David McWilliams on Irish (and Italian) euro exit

When I was running through Italian default scenarios earlier in the day, I asked “Could Italy unilaterally exit the euro zone and redominate euro debts at par into a new Lira currency to forestall the default? Perhaps. That is something to consider at a later date.”

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Well that later date is now. I caught David McWilliams writing how he thought the end of the euro is nigh. In his discussion he outlines how a ‘two-speed’ Europe would function after an Irish exit from the euro zone. I imagine the same could work for Italy too. The part highlighted caught my eye:

Consider what the two-speed Europe might look like.

The first thing we know is that the peripheral countries can’t keep up with Germany. Take Ireland as an example. When we had the Punt linked to the Deutsche Mark we devalued six times in thirteen years just to try to keep up competitively with the Germans. Conversely, when we joined the Euro and could not devalue, we lost 30% competitiveness against Germany. It could not be clearer.

For the other peripheral countries the situation is worse.

So we all need a change in the value of the currencies we trade in to make our companies more competitive and thus, more likely to export. In tandem, we need to make imports more expensive so we don’t buy too many of them. The weaker exchange rate achieves this. Devaluations work. And to any one who doubts this, just point to the lasting competitive gains garnered by Finland and Sweden after their 1992 devaluations.

Without currency change, we can’t keep up with the Germans and this makes the EU’s promise of economic convergence hard to achieve without huge borrowing. Up till now, we borrowed to achieve a lifestyle and a level of economic activity. Now none of us can pay this money back.

So we need debt forgiveness or some debt deal. Accompanying the new euro would be mass debt write downs because if you reduce the value of the currency that the people get paid in but you don’t commensurately reduce the value of their outstanding debts, the people will simply not be able to pay and the country will default after the devaluation. This would not be clever. Everything must be done together.

So let’s think about the new euro. The new soft euro would trade at 70% of the old one (my figure plucked out of the air). This would mean that relative to Germans, our standard of living would be cut by one third overnight. We would achieve in one night what the present policy seeks to do in five years.

We would be extremely attractive place to investment in because our labour would be much cheaper. But don’t forget that this reduces our income by the same amount.

All our debts would be reduced by 30% because they would be in a new currency. Obviously, the banks that lent in hard euros and would now get paid in soft euros would carry a huge exchange rate loss. This would need to be dealt with. Possibly, the banks in each country could issue bonds backed by the EU and redeemable for new euros at the ECB. These bonds could be considered capital so that the banks didn’t go bust.

What about the savers who lost out on their stock of old euro saving which would be devalued by 30% when converted into the new euro? They could be given new inflation-linked euro bonds issued by the State and redeemable from the ECB but not straight away. There would be an incentive to keep them in the banks as savings. This is normal because if you think about it, most people don’t touch their savings. The State would have to make sure that the new bonds were credible enough so that people wouldn’t want to cash them straight away.

There is no easy way out of this mess. There is no way we can wave a magic wand and promise that no one will be affected, but it is clear that the euro is on its way out and will at best, mutate into something else.

The two-speed euro idea, at least prevents the chaos of a messy implosion and the rushed reintroduction of many currencies. It achieves the competitive devaluation, which for us with the majority of our trade and investment coming from and going to, America and Britain, it would give us a shot in the arm. The debt forgiveness element would also give the heavily indebted commuter generation – the Pope’s Children – a break.

There is never a best way to do things in a crisis, simply a least bad way. Maybe this is it.

One thing we do know for sure is that “when things can’t go on forever, they stop”.

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The key part: “All our debts would be reduced by 30% because they would be in a new currency”. It sounds like he’s thinking about Ireland the way I was about Italy. If it works for them, why wouldn’t it work for Greece, Spain and Portugal too?

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13 Comments
  1. Rafael Barbieri says

    I can’t help but think that this is flawed seeing as Ireland’s competitiveness relative to Germany would remain the same.  Thus, the underlying dynamics between intra-EU nations would go unchanged.  

  2. Rafael Barbieri says

    I can’t help but think that this is flawed seeing as Ireland’s competitiveness relative to Germany would remain the same.  Thus, the underlying dynamics between intra-EU nations would go unchanged.  

  3. John Haskell says

    Consider the coercive power available to Josef Stalin to change the “underlying dynamics” between the various countries which made up the USSR.
    Further consider Josef Stalin’s willingness to use that coercive power.
    Finally consider whether or not Tajikistan has “converged” to Estonia over the past century.

    Now consider how Merkozy stacks up against Josef Stalin on the criteria above.

    Take your time and good luck!  You’ll need it.

  4. Anonymous says

    Consider the coercive power available to Josef Stalin to change the “underlying dynamics” between the various countries which made up the USSR.
    Further consider Josef Stalin’s willingness to use that coercive power.
    Finally consider whether or not Tajikistan has “converged” to Estonia over the past century.

    Now consider how Merkozy stacks up against Josef Stalin on the criteria above.

    Take your time and good luck!  You’ll need it.

  5. Dave Holden says

    Acting Man (http://www.acting-man.com/?p=11743) points to a piece in Der Spiegel http://www.spiegel.de/international/europe/0,1518,797666,00.html.

    Then makes the point

    “Interestingly,
    Germany’s public, its most prominent economists and its commercial
    banking establishment are all backing Weidmann’s views.

    So
    if there really is a ‘plan B’ regarding the disposition of the ECB’s
    printing press, then it will have to happen over the dead body of
    Weidmann, metaphorically speaking.”

    1. Edward Harrison says

      The anti-inflation phobia runs deep and so despite the obvious signs of edge of disaster panic all around, the cognitive dissonance this anti-inflation fear creates is huge. Moreover, Germany takes rules very seriously. Their policy makers are more inclined to stick to a principle than most. I believe the Germans will dither until the last possible moment. If they have underestimated the effect this dithering will have (which I believe they have), we will see a deep downturn.

  6. David says

    I’m based in Ireland and quite honestly, I no longer know where I stand with anything anymore. 
    Day-to-day life is still relatively unchanged in many respects for many people. On the surface of it, you really wouldn’t notice that there has been a major economic disaster here. Things are ticking over, people are shopping, going to restaurants, doing normal ‘stuff’.

    I suppose, perhaps unlike Greece and even Spain and Portugal, Ireland had truly remarkable levels of growth at the peak of the bubble, particularly from about 2004-2008. Many of those gains were largely theoretical, speculative, paper wealth which had little impact on the real economy other than for a handful of speculators in the property sector. Also, the gains that most people made were quite short term and unusual, so they had an ability to take a pay cut, at least a little one. So, perhaps there was a little bit more of a cushion / buffer than there was in Greece where that growth probably was reflected in real economics. For us, there was definitely a little bit of a ‘what goes up, must come down’ feeling to it.

    There is a real ‘Celtic Tiger’ economy i.e. the actual growth that took place in the 1990s, based on real exports in food, IT, pharma, biopharma, etc etc buried under all the remains of the bubble and that is still ticking away quite strongly. 

    A lot of people are in negative equity with their mortgages, but the banks are not really foreclosing on anyone either, certainly no anything like the way American banks are behaving. 

    State services have been somewhat curtailed, but they were never particularly great to begin with in comparison to the rest of Europe. For example, our healthcare system does not, and has never, provided full universal care. It’s always been topped up with private insurance and only provides universal coverage for those on the lowest incomes. Nobody really expects all that much from it. 

    Taxes have increased, but again, they are not intolerable (yet). The public have also vented a lot of their rage in the last general elections by completely wiping-out Fianna Fail, the party which was dominant in Irish politics all through the boom times and has been the default option for Government since the foundation of the state. 

    Mass emigration is most definitely underway. It’s a little odd though as the population is not shrinking dramatically. Rather, the people with the wrong skill sets i.e. those in construction, architecture, aspects of engineering related to construction, tradesmen/women etc are leaving for other property bubbles like Australia and the Canadian mining boom, while there are still lots of career opportunities in areas like IT in Ireland which are being filled in part, by people coming from abroad or by Irish graduates / those retraining.

    All that being said, there is still a recipe for serious problems in Ireland. I don’t think that the penny has fully dropped yet. People are uncomfortable, but not very uncomfortable. It’s like the tires are flat, but the wheels haven’t quite fallen off just yet.

    If/when services are seriously cut back or if/when banks start evicting people from their homes, that’s when I think you will start to see serious unrest in Ireland and probably a major political shift away from the centrist parties. I don’t think that you’ll see a swing to the right in Ireland, there’s really very little interest in that sort of thing here, rather you’ll probably see a swing towards independents and the centre-left nationalist parties with more radical anti-banker policies like Sinn Fein.

    Depressingly, every week there are more and more revelations into how badly things were regulated and how a group of speculators, bankers and light-touch regulators, combined with a “see no evil, hear no evil” Government that only saw growth have left us in a situation where ordinary folk are baling paying off the debts of speculators and former billionaires who lashed their borrowed cash on high-risk gambling i.e. the property market, and several of the high-risk lenders.

    A lot of us are feeling like we’ve been “conned”, “had”, “taken for fools”, sucked into a stupid pyramid scheme in which we not only lost our money, but lost our sovereignty too. My grandparents generation left the UK and the British empire, overthrew a whole unfair system of landlord-classes owning everything and setup a new country with all sorts of hopes, dreams and aspirations and I have a terrible sense that we are about to spiral into another lost century, never mind decade, of paying off the gambling debts of a new aristocracy.

    All in all, as a citizen, I just feel completely confused. It’s crazy really, in 2011, in post-war Europe, I don’t know if my bank account is safe, I don’t know what currency I’ll be using in a few months, I have no idea if my pension provisions are safe. I don’t know if the education system will be functioning, if the roads will be maintained, if the health system will work. The whole situation is nuts and I don’t think anyone really ever thought that we would ever be in a mess like this.

    I’ve personally lost all confidence in not only the Irish political establishment, banks, and regulators but also in the wider European systems and perhaps even the whole model of banking/economics that’s been pursued in Europe and the US over the past couple of decades.

    I really just feel totally disillusioned and I think it’s time for a serious rethink of everything! We cannot simply go on throwing open markets and deregulating everything. It clearly has not worked and has caused a total mess.

    Apologies for the very long post, but I just felt perhaps it might be a nice idea to give a sense of perspective from ‘the front lines’ of the Euro Crisis.

    1. Beckyboy1 says

      Yes,  One may lose faith in Ireland but not by German led EU. 
      The reason I say ” Time has proven that Ireland by enlarge talks too much rather than perform properly unlike northern European”.  It will bloom well after few months.  This drama will settle into better things. 
      But there will a bigger bubble later in 8-10 years but that time inner core EU will withstand the ideology if they sort out . The bankers will reappear in different disguise. 
      Banks will no longer be safe heavens any more.  

    2. Dave Holden says

      Golem XIV points to a piece by the UniCredit Ireland Whistleblower done by Australian Television

      http://www.golemxiv.co.uk/2011/11/whistleblowerirl-revealed/

      I never failed to be shocked by what went (and most probably is still) going on.

    3. Edward Harrison says

      Sobering thoughts. Thank you for posting them. Two weeks ago, I linked to this video of a Greek woman showing the same kind of despair:

      http://www.bbc.co.uk/news/world-europe-15592957

      And her analogy of the citizens’ marriage to policy makers secretly running up debts and putting the family in jeopardy was superb.

      Everyone has been blindsided by all of this. I think your sentiments, already entrenched in places like Spain and Greece, will spread to Germany and France as well when people wake up to the contingent liabilities of their banking system.

      Right now, the Germans are riding high because their economic model is working well in this environment.But, as a rule of thumb, it is usually the net creditor that suffers the most in a deflationary bust. Creditors everywhere are trying to prop the system up and extract as much as they can from the credit they recklessly lent. But the burden is too high. The day of reckoning is coming.

      My hope is that when it does come, we can move quickly to writing these debts down and moving forward because not doing so means we are in for problems,

  7. David says

    I’m based in Ireland and quite honestly, I no longer know where I stand with anything anymore. 
    Day-to-day life is still relatively unchanged in many respects for many people. On the surface of it, you really wouldn’t notice that there has been a major economic disaster here. Things are ticking over, people are shopping, going to restaurants, doing normal ‘stuff’.

    I suppose, perhaps unlike Greece and even Spain and Portugal, Ireland had truly remarkable levels of growth at the peak of the bubble, particularly from about 2004-2008. Many of those gains were largely theoretical, speculative, paper wealth which had little impact on the real economy other than for a handful of speculators in the property sector. Also, the gains that most people made were quite short term and unusual, so they had an ability to take a pay cut, at least a little one. So, perhaps there was a little bit more of a cushion / buffer than there was in Greece where that growth probably was reflected in real economics. For us, there was definitely a little bit of a ‘what goes up, must come down’ feeling to it.

    There is a real ‘Celtic Tiger’ economy i.e. the actual growth that took place in the 1990s, based on real exports in food, IT, pharma, biopharma, etc etc buried under all the remains of the bubble and that is still ticking away quite strongly. 

    A lot of people are in negative equity with their mortgages, but the banks are not really foreclosing on anyone either, certainly no anything like the way American banks are behaving. 

    State services have been somewhat curtailed, but they were never particularly great to begin with in comparison to the rest of Europe. For example, our healthcare system does not, and has never, provided full universal care. It’s always been topped up with private insurance and only provides universal coverage for those on the lowest incomes. Nobody really expects all that much from it. 

    Taxes have increased, but again, they are not intolerable (yet). The public have also vented a lot of their rage in the last general elections by completely wiping-out Fianna Fail, the party which was dominant in Irish politics all through the boom times and has been the default option for Government since the foundation of the state. 

    Mass emigration is most definitely underway. It’s a little odd though as the population is not shrinking dramatically. Rather, the people with the wrong skill sets i.e. those in construction, architecture, aspects of engineering related to construction, tradesmen/women etc are leaving for other property bubbles like Australia and the Canadian mining boom, while there are still lots of career opportunities in areas like IT in Ireland which are being filled in part, by people coming from abroad or by Irish graduates / those retraining.

    All that being said, there is still a recipe for serious problems in Ireland. I don’t think that the penny has fully dropped yet. People are uncomfortable, but not very uncomfortable. It’s like the tires are flat, but the wheels haven’t quite fallen off just yet.

    If/when services are seriously cut back or if/when banks start evicting people from their homes, that’s when I think you will start to see serious unrest in Ireland and probably a major political shift away from the centrist parties. I don’t think that you’ll see a swing to the right in Ireland, there’s really very little interest in that sort of thing here, rather you’ll probably see a swing towards independents and the centre-left nationalist parties with more radical anti-banker policies like Sinn Fein.

    Depressingly, every week there are more and more revelations into how badly things were regulated and how a group of speculators, bankers and light-touch regulators, combined with a “see no evil, hear no evil” Government that only saw growth have left us in a situation where ordinary folk are baling paying off the debts of speculators and former billionaires who lashed their borrowed cash on high-risk gambling i.e. the property market, and several of the high-risk lenders.

    A lot of us are feeling like we’ve been “conned”, “had”, “taken for fools”, sucked into a stupid pyramid scheme in which we not only lost our money, but lost our sovereignty too. My grandparents generation left the UK and the British empire, overthrew a whole unfair system of landlord-classes owning everything and setup a new country with all sorts of hopes, dreams and aspirations and I have a terrible sense that we are about to spiral into another lost century, never mind decade, of paying off the gambling debts of a new aristocracy.

    All in all, as a citizen, I just feel completely confused. It’s crazy really, in 2011, in post-war Europe, I don’t know if my bank account is safe, I don’t know what currency I’ll be using in a few months, I have no idea if my pension provisions are safe. I don’t know if the education system will be functioning, if the roads will be maintained, if the health system will work. The whole situation is nuts and I don’t think anyone really ever thought that we would ever be in a mess like this.

    I’ve personally lost all confidence in not only the Irish political establishment, banks, and regulators but also in the wider European systems and perhaps even the whole model of banking/economics that’s been pursued in Europe and the US over the past couple of decades.

    I really just feel totally disillusioned and I think it’s time for a serious rethink of everything! We cannot simply go on throwing open markets and deregulating everything. It clearly has not worked and has caused a total mess.

    Apologies for the very long post, but I just felt perhaps it might be a nice idea to give a sense of perspective from ‘the front lines’ of the Euro Crisis.

    1. Beckyboy1 says

      Yes,  One may lose faith in Ireland but not by German led EU. 
      The reason I say ” Time has proven that Ireland by enlarge talks too much rather than perform properly unlike northern European”.  It will bloom well after few months.  This drama will settle into better things. 
      But there will a bigger bubble later in 8-10 years but that time inner core EU will withstand the ideology if they sort out . The bankers will reappear in different disguise. 
      Banks will no longer be safe heavens any more.  

    2. Dave Holden says

      Golem XIV points to a piece by the UniCredit Ireland Whistleblower done by Australian Television

      http://www.golemxiv.co.uk/2011/11/whistleblowerirl-revealed/

      I never failed to be shocked by what went (and most probably is still) going on.

    3. Edward Harrison says

      Sobering thoughts. Thank you for posting them. Two weeks ago, I linked to this video of a Greek woman showing the same kind of despair:

      http://www.bbc.co.uk/news/world-europe-15592957

      And her analogy of the citizens’ marriage to policy makers secretly running up debts and putting the family in jeopardy was superb.

      Everyone has been blindsided by all of this. I think your sentiments, already entrenched in places like Spain and Greece, will spread to Germany and France as well when people wake up to the contingent liabilities of their banking system.

      Right now, the Germans are riding high because their economic model is working well in this environment.But, as a rule of thumb, it is usually the net creditor that suffers the most in a deflationary bust. Creditors everywhere are trying to prop the system up and extract as much as they can from the credit they recklessly lent. But the burden is too high. The day of reckoning is coming.

      My hope is that when it does come, we can move quickly to writing these debts down and moving forward because not doing so means we are in for problems,

  8. David says

    One has lost faith in the whole system. I don’t really see a German-led EU doing anything other than floundering around in a mess and being utterly paranoid about non-existent hyper-inflation.

    The Euro is not the Deutsch Mark and I think German commentators in particular are failing to realise this. It is a currency that is supposed to reflect the reality of the Eurozone. It has to work for a whole range of economies i.e. Germany, France, Ireland, Belgium, Austria, and even Greece.

    It’s grossly over-valued, it’s being operated as a very hard currency and is doing immense damage to countries that need a different approach.

    The Eurozone is a very large diverse economy with a whole load of different economic cycles going on. It’s completely ridiculous to try and shoe-horn everything into a German model. That is unlikely to work and is quite likely to cause an absolute disaster for all involved, ultimately including Germany.

    We desperately need pragmatism and we are getting nothing but weird, dogmatic inflexibility.

    What probably needs to happen is a devaluation of the entire Euro, write downs of debts, and a complete reorganisation of the banking system similar to what happened in the US after the Wall Street Crash in the 1920s. There are successful non-idiotic EU banks out there, and I think they should be encouraged to enter retail banking markets where other banks have failed.

    We should not be rewarding failed banking institutions with state, ECB or EU handouts. It’s not capitalism and it’s not socialism, it’s just corruption of the system. We should be trying to get the market to function and rewarding those institutions that didn’t go off the rails by allowing them to gain more market share.

    I am quite sick of people trying to have it both ways when it comes to the Euro. The economies were totally mismatched, and very different. EU regulation of the lending system failed abysmally on a whole load of levels and it has to be reset and rebuilt.

    We all took a risk joining the Euro. We all knew there was a possibility that something could go wrong. It has gone wrong, and we now need to fix it. 

    From what I can see, we will either all hang together, or the markets will hang us all separately, starting with Greece and moving on until eventually they get right through everyone to Germany. One by one we are being picked off because we cannot manage to get our act together and come up with a viable solution. Instead, we’re bickering, squabbling and blaming each other.

    1. David Lazarus says

      I do not like the idea of allowing those that do not go bust to gain even more market share. What should be happening is that if in the case of Ireland, the nationalised banks are broken up. Into much smaller operations, even by type of business. So these new banks could be specialised in retail lending, trade finance, investment banking or market making in currencies or commodities, but importantly not both. Have really simple rules on capital and leverage, so simple that anyone can see if they are being broken. Then these new banks bid for branches. That way banks that cannot get the coverage that they want either build new branches reopen closed branches or come to some deal with competitors to work to get for customers. This would create far more competition with other rules that block banks access to interbank markets or limit their access to stop them having business models that are dangerous. A whole new banking system is needed and no one has espoused a new stable model for banking. 

  9. David says

    One has lost faith in the whole system. I don’t really see a German-led EU doing anything other than floundering around in a mess and being utterly paranoid about non-existent hyper-inflation.

    The Euro is not the Deutsch Mark and I think German commentators in particular are failing to realise this. It is a currency that is supposed to reflect the reality of the Eurozone. It has to work for a whole range of economies i.e. Germany, France, Ireland, Belgium, Austria, and even Greece.

    It’s grossly over-valued, it’s being operated as a very hard currency and is doing immense damage to countries that need a different approach.

    The Eurozone is a very large diverse economy with a whole load of different economic cycles going on. It’s completely ridiculous to try and shoe-horn everything into a German model. That is unlikely to work and is quite likely to cause an absolute disaster for all involved, ultimately including Germany.

    We desperately need pragmatism and we are getting nothing but weird, dogmatic inflexibility.

    What probably needs to happen is a devaluation of the entire Euro, write downs of debts, and a complete reorganisation of the banking system similar to what happened in the US after the Wall Street Crash in the 1920s. There are successful non-idiotic EU banks out there, and I think they should be encouraged to enter retail banking markets where other banks have failed.

    We should not be rewarding failed banking institutions with state, ECB or EU handouts. It’s not capitalism and it’s not socialism, it’s just corruption of the system. We should be trying to get the market to function and rewarding those institutions that didn’t go off the rails by allowing them to gain more market share.

    I am quite sick of people trying to have it both ways when it comes to the Euro. The economies were totally mismatched, and very different. EU regulation of the lending system failed abysmally on a whole load of levels and it has to be reset and rebuilt.

    We all took a risk joining the Euro. We all knew there was a possibility that something could go wrong. It has gone wrong, and we now need to fix it. 

    From what I can see, we will either all hang together, or the markets will hang us all separately, starting with Greece and moving on until eventually they get right through everyone to Germany. One by one we are being picked off because we cannot manage to get our act together and come up with a viable solution. Instead, we’re bickering, squabbling and blaming each other.

    1. Anonymous says

      I do not like the idea of allowing those that do not go bust to gain even more market share. What should be happening is that if in the case of Ireland, the nationalised banks are broken up. Into much smaller operations, even by type of business. So these new banks could be specialised in retail lending, trade finance, investment banking or market making in currencies or commodities, but importantly not both. Have really simple rules on capital and leverage, so simple that anyone can see if they are being broken. Then these new banks bid for branches. That way banks that cannot get the coverage that they want either build new branches reopen closed branches or come to some deal with competitors to work to get for customers. This would create far more competition with other rules that block banks access to interbank markets or limit their access to stop them having business models that are dangerous. A whole new banking system is needed and no one has espoused a new stable model for banking. 

  10. Edward Harrison says

    The anti-inflation phobia runs deep and so despite the obvious signs of edge of disaster panic all around, the cognitive dissonance this anti-inflation fear creates is huge. Moreover, Germany takes rules very seriously. Their policy makers are more inclined to stick to a principle than most. I believe the Germans will dither until the last possible moment. If they have underestimated the effect this dithering will have (which I believe they have), we will see a deep downturn.

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