The Consequences of Monetary Union (1972)

The financier and businessman Emmett O’Connell, formerly of Aminex and Eglinton Oil and still successfully engaged in the international mining business, has long held the view that abolishing the Irish pound and joining the eurozone was the biggest policy error ever made by the Irish State. The Greek crisis and its drastic implications for the euro-currency, interwoven as it is with the crisis of the Irish public deficit and banks, seems to be confirming this daily before our eyes.

Linked below for your information is a facsimile of a pamphlet☚ which Emmett O’Connell wrote in 1972. It sets out why joining a European currency union would not be in Ireland’s best interests.

[Also linked below: a Podcast audio extract☚ of an interview with Mr. O’Connell by George Hook on this subject, on NewsTalk106fm, Monday 10th of May]

This was one of a number of pamphlets published at the time by the Common Market Study Group, of which the undersigned, the late Raymond Crotty and Mr Micheal O Loingsigh of Tralee were key members. The Common Market Study Group was the principal centre of intellectual criticism of Irish membership of the EEC in the Accession Referendum of May 1972. Central to such criticism was the belief that what was then called the Common Market was intended to lead on to a European Monetary and Political Union under the political hegemony of what Dr Garret FitzGerald recently termed “The Big Three” EU Member States – Germany, France and Britain – as has broadly been happening since.

Emmett O’Connell repeated his criticisms of EMU at the time of the 1992 Maastricht Treaty which led to the establishment of the euro and he has written occasional press articles on this and related economic topics over the years. The core of his argument is the section of his pamphlet setting out “The case for Sovereign Money” on pages 12-14, as well as pages 22-26. The validity of what he wrote then, he believes, is confirmed by the current crisis of the eurozone and the fact that Ireland is unable to restore its lost economic competitiveness because of the abolition of the Irish pound and with it our ability to have any control over either the currency exchange rate or interest rates with a view to maximising Irish development and employment.

For Your Information: Ireland, EU, Eurozone, Banks & Economy – News & Analysis

Ghosts of debt and jobs will haunt economy
The Irish Times – Tuesday, December 29, 2009
http://www.irishtimes.com/newspaper/opinion/2009/1229/1224261354227.html
Morgan Kelly
OPINION : By 2015, Iceland will almost certainly be a lot better off than Ireland because it dealt decisively with its banks.

For grand corruption, though, we will have to look to Nama. By allowing the banks to dictate the terms of their bailout, the bank rescue was turned into the most lucrative and audacious Tiger Kidnapping in the history of the State, with the difference that, like the sheriff in Blazing Saddles, the bankers held themselves hostage.

Bad banks like Nama were tried on a large scale in the early 1930s in the US, Austria and Germany; and proved to be profoundly corrupt and corrupting institutions, whose primary purpose was to funnel money to politically connected businesses. The German bank is best remembered for setting up what we would now call a special purpose vehicle to fund the presidential election campaign of the odious Paul Hindenberg.

Bad banks do not just happen to be corrupt and anti-democratic institutions, it is what they are designed to be. Effectively, bad banks give governments the power to choose which of a country’s most powerful oligarchs will be forced into bankruptcy, and which will be resuscitated to emerge even more powerful than before.

Nama will get to pick which of the fattest hogs of Irish development will be sliced up and fed, at taxpayer expense, to better connected hogs (remember that Nama has been allocated at least €6.5 billion, considerably more than the Government saved by draconian budget cuts, to “lend” to favoured clients).

While Nama may have momentous political consequences, it has already failed economically: the Irish banks are still zombies, reliant on transfusions of European Central Bank funding to survive until losses on mortgages and business loans finally wipe them out. In the next few months we will discover if the State bankrupts itself by nationalising the banks; or if it has the intelligence to free itself from bank losses by turning the foreign creditors of banks into their owners, as Iceland has just done with Kaupthing bank.

It is ironic that by 2015, having devalued its currency and dealt decisively with its banks, Iceland will almost certainly be a lot better off than Ireland.


Why the eurozone has a tough decade to come
Financial Times – January 6 2010
http://www.ft.com/cms/s/0/54cc3b20-fa62-11de-beed-00144feab49a.html
Martin Wolf

What would have happened during the financial crisis if the euro had not existed? The short answer is that there would have been currency crises among its members. The currencies of Greece, Ireland, Italy, Portugal and Spain would surely have fallen sharply against the old D-Mark. That is the outcome the creators of the eurozone wished to avoid. They have been successful. But, if the exchange rate cannot adjust, something else must instead. That “something else” is the economies of peripheral eurozone member countries. They are locked into competitive disinflation against Germany, the world’s foremost exporter of very high-quality manufactures. I wish them luck.
[…]
Where does that leave peripheral countries today? In structural recession, is the answer. At some point, they have to slash fiscal deficits. Without monetary or exchange rate offsets, that seems sure to worsen the recession already caused by the collapse in their bubble-fuelled private spending. Worse, in the boom years, these countries lost competitiveness within the eurozone. That was also inherent in the system. The interest rates set by the European Central Bank, aimed at balancing supply and demand in the zone, were too low for bubble-fuelled countries. With inflation in sectors producing non-tradeables relatively high, real interest rates were also relatively low in these countries. A loss of external competitiveness and strong domestic demand expanded external deficits. These generated the demand needed by core countries with excess capacity. To add insult to injury, since the core country is highly competitive globally and the eurozone has a robust external position and a sound currency, the euro itself has soared in value.

This leaves peripheral countries in a trap: they cannot readily generate an external surplus; they cannot easily restart private sector borrowing; and they cannot easily sustain present fiscal deficits. Mass emigration would be a possibility, but surely not a recommendation. Mass immigration of wealthy foreigners, to live in now-cheap properties, would be far better. Yet, at worst, a lengthy slump might be needed to grind out a reduction in nominal prices and wages. Ireland seems to have accepted such a future. Spain and Greece have not. Moreover, the affected country would also suffer debt deflation: with falling nominal prices and wages, the real burden of debt denominated in euros will rise. A wave of defaults – private and even public – threaten.

The crisis in the eurozone’s periphery is not an accident: it is inherent in the system. The weaker members have to find an escape from the trap they are in. They will receive little help: the zone has no willing spender of last resort; and the euro itself is also very strong. But they must succeed. When the eurozone was created, a huge literature emerged on whether it was an optimal currency union. We know now it was not. We are about to find out whether this matters.


Are we about to see the end of the much-vaunted eurozone?
The Observer – Sunday 3 January 2010
http://www.guardian.co.uk/commentisfree/2010/jan/03/peter-oborne-end-of-eurozone
Peter Oborne
In putting financial considerations before social ones, the governments of Europe have ensured that things can only get worse

It is nearly 20 years since the Conservative chancellor of the exchequer Norman Lamont made his notorious remark that unemployment was a “price worth paying” for the restoration of economic stability. Lamont was at once condemned for his comments, made at the height of Britain’s ill-fated membership of the Exchange Rate Mechanism. The progressive left universally denounced him as arrogant, brutal and out of touch. And yet, only two decades later, the European left has made the identical calculation. The imposition of the euro, and the rigid economic policy a single currency implies, is having socially catastrophic effects across much of Europe on a scale that dwarfs Britain’s suffering in the 1990s.

Consider the facts. In Spain, unemployment has already reached a gut-wrenching 19.3%. But unemployment for those between 16-24 is a catastrophic 42%. In Greece, youth unemployment is 25%, in Ireland 28.4% and Italy 26.9%. Marginal eurozone countries such as Greece, Spain and Ireland are not just in recession. They are in depression – and so long as they remain inside the euro there is no exit.

Before their decision to abandon economic sovereignty and sign up to the euro, policymakers had a tried and tested response to the kind of global setback of the last two years – depreciate the currency and loosen fiscal and monetary policy[…] But inside the euro, individual countries are stripped of the ability to manage their own economies. That is why the global recession has been far, far more devastating for some eurozone members than would otherwise have been the case – in just the same way that membership of the ERM inflicted wholly unnecessary damage on the British economy in the early 1990s.

The European single currency amounts to an experiment in social and economic engineering on a scale only very rarely before encountered in world history. The great question is whether it will work. There is a universal belief among the European political and economic elite that the euro will continue, no matter how much damage it inflicts or how many jobs it costs.
[…]
I believe that this heartless analysis is mistaken, and that the eurozone will in due course collapse (as Karl Marx might well have remarked) under the weight of its own contradictions. Economically, the euro can be spotted a mile off: it is a classic bankers’ ramp. It is designed to do all the things that bankers have historically wanted: create efficient markets, drive down the cost of labour, impose price stability, eliminate trade barriers, confound national boundaries and maximise corporate profits. Bankers don’t care much about youth unemployment in Madrid or home repossessions in Lisbon or riots on the streets of Athens. They worry about the bottom line and the euro has been very good for the bottom line, with stock markets up by an obscene 50% over the last eight months.


Should we divorce the euro?
The Sunday Business Post – 10 January 2010
http://www.sbpost.ie/commentandanalysis/should-we-divorce-the-euro-46642.html
David McWilliams

Joining a currency union is the economic equivalent of a marriage. If a country decides to give up its currency and get into bed with another currency, it would seem ludicrous to entertain this move without being sure that the union was suitable. As we all know, there is a difference between fancying someone and making the thing last.

To avoid single currency arrangements going sour, there is also a ‘matchmaker’ in economic theory. The economic matchmaker goes by the typically incomprehensible name of the ‘optimal currency area theory’. This theory is a checklist of economic attributes which need to line up in order for a monetary union to work.

For a currency union to work for a country, the most important thing is that the country trades overwhelmingly with the other members of the monetary union.

This ensures that all the countries in the union move roughly in the same economic cycle. It is also important that the structures of the respective economies are broadly similar, so that one country doesn’t experience a huge boom, while the rest are just motoring along nicely.

Having similar structures in banking and housing, for example, will imply that a country should not suffer a monumental bust, while the others are merely experiencing a normal recession. Equally, it is important that there is significant movement of people within the currency union – like there is in the US between its states – so that, if a country does slump, its citizens can move to find work in another member country.

In general, for a currency union to work, there should also be a single fiscal policy so that, when one area of the currency slumps, the rest of the union’s taxes go some way to ease the problems in the region in difficulty. This is how the currency unions in the US, Canada and Australia work.

Guess what? None of these attributes was in place when Ireland joined the EU economic and monetary union (EMU) and the euro. So it is clear that we didn’t join for economic reasons. So why did we join? It seems that we were too insecure to behave logically and this national insecurity – particularly among our senior mandarins – prevented us from having a debate.
[…]
The reason we should ask these questions is that it is clear the euro has been a disaster for Ireland, and will ensure our slump lasts considerably longer than it has to. When we look at other countries, we see that, of the three entrants into the then EEC in 1973,we are the only ones using the euro. However, we trade less with other eurozone countries than either Denmark or Britain.


The Irish Credit Bubble
University College Dublin Centre for Economic Research Working Papers Series – WP09/32 – December 2009
http://www.ucd.ie/t4cms/wp09.32.pdf
Google Cache (Web Page)
Morgan Kelly

While NAMA is intended to repair, for now, the damage to the asset side of Irish bank balance sheets from developer loans, their liability side appears unsustainable. The aggressive expansion of Irish bank lending was funded mostly in international wholesale markets, where Irish banks were able to borrow at low rates. From being almost entirely funded by domestic deposits in 1997, by 2008 over half of Irish bank lending was funded by wholesale borrowers through bonds and inter-bank borrowing. This well of easy credit has now run dry. In the words of Bank of England Governor Mervyn King: “But the age of innocence—when banks lent to each other unsecured for three months or longer at only a slight premium to expected policy rates—will not quickly, or ever, return.” As foreign lenders have become nervous of Irish banks, their place has increasingly been taken by borrowing from the European Central Bank and short-term borrowing in the inter-bank market. Payments from NAMA will allow Irish banks to reduce their borrowing by a trivial amount.

Without continued government guarantees of their borrowing and, more problematically, continued ECB forbearance, the operations of the Irish banks do not appear viable.
[…]
By pushing itself close to, and quite possibly beyond, the limits of its fiscal capacity, the Irish state has succeeded in rescuing Irish banks from their losses on developer loans. Despite this, these banks remain as zombies entirely reliant on continued Irish government guarantees and ECB forbearance, and committed solely to reducing their own debts.

While bank capital levels are, probably, adequate for the markedly smaller scale of their future lending, we will see below that even fairly modest losses on their mortgage portfolios will be sufficient to wipe out most or all of that capital. Having exhausted its resources in rescuing the Irish banks from the first wave of developer losses, the Irish state can do nothing but watch as the second wave of mortgage defaults sweeps in and drowns them. In other words, it is starting to appear that the Irish banking system is too big to save. As mortgage losses crystallise, the Irish government’s ill conceived project of insulating bank bond-holders from any losses on their investments is sliding beyond the means of its taxpayers.

The mounting losses of its banking system are facing the Irish state with a stark choice. It can attempt a NAMA II for mortgage losses that will end in a bond market strike or a sovereign default. Or it can, probably with the assistance of the IMF and EU, organise a resolution that shares property losses with bank creditors through a partial debt for equity swap. It is easy for governments everywhere to forget that their states are not wholly controlled subsidiaries of their banks but separate entities; and a resolution that transfers bank losses from the Irish taxpayer to bank bond holders will leave Ireland with a low level of debt that, even after several years of deficits, it can easily afford.

⁂ European Central Bank capitulating in face of crisis

Two similar articles from newspapers on the political Right and Left forwarded for your information by Anthony Coughlan:

TELEGRAPH
Tuesday 24.2.09

ECB faces mutiny from national bank governors as recession deepens
– The European Central Bank is capitulating.

By Ambrose Evans-Pritchard

For months the ECB held sternly to the high ground of orthodoxy as the US, Japanese, British, Canadian, Swiss and Swedish central banks slashed rates towards zero and embraced quantitative easing, but a confluence of fast-moving events is now forcing it to move.

The credit default swaps that measure bankruptcy risk on the debts of Ireland, Austria and a clutch of Latin Bloc states have vaulted to dangerous levels. In the case of Ireland, the slump is spilling on to the streets. Some 120,000 marched through Dublin over the weekend to protest austerity measures.

The slow fuse on Eastern Europe’s banking crisis has detonated, leaving Austrian, Belgian, Italian and other West European banks with $1.5 trillion (£1 trillion) in exposure.

It is happening just as industrial output collapses in the eurozone’s core states. Germany’s economy contracted at 8.4pc annualised in the fourth quarter. ECB president Jean-Claude Trichet said on Monday that “a process of negative feedback” has set in where the banks and the real economy are pulling each other down in a self-reinforcing spiral. Eurozone credit is contracting. Banks are rationing credit as deleveraging gathers pace.

Rob Carnell, global strategist at ING, said the ECB has been painfully slow to acknowledge the global deflation tsunami sweeping across Europe.

“It seems divorced from reality. It is clearly nonsense to talk about inflation now: it has been negative on average for six months. The eurozone purchasing managers’ index has fallen twice as fast as in the US, so the ECB should be acting even faster than the Fed,” he said.

Mr Trichet said the ECB has increased its balance sheet by ¤600bn (£525bn) since the Lehman collapse in September. The bank is providing “unlimited liquidity” in exchange for a wide range of collateral, including mortgage bonds issued for the sole purpose of extracting ECB funds.

But the ECB’s leading voices have adamantly refused to contemplate going to the next stage: buying bonds and other assets with “printed money”. They see that as the Primrose path to hell. This week the tone has abruptly changed, suggesting that a majority of the 16 national bank governors on the ECB council are having second thoughts.

The apparent ring-leader is Cypriot member Anastasios Orphanides, a former Fed official and a world authority on deflation traps. He said on Monday that the ECB may have to go beyond “zero-bound” rates and revealed that an “internal discussion” was under way.

Italy’s Mario Draghi is in the “activist-easing” camp. “The experience in the US in the 1930s and Japan in the 1990s suggests that it is necessary to fight, in the early phases of the crisis, the tendency for real interest rates to rise,” he said.

Finland’s Erkki Liikanen is of the same opinion. “We are facing the worst financial crisis in our time. It is important not to exclude, ex ante, any measures.”

Julian Callow from Barclays Capital said 10 ECB governors are now doves.

This amounts to a mutiny against the Bundesbank-dominated executive in Frankurt. It is no great surprise. They have to answer to their democracies. The plot is thickening.


The Euro, an Illusory Shield against the Crisis ?

L’Humanite, Paris , Thursday 19 February 2009,

by Isabelle Metral (Translated)

Most political leaders of euro-zone countries make it sound as though the single currency has shown its capacity to play a protective role as the financial crisis sweeps across the Old Continent. So much so that today, even the staunchest of the Euro-sceptics (the British, Icelanders, Swedes, or Danes) are supposed to have suddenly realized the advantages of joining the euro…

The claim was made by Joaquin Almunia, European commissioner for economic and monetary affairs, on Tuesday last.

The EU leader’s statement actually betrays a growing concern in the face of signals showing increasing divergences between the different regions or countries of the euro zone. These divergences might eventually lead some countries to consider opting out of the single currency.

The crisis shows up the very serious defects in the original conception of the euro.

Entirely obsessed as they were with the stability criteria put forward by financial markets, those that championed its creation in 1999 were aiming first at a “strong euro” in the hope of luring as much capital as possible to the European market.

Hence the curb on public spending (with the Maastricht treaty), the pressure on wages through the deregulation of labour markets that diminished labour’s negotiating power. “The euro has brought war over exchange rates to an end, but it has exacerbated competition over prices,” rightly claimed Jean-Paul Fitoussi, president of the Observatoire français des conjonctures économiques

Today, the deepening crisis and the effect of the competition between states that sink deeper and deeper into debt have the additional effect – a refinement on the earlier stages – of bringing the pressure of competition to bear on the States’ capacity to meet their debts (in treasury bonds).

Indeed, if euro zone countries are united by the single currency and the European Central Bank, the rates at which they get loans, and the conditions attached to them, vary from one country to the next. Before the crisis, the spreads remained quite limited. But with the plunge into recession, and the gigantic assistance granted by the various states through bank bail-outs or economic stimulus plans, this is no longer true.

Spain and Ireland, for instance, which until a short time ago, were still praised as models of economic success by pro-marketers in Brussels and elsewhere, are now going through a period of fierce turbulence. As a result, they are at a disadvantage on financial markets and find it difficult to raise money.

Sovereign loans in the euro- one consequently tend to be widely spread. The risk premiums demanded from the frailest countries are soaring, unlike those demanded of Germany, which is still considered an exemplary borrower. The benchmark rate for German (Bund) loans over 10 years last Monday stood at 2.98%, much lower than that of France (3.50%), or of Spain (4.13%) or, above all, of Greece (5.47%).

The over-rated credit rating agencies were not slow in down-grading Madrid and Athens. Downgrading a state amounts to casting suspicion on its ability to pay back its debts as settled, in the best conditions.

In such circumstances, some countries that are strangled by the service of an increasingly heavy debt might be tempted simply to leave the euro ship. To ease the stranglehold, they might try devaluing their restored national currency as a last resource, in order to boost their exports.

This prospect has made the fortune of the managers of the Intrade site where, for the last few months, it has been possible to bet on one or several of the sixteen euro-zone countries opting out of the euro. The contract expires at the end of 2010.

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