Over the last few weeks we have been hearing the Eurozone alarm bells ringing. This time it was Ireland, which had to call the European Union fire brigade – or, as it is otherwise known, the European Financial Stability Facility (EFSF). The yield for 10-year Irish government bonds rocketed to above 9%, marking the highest level since the introduction of the Euro twelve years ago. This number mirrors the uncertainty over Ireland which prevails in the market. The benchmark for bonds in Europe are the German bonds which are at 3% (10year) at the moment. With uncertainty about the strength of the Irish economy and worries that they will not be able to pay back their debts, investors start fleeing, i.e. selling the bonds they hold, which causes a dramatic fall in the value of the bond and therewith a rise in the yield. The yield is like a mirror of investor sentiment of a certain bond.
In this case, there are two main reasons for this substantial increase in the cost of borrowing of the Irish government. Firstly, Ireland will have to pump yet more money into its troubled banking sector. Given that saving Irish banks from bankruptcy during the financial crisis has already cost the taxpayer 50 Billion Euro – or 30% of GDP – this is a very important and real worry. With an astronomical 32% budget deficit this year, Ireland simply could not afford to spend more money on bailing out its banks from its own reserves. Out of the €85 billion aid package that has been announced, an estimated 65% will need to go into Ireland’s banking system – which brings with it the prospect of nationalising its two biggest banks. Secondly, there is still uncertainty over whether private investors will also be asked to chip into the aid package of the EU and IMF. In late October, Angela Merkel pushed her plan through to set up a new bailout system for future Greek-like scenarios. She demanded that this new system should force private investors to contribute up to 30% of the cost of a bailout. Despite the fact that this permanent crisis resolution mechanism will not replace the EFSF until its funds run out in 2013, the prospect of having to pay such extra costs – or “haircut” – spooks current bondholders, triggering huge activity on the bonds market. Next to Ireland, this also significantly affected the bonds of Europe’s other black sheep – Greece, Spain and Portugal.
Despite the insistence of the Irish government that they would not need to borrow any more money until June next year, the Prime Minister has since submitted his government to the conditions of an EFSF aid package, which primarily comprises rigid austerity cuts. So in December the government has a crucial chance to calm the markets, when Parliament will vote on the new budget. This bill must be passed; otherwise, Ireland will be at risk of losing European support and the country will be left at the brink of bankruptcy. But this austerity will, most certainly, also be political hara-kiri for the current government, which is now under pressure from the opposition to call new elections early next year. In order to maintain the “unique selling point” of the Irish political economy for foreign investment – the lowest corporation tax of any OECD country at 12.5% – the government will have to cut the minimum wage and reduce public sector pay and welfare spending. In other words, the cuts will hit the poorest people the hardest and further Ireland’s structural problems of regional differences and an unequal labour market (neglecting old people and women) amidst the vow to seize Ireland’s only opportunity to return to growth and meet the European Stability and Growth criteria by 2015. Ireland is relying on a return of the Celtic Tiger, a problematic idea to say the least, given the current mess that this approach has got Ireland in.
So Greece is down, Ireland is down – only two to go! Admittedly, Portugal’s situation bears great resemblance to a toxic mixture of Ireland and Greece, with traditionally poor (Southern-European style) public administration and sluggish growth over the last decade and now a sovereign debt level of 109%, similar to Ireland. After the biggest Portuguese strikes in its democratic history in November and an austerity package passed, it still looks like Portugal will be forced to call the European fire brigade during the next few weeks. Spain, however, is in a very different situation and arguably should not be brand-named together with the other countries to form the PIGS. Spain’s sovereign debt is comparatively low at 60% of GDP, its liabilities to the international capital markets is only at 40%, less than half of Ireland, and austerity measures have been implemented early and are already starting to show positive effects. If Spain, the country with 20% unemployment, does, however, fall, the Eurozone is very likely to stumble too. The member countries simply cannot afford a bail-out of an economy of Spain’s size, which is four times bigger than Greece.
With the current worries over the European debt crisis, a more general discussion about the Eurozone is emerging – as, notably, this crisis is the first big test for the Euro. Many have started to argue that it marks the beginning of the downfall of the currency. It is true that, in the aftermath of this crisis, we are witnessing the 16 Eurozone member states beginning to drift apart. Whilst Germany and France are enjoying remarkable growth, the weaker economies – most prominently the four black sheep mentioned above – are drowning in their debts. The problems of coping with differences in the national approaches of the separate political economies under the Euro-umbrella have come to light most vividly. The diversity of the Eurozone members makes crisis management a daunting task for the EU. Bob Rubin eloquently paints this diverse image, stating that Europe is like a museum with splendid antique relics: to the left, the French room devoted to social solidarity; to the right, the German room devoted to metal bashing and mass manufacturing; and out in front, the Swedish room devoted to social democracy. In short, Europe looks politically and structurally incapable of adapting to the challenges of today, let alone tomorrow. Add to this the situation in the new crisis economies of Ireland and Southern Europe, and we can begin to grasp the size of the mess that the Euro is in and the multitude of levels on which solutions have to be found. But we cannot forget the immense political import of the step to establish a joint currency and the commitment of the EU and each of the 16 Eurozone members to support the Euro. The €750 billion crisis fund illustrates most strongly that the political elite of Europe is certain that its Euro is here to stay.