading to other eurozone countries, is it time to start thinking the unthinkable? With Portugal and Spain now in the firing line, we in Ireland need to start asking the hard questions about both our exchange rate policy and our debt mountain.

On Tuesday, Finance Minister Brian Lenihan was quoted as saying that leaving the euro would be a "disaster" for Ireland.

"Were a country to contemplate leaving the euro there would a flight of capital and a collapse of the banking system", according to Mr Lenihan.

While we have no reason to doubt the minister's sincerity, the fact that he is even discussing the issue, even if only to rubbish the possibility of Ireland exiting the single currency, demonstrates that the worsening of the Greek crisis has massively upped the stakes for all 16 members of the eurozone.

Last week's downgrading by ratings agency Standard & Poors of Spanish and Portuguese government bonds demonstrates that the crisis is no longer confined to just one country. Instead we are witnessing the beginnings of what looks suspiciously like a wider collapse of market confidence in all of the peripheral eurozone economies. If this does prove to be the case then it won't be long before Ireland finds itself in the firing line once again.

There comes a time in every crisis when it becomes impossible to ignore the unpleasant facts.

Yes, our membership of the euro has sheltered us from the immediate consequences of the collapse of our banking system since September 2008. However, was it not our membership of the single currency that was largely responsible for landing us in our current mess in the first place?

At the end of 1997, total bank lending to Irish residents stood at €56bn.

Most of this lending, €48.8bn, or 87 per cent, was financed by Irish retail deposits. Fast-forward to the end of December 2009, and bank lending had risen six-and-a-half fold to €365bn while deposits had less than quadrupled to €171bn. As a result, the proportion of Irish bank lending funded by Irish deposits has fallen from 87 per cent to 47 per cent over the past 12 years.

In other words, by removing the effective cap on Irish bank lending represented by domestic deposits, our membership of the euro was the main cause of the credit bubble which drove property prices to insane heights over the past decade. We are now living with the consequences of the bursting of that bubble.

That's water under the bridge. We must now find a way of extricating ourselves from the mess we are in.

It won't be easy. As the financial crisis has worsened, we have, courtesy of the deposit guarantee and Nama, been gradually nationalising ever-larger amounts of private sector debt. This has meant that conventional measures of measuring the national debt are now virtually meaningless.

For what it is worth, the national debt is expected to reach €95bn by the end of this year. That doesn't include the €80bn, the vast bulk of which will come from the taxpayer, that the Government has committed to recapitalising the banks and to Nama. This will bring the de facto national debt to €175bn by the end of this year and to €190bn by the end of next year.

But that isn't even the half of it. With the taxpayer now effectively on the hook for most of the loans of the Irish-owned banks, the real indebtedness of Ireland Inc is even greater than most people realise. While the Irish taxpayer is not exposed to the Irish loans of the foreign-owned banks, he or she is potentially liable for the overseas loans of the Irish-owned banks.

Coincidentally, at €372bn, the total loans of the Irish-owned banks, both in Ireland and overseas, are virtually the same as the total lending of all banks, both Irish and foreign-owned, in Ireland. Even when one strips out the bad loans with a book value of €81bn which are headed for Nama, that adds another €291bn to the Irish taxpayer's liabilities, bringing the grand total to a scarcely credible €466bn by the end of this year and to €481bn by the end of next year.

At the same time as the debts of Ireland Inc are soaring, the resources available to service those debts are shrinking rapidly. In 2007 Irish GNP peaked at just over €160bn. This year it will be just €126bn, a fall of almost 22 per cent. This is due to a combination of a 16 per cent reduction in the real economy and falling prices.

Deflation, a shrinking economy and rising debts constitute a lethal cocktail. Falling prices push up the real value of our debts, a shrinking economy makes it more difficult to service the debts, while all the time those debts keep piling up.

This makes Brian Lenihan's job well nigh on impossible. In order to keep the bond markets sweet, he needs to keep cutting public spending. In the short term at least this will depress the economy and tax revenues even further. This means that Mr Lenihan, no matter how successful he is in restoring order to the public finances, is going to have to keep running faster just to stand still.

Meanwhile, there are growing signs that, as the Irish economic downturn enters its third year, many companies that survived the initial shock are now experiencing serious difficulties. While the level of economic activity may have bottomed out, with the cash economy now almost a quarter smaller than it was less than three years ago, the situation remains desperate.

With the Irish economy likely to do no more than bump along the bottom for the next few years, many companies that are now hanging on by their fingernails are unlikely to survive long enough to see the return of better times.

So what can we do? It must now be as clear as daylight that there is no way that a €126bn economy can support a debt load of almost quarter of a trillion euro. By attempting to do so we will merely prolong the agony. We urgently require some sort of debt restructuring, default, call it what you will. Otherwise the Irish economy will remain mired in depression for a decade or longer.

However, even if our debts were restructured we would still need a strong economic recovery to service even our reduced indebtedness. Unfortunately our membership of the euro, which ties us into an over-valued exchange rate, makes this difficult perhaps impossible.

All of which leaves us needing to think the unthinkable, something which the intensifying eurozone crisis will force us to do in any event. Given that it was our membership of the euro which largely created the economic crisis in the first place, will withdrawal from the euro form part of any solution?


Report - Sunday Independent

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