Nov. 19 (Bloomberg) -- There will be many twists and turns as the Ireland debt crisis unfolds and there’s a chance a resolution might just lead to Asia.
Here’s how I see it playing out. Ireland will accept a modest package of support from the European Union, presumably with International Monetary Fund involvement. At the same time, investors are coming to realize that Ireland’s future debt path is, beyond a reasonable doubt, unsustainable.
But a modest package will make very little difference. Ireland and its EU partners will have to resolve the underlying issues, including a restructuring of banking and sovereign debt.
We’ll get to that point because, absent a global growth miracle, the numbers are stacked too high against Ireland. But there won’t be any quick jump to a solution; it will be slow, painful-to-watch chess match in Dublin, Brussels and around the IMF headquarters in Washington, with obvious and costly spillovers to Portugal, Spain and perhaps other countries.
Why does it have to be this way? Delay and prevarication at this stage have nothing to do with any of the key players being taken by surprise. The writing has been on the euro-zone wall for at least two years.
In late October 2008, Peter Boone, James Kwak and I suggested that some European countries had given taxpayer-backed pledges to banks that had liabilities that were larger than their own gross domestic products. We also proposed the creation of a European Stability Fund with at least 2 trillion euros ($2.7 trillion) of credit lines guaranteed by all EU member nations as well as Switzerland, Sweden and the U.K. to buy time for dealing with the underlying issues of solvency in Ireland and elsewhere.
The euro zone belatedly acted on that piece of advice, but the politicians in charge, both at the core and on the periphery of Europe, have refused to take responsibility for what they allowed to happen in the run-up to 2008. Europe’s leaders have told themselves and their voters that most of the world’s problems are due to the meltdown of the U.S. housing market and the way in which America’s megabanks went mad.
There is, of course, an element of truth to this. But it also misses the bigger European picture and what is blocking progress even today. The main proponents of unconstrained financial globalization may have been U.S. Treasury officials in recent decades, but it was European banks that really became too large relative to their economies. Along the way, they captured their regulators and engaged in incredibly irresponsible behavior.
‘Ship of Fools’
Ireland may be an extreme in this regard. It’s worth checking David Lynch’s perceptive new book, “When the Luck of the Irish Ran Out,” (disclosure: I provided a dust-jacket blurb) or the even more scathing “Ship of Fools: How Stupidity and Corruption Killed the Celtic Tiger,” by Irish journalist Fintan O’Toole. Both lay out the web of connections between politicians, bankers and real-estate developers that accounted for the frenzied growth and subsequent crash of the Irish economy.
In “The Quiet Coup,” published in Atlantic magazine in May 2009, I compared the U.S. economic boom-bust-bailout cycle to what has become typical in emerging middle-income countries such as Russia, Argentina or Indonesia. Just don’t think these problems are limited to emerging markets.
There is a much more general or global phenomenon in which powerful people cooperate to build an economic model that provides growth based on a great deal of debt. When the crisis comes, those who control the state try to save their favorite oligarchs, but there aren’t enough resources to go around.
Pushed From Lifeboat
Even after social spending is cut and taxes are raised, shifting as much of the costs from the elite to ordinary citizens, some of the rich and powerful -- think Lehman Brothers -- still need to be pushed from the lifeboat.
Here is the present problem: It’s not just the Irish elite that is under pressure and struggling to sort out who should be saved. It’s also the European bankers who funded them.
Under justifiable public pressure, the German government has taken up the theme of burden sharing, meaning that creditors must face losses in future crises. Chancellor Angela Merkel and her colleagues haven’t thought through the signal this sends to the markets today, which is “Get out of Irish banks, now.”
Presumably about now, big German and French banks are pointing out to their governments that when Ireland defaults, they will face big losses too. In turn, problems will spread to Portugal and probably Spain, thus taking some of the spotlight off Irish politicians.
Incentive to Delay
In fact, the Irish leadership has every incentive to delay until other countries can be dragged into turmoil. The crisis will become euro-zone wide, at which point all eyes will turn to some combination of the European Central Bank, the German taxpayer, and the IMF. But the ECB can’t pay and the German taxpayer won’t pay. Does the IMF have the resources to tackle Spain, let alone a bigger country like, say Italy or even France?
The U.S. could add sufficient funding to the mix -- this is what it means to be a reserve currency -- but the mood in Washington has shifted against bailouts.
As an alternative, Europe could place a call to Beijing to find out if China would like to commit some of its $2.6 trillion in reserves to keep European creditors whole. This would be an enormous opportunity for China to vault to a leading global role. Perhaps it was a good idea to place Min Zhu, a top Bank of China official, in a senior position at the IMF.
If China offered to recapitalize the IMF, become the largest shareholder, and move the organization to Beijing (according to the Articles of Agreement, the IMF’s headquarters should be in the capital of the largest shareholder), wouldn’t that make for an interesting chess game?
(Simon Johnson, co-author of “13 Bankers: The Wall Street Takeover and the Next Financial Meltdown,” is a professor at MIT’s Sloan School of Management and a Bloomberg News columnist The opinions expressed are his own.)
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