Roadmap For Departure

Today it was announced that the Wolfson Economics Prize has been awarded to a proposal on how a country could best leave the Eurozone. A year ago such a proposal would have been greeted with little more than a theoretical appreciation, now it has real world significance. 
Credit Suisse, in May, estimated there was about a 15% chance of Greece leaving the Euro. Others like Standard & Poor's believe this likelihood to be "at least" a one-in-three chance of leaving the Eurozone. While the Greek election results may have allayed fears to some degree, the threat looms large. Fears also remain over other fragile Euro economies like Ireland or Spain for example especially should the Greeks leave which would set a precedent and perhaps initiate a domino effect.


Advocates of leaving the common currency point primarily towards the benefits of a cheaper currency on exports, leading to increased employment and eventually sufficient levels of growth to escape from the grips of seemingly endless austerity. Accompanying such a plan would be an Icelandic style debt default and away we go free of our terrible debt burden and with the reassurance of more prosperous times ahead. So the attractions are clear, how about the practicalities? We will examine these from an Irish perspective. 

                                                           Economist Roger Bootle of Capital Economics

As the Wolfson entry states leaving the Euro would be a combination of two distinct monetary events;


(a) Currency Conversion and redenomination of wages, prices and all other domestic values into the new currency; (an Punt Nua as it is being touted)


(b) Change in the exchange rate of currency, i.e. a devaluation


In addition to the core monetary events are other concerns;


-How and when to leave.
-Subsequent legal effects and relations with outside interests, i.e. EU, creditors, markets.
-Consequences of debt default.
-Social Consequences.


It is would be desirable that any decision to leave the common currency be made in private as much as is possible. Additionally the imposition of capital controls to combat the risk of large scale withdrawals would serve to protect the exiting country's interests. There are many obvious obstacles to this optimal exit strategy. Firstly the ability to keep plans of such a nature confidential is far from certain. Given that reports, although not substantiated, have already surfaced over plans for a Greek exit being drawn up the question must loom even larger. Additionally any sudden announcement of withdrawal from the Euro would seriously damage the democratic foundations of the State having allowed for no discussion or democratic will of the People to be accounted for. Policy makers should thread very carefully in this regard. Setting a precedent for the abandonment of sound democratic practices, regardless of necessity or motive, would have a strong and long-lasting impact on society. While it seems likely that a country would be able to leave the Euro while still remaining part of the EU and that a new currency would be acknowledged by the International community this should not serve to disguise the inevitable difficulties with such 'successes'. It would be desirable to disclose as much information as possible in a reasonable time frame to other EU member states in order to retain goodwill and to smooth the transition for the entire EU. This unfortunately would compromise the need for secrecy in any such plans. Similarly honouring a large degree of debt obligations would lessen the negative impact of a withdrawal but a weak nation like Ireland would be in no position to do so. From the outset then it appears that the theoretically most advantageous exit strategy is questionable at best when faced with the realities of  the political and legal backdrop.


The redenomination of euro to the new currency (An Punt Nua) offers an array of difficulties. The Capital Economics Report dismisses the notion of stamping euro currency to indicate its new identity as An Punt Nua. This 'overstamping' has previously been the most common method of administering a new currency. As the production of new notes and coins is likely to take between four and six months this has often proven to be the most convenient method. The report's suggestion is two-fold;


a) To rely on non-cash transactions
b) To continue to trade in euros for the remainder of transactions where option a) is not viable


The notion of using a new currency of lesser value (the exchange rate of the euro having risen in comparison to An Punt Nua) to pay for goods seems to be somewhat overlooked by the report. The authors contend that small level payments becoming hypothetically 30% more expensive (given the rate change) should not pose a significant concern. While it is important to remember that no ideal solution exists and that this method may indeed offer the most desirable option, I would tend to disagree with the opinion expressed in the report. The ordinary consumer whose disposable income is already greatly reduced due to austerity measures that have been implemented is likely to find it extremely difficult to manage in a scenario where such transactions, even if infrequent, become far more expensive. One doesn't bare to think what anarchy would befall the nation should a situation akin to that presently at Ulster Bank again rear its head. In such a scenario cash becomes an ever more valuable asset.

A capital flight or 'run on the banks' is also a very acute risk. It is extremely likely that citizens would seek to withdraw large amounts of cash from banks, especially if the euro were to be worth more than the new currency. The solution offered to this is largely to prohibit access to deposits for a period of time until arrangements could be made for withdrawals to be treated as foreign currency debited against An Punt Nua. There is also the likelihood that institutional investors will seek to withdraw their holdings from Irish banks and instead deposit them in a 'safer' bank. Such a 'flight to safety' further diminishes the liquidity of the banking sector. Less liquidity means greater likelihood of a banking collapse or alternatively greater outside assistance from the ECB in the manner we are currently witnessing. It would, however, be foolhardy to expect the ECB to blindly continue to pump vast sums of money into a failing banking sector once they become sufficiently disillusioned with their chances of getting their money back.


The devaluation of the new currency is the kernel of the argument for leaving the common currency. Devaluing to such an extent that competitiveness is restored and export led growth allows the economy to grow out of its current difficulties. Managing the devaluation is fundamental to the success of the strategy. It is estimated by the report that Ireland would require a devaluation of roughly 15% but that initially this may reach closer to 25%. A problem arises when the depreciation goes beyond the desired levels and are marginally less beneficial to the economy. That is, that the price of imports rise by more than the price of exports as seen in the Icelandic economy. The core solutions set out by the report are;

"Act pre-emptively and put in place credible monetary and fiscal frameworks: inflation targets should be laid down; establish limits to the use of quantitative easing; publish a framework to constrain fiscal policy; and task an independent body to monitor the authorities' adherence to these targets."

Should these measures fail however, and the new currency devalue to a larger extent than is expected or desirable it will serve to devalue citizens personal wealth while delivering diminishing positive impact to the growth of the economy. Devalued wealth means more expensive goods and services. The impact could not be avoided. The average price of petrol is, at present, 159.9 c per litre. Already hugely costly. Now imagine with a devaluation of An Punt Nua of 25% and the price at the pumps becomes a frightening 199.88 c per litre. And lets face it we may export a lot in this country but equally we import a lot too. Expect many of what we would consider to be fundamental goods & services to either disappear completely or become significantly more expensive.


The other main concern raised by leaving the Euro is that in the minds of most experts it would absolutely be accompanied by a large-scale debt default. Both go hand in hand. A debt default means we as a nation could not, in all likelihood, access credit from anywhere. Certainly not the money markets, and probably not the IMF. Should this arise where then do we find the money to continue the smooth running of the country. The payment of wages being perhaps the most obvious casualty. A deficit of €16bn would have to closed in this country through extreme cutbacks in expenditure. To put it into context the current public sector wage bill is approximately €14bn, cut that and you still have another €2bn to find. It's a huge swathe of money that would have to be cut and which would in all lieklihood result in untold hurt for citizens. Unfortunately we have already witnessed across Europe the degradation of social harmony and a disregard of peaceful protest. Given the circumstances in which people find themselves in their motives can largely be appreciated. Should even greater hardship be placed on the shoulders of our citizens I wouldn't bet against the same unsightliness on the streets of our cities, towns and villages. Eventually people will tolerate no more.

I may seem to have disregarded the work of the Wolfson prize winners in the summary it inspired above. Far from it. As the saying goes; you can't make a silk purse out a sow's ear. The contents of the report will never make for pleasant reading and will inevitably raise concerns as to the efficacy of the recommendations as expressed above. Perhaps given all its drawbacks it may be the best option for a struggling nation like Ireland, burdened by a crippling sovereign debt and bowed by continued austerity and the absence of growth. It is my opinion that this is not the case and that exiting the Euro remains the option of last resort, that for now at least we need not consider. What is not in doubt is that this is an issue that is becoming increasingly significant across the Eurozone and will in all likelihood continue to do so for the forseeable future. For now the departure remains conveniently contained in its hypothesis only. Should the time come for it to break into reality we'll all be scrambling for the Woolfson Prize winning entry 2012, here for your convenience.... 


http://www.policyexchange.org.uk/images/WolfsonPrize/

The Fiscal Compact Treaty
An Irish Perspective


May 31st 2012 is a date likely to resonate with generations of this country for years to come. That day the people of Ireland will be asked to either support or reject the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, or the Fiscal Compact to you and I. Unfortunately the day is fast approaching, and with 19% of the population undecided as to which way to cast their vote time is running out. The American writer Henry Adams' assertion that "during a campaign the air is full of speeches- and vice versa" has never seemed so apt. This campaign, like most others in this country, has been dogged by a litany of mistruths, political point scoring, and claim and counter-claim . To distinguish fact from fiction has been an unnecessarily arduous task. The following seeks to chart a different course and lay out the facts of the Treaty as they pertain to its key elements.

Firstly it is important to establish the budgetary changes that the Fiscal Compact will initiate if ratified. The Compact;

• introduces a lower limit of a structural deficit of 0.5% of GDP
• requires member states whose Debt:GDP ratio is greater than 60% to reduce this ratio at an average rate of 1/20th  of the deviation per annum. (i.e. if a country's Debt:GDP ratio is 80%, then the deviation from the threshold is 20% thus requiring a reduction of 1% per annum.)
• introduces the key provision that budgetary rules shall be enshrined in national law through provisions of "binding force and permanent character, preferably constitutional." (Article 3(2) )

It is prudent to note that the Fiscal Compact itself does not alter much by way of budgetary provisions as set under the 'six pack' of reforms introduced in late 2011. The key innovation is the proposal to enshrine these provisions in national law. Philip Lane, Professor at TCD notes that "domestic legal requirements are more likely to induce fiscal discipline than external rules such as the SGP, since only the domestic system can effectively hold a government to account". Given the weak fiscal governance and enforcement that checkers the history of the EU Council, Prof. Lane might just have a point.

Bunreacht na hÉireann

If ratified the Treaty will introduce a new way of measuring budget balances- the structural deficit. The introduction of the structural deficit has caused consternation amongst some commentators, but drawn high praise from others. Essentially, the structural budget makes sense. It takes into account changes in the business cycle and may therefore aid governments in implementing sustainable fiscal policies and effectively promoting macroeconomic stability through counter-cyclical measures. The problem is the structural deficit is not easily calculated, in fact no consensus exisits as to whether it can be accurately calculated at all. It seems wholly illogical and irresponsible to base facets of such an important treaty on a concept which is incapable of meaningful measurement.  Brian Lucey, Professor of Finance at TCD perhaps then put it best in stating that"we are asked to support the immeasurable in the pursuit of the unattainable." Regrettably it appears support of the structural deficit is a matter of faith and no more. 

Another topic of debate in this referendum is the access to funding that the State will have as a result of the vote. In reality, however, little time and effort need be exerted in the discussion of this issue. Should we reject the Treaty, Ireland will not have access to the European Stability Mechanism (ESM). Only those member states that ratify the Treaty will have access to these funds. Consequently, were the country to need a second bailout (as is looking increasingly likely) it is unclear as to where the money would come from. Rejecting the Treaty sets our course through uncharted waters in this regard. Alternative sources of capital have been mooted, such as simply raising funds through the market or receiving further assistance from the IMF. It seems unlikely, however, that the IMF would provide such funds, or at the very least wholly speculative that they would do so. Minister Michael Noonan has also advised the Dáil that the IMF has "indicated that it will provide funding to Ireland only as part of a European initiative". Even more unlikely is the prospect of reentering the bond markets in late 2013 at any reasonable interest rate. As recently as Wednesday (23rd May) the National Treasury Management Agency (NTMA) advised that rejection of the Treaty "would mean in all likelihood that it would not be possible for Ireland to re-enter the bond markets at sustainable rates".

The final bone of contention for many is the proposed introduction of a Financial Transactions Tax (FTT). Bear in mind, The Fiscal Treaty does NOT expressly include these proposals, instead it is thought that ratifying the Treaty would lead inevitably to greater fiscal unity and integration which would ease the way for the introduction of such a tax. The tax, commonly referred to as a 'Tobin tax' would apply to the sale and purchase of financial instruments, when transfer of ownership occurs, a levy must be paid. The concept is no different to say the working of a property tax. There are too schools of thought on the issue. The first, argues in the name of prudence and equity that it is high time such a tax were introduced as it would serve to curtail the highly speculative trading that initially led to the financial crisis and would also force the financial sector to contribute towards the resolution of a problem they helped create. Conversely, the Irish government is staunchly opposed to such a tax and perhaps with good reason. It is their belief that the imposition of such a tax would be catastrophic for the financial services sector in this country, in encouraging business to migrate to non-taxable areas. David Cameron has already vowed to fight the tax in defence of the City of London and refused to back the Treaty at a summit late last year as a result. The fear is that those in the IFSC will follow the path trodden by the Irish diaspora of times both past and present, in heading for the safe refuge and greener pastures of the city of London.

Dublin's International Financial Services Sector (IFSC)

Ratifying this Treaty guarantees the country access to future funding in the all too likely event of needing to access it. It seeks to encourage a degree of fiscal discipline which has been largely found wanting in the history of the State, and as such must be welcomed. Unfortunately it is likely to send the country into further decline and deeper recession, along with the other fringe nations of Europe. It is flawed in the absence of any growth agenda and seeks to impose sanctions on offending nations in the name of a concept many experts consider immeasurable. It may help herald the introduction of a tax regime whose costs and benefits have not been adequately determined and enshrines budgetary provisions in national law. The war currently being waged for the favour of the people is a tumultuous affair. One that cares for its outcome is faced with any number of conflicting views, through which they must sift in order to cast their vote with conviction rather than faith.

The edict handed down by the will of the German's is a tough pill to swallow, yet perversely it might be in the country's interests to do so given the forsaken state we find ourselves in and the prospect of even greater hardship that lies ahead should we decide not to.