After much initial hesitation, the Irish finally agreed on a “rescue package” over the previous weekend. At first glance it looks like the worst is behind them, but it’s not. Ireland’s public debt will now top out at 130%, so in plain English the fundamentals have not improved. Nonetheless, the ECB is trying to sell this latest “rescue package” as the ultimate solution, or “mission accomplished” if you will. The international loan which the ECB brokered grants Ireland an interest rate of 5.8%, but that’s only on the surface, since Ireland couldn’t repay the debt immediately without causing quite a stir of Irish discontent and frustration.
But well, Ireland’s generous lenders are anything but a good Samaritan driven by charitable motives. The international loan is first and foremost a good business deal for the international group of lenders.
The structure of the Irish deal has been cut out in a way that interest and principal payments the bondholders will add up to nearly 10% of the country’s national income.
This way, painful austerity measures across the board will become the ‘new normal’ for Ireland and this will translate at best to an anemic growth rate of near zero, or even worse, a harsh economic decline.
Without robust growth, the share of Ireland’s debt to GDP will keep growing and once the payments kick in, they will cripple the economy even further.
Also, drastic cost-cutting measures won’t be popular with the Irish constituency. The ECB and the German government have created a marketable “solution” driven by short-term populism instead of finding a sustainable and viable path to growth. The ink on the deal might not have yet dried when early next year the new Irish government could opt to reject the deal brokered by its predecessor.
A vicious cycle ahead for Ireland
In a pre-Euro era Ireland would go about devaluing its currency. But this option is no longer available to Ireland as a member of the Euro zone. The fact that the ECB, which is conveniently headquartered in Frankfurt, Germany, and the German government insisted on severe cuts is a clear sign of total ignorance of rather basic economic theory. Whoever is putting the Keynesian “paradox of thrift” to a test in the middle of the biggest recession in almost a century is in for a rude awakening. Austerity, while unavoidable in light of the current sentiment, will put a damper on the aggregate demand and choke off both consumption and economic growth. The more Ireland succeeds in cutting wages and costs the less the Irish will be able to spend (on German imports, too), the more Ireland’s GDP will fall. The more the GDP falls, the higher a share of it will be due bondholders. The higher the payments in relation to the national income, the more Ireland will have to tighten the belt to come up with the money, setting in motion a vicious cycle of ever more austerity.
Estland’s economy has recently shrunk by a whopping 30% following a similar self-imposed recipe for economic disaster. What makes the ECB think this scenario is not going to repeat itself and render the payment schedule all but obsolete?
Germany’s Chancellor Angela Merkel has reportedly announced that Germany was prepared to leave the Eurozone. So long as Germany keeps bankrolling the periphery, the periphery probably won’t mind.