Irish Crisis: The Lesson Learned?

The events of the weekend were both predictable and drastic. The Irish government has caved into to the obvious: Ireland cannot continue without a vast amount of outside help. There will be the inevitable backlash against the government – it depends on a very thin majority formed from a coalition. That coalition is now sundered and an early election is likely in January. Nothing substantial will come from that election other than a bout of voter anger and, presumably, the ouster of the present governing party.

There is no equivalent method for voters to vent here in the US. The American electoral system is designed to resist democratic impulses such as those about to swamp Ireland. Instead we move more slowly. When anger leads to a defeat for one of our parties, it is by no means guaranteed that the government will change. A good example of this is the recent mid-term election. Instead of a clean change of power, and thus clear accountability, we have a butchered half-transfer of power in which the incoming party still has no substantial commitment to government as it is still in partial opposition. So, over the next two years it will be very difficult to pin blame or credit for events on either party. Our change of power is delayed and bears no direct relationship to competence, it is run according to a timetable indifferent to such things.

Meanwhile, back in Ireland:

Like all countries who find themselves in the hands of creditors the Irish will feel as if they lost their independence. Questions of sovereignty always emerge in such moments. Policy decisions will be made by faceless bureaucrats whose allegiance is not clearly to the Irish people.

But.

That is the way when a country abdicates control of its banking system. For the Irish crisis is not one of mismanagement. It is not at all similar to the Greek crisis. The Greeks were simply awful at running their country. They were profligate, lazy, and cheated with abandon. Sooner or later that sort of incompetence will implode. Not so the Irish: they ran a tight ship and had good debt ratios before their banks blew the country apart. There have been ill thought through references to the Irish sinking beneath a wave of social programs. This is simply not true. The current crisis began when the Irish banks fell apart under the weight of their incompetent investments in real estate, both in Ireland and elsewhere. As the banks needed more help to stay afloat, the Irish found themselves being sucked into the vortex of toxic banking.

The difference between the US and Irish banking crises was simply the relative size of the banks with respect to the economy as a whole. The Irish banks were large enough that their losses swamped the local economy. Fortunately for us, and it was dumb luck on our part not good governance, our banks are not quite big enough to destroy our economy.

Yet.

They will be one day. And the Irish crisis gives us a hint of the difficulties that rogue banks can create.

There is one other difference though. And it is one that most of the media seem to ignore. We read silly headlines such as “The European dominos fall, is the US next?”.

No. No. No it isn’t.

Why?

We print our own money. Simple. We will always be able to pay our debts because we can simply print enough dollars to pay it off.

Whether that is inflationary is a different question. But default is not happening.

So this highlights another aspect of the Irish crisis. The question of sovereignty. My view is that the moment the Irish signed up for the Euro, they signed away a part of their independence. they effectively agreed to tether their fate to that of the other European countries. Since the German economy is the largest in the Euro zone, the Irish thus tethered themselves to German economic policy. They were bound to be whipped by it sooner or later. By sharing a monetary policy with a behemoth economy the Irish surrendered their ability to combat economic crises without resort to extreme measures. Once they gave up an independent monetary policy they were forced to rely on fiscal policy.

And, as we have now seen, even the most austere measures are not sufficient to calm nervous credit markets.

One last point: since this crisis is an aftermath of a banking collapse, and the botched effort to save those banks rather than letting them fail, the lesson to learn is to fix the banks so that they cannot do this to an economy.

Let’s think about this briefly. The credit agencies clearly messed up – what else is new? – when they failed to realize that a country with banks sufficiently large to destroy the host economy should be given a rotten rating on its debt. The experiences of Iceland, Ireland, Portugal, Spain, and perhaps Italy all suggest that where a country’s economy could be overwhelmed by the collapse of its largest banks, and where that country’s government is committed to bailing the banks out, then the sovereign debt of that country should be downgraded accordingly. The implicit fiscal burden of the banks should be viewed as a contingent liability of the host nation and thus be added to any calculation of debt to GDP ratios. Viewed through that lens, the Irish economy has been a basket case for years, and the crisis is simply the denouement of an inevitable process.

As long as governments mistake the current large banks within their economies for the generic banking system we will have crises like the Irish one: saving the banks, and saving the banking system are not the same thing. Indeed it is often better to let one or two banks go into bankruptcy so that the system as whole can be better evaluated by creditors. This is exactly why I was an advocate of nationalization for Citibank back in the dark days of our own crisis. But that opportunity to fix our system has long gone.

Instead we wait for our banks to foul up again.

So the lessons learned:

1. Cut your banks down to size. By force if you need to. Else they will cut you down instead.
2. Do not join half hearted international programs like the Euro. Either go all in – via total union, or stay all the way out and keep your independence.

The Irish messed up on both counts.