The Rescue Ireland Can Do Without

12/02/2010 10:05 am EST

Focus: GLOBAL

Igor Greenwald

Chief Investment Strategist, MLP Profits

Another bailout like this and Germany can quit fretting about Europe. The poor old lady will be torn apart, her northern regions getting on just fine while the south chooses between permanent austerity and an exit from the euro.

The terms of Ireland’s rescue proved generous only to those betting against the common currency and European bonds. They made out like bandits, thanks to the German insistence on extracting the last pound of flesh from allies down on their luck.

In effect, Germany will be borrowing at 2%, then lending to Ireland at 5.8% so that the Irish can recompense German banks, among the other creditors of the insolvent Irish lenders.

Annual interest on Ireland’s $90 billion in new external loans, once they’re fully disbursed, will work out to more than 2% of the Irish gross domestic product—meaning that even moderate growth would feel like a recession after Ireland pays its tribute to Brussels and Frankfurt. That’s in the ballpark of the pain inflicted on Germany by Allied reparations after World War I, except that Germany won’t get to occupy County Cork should the Irish balk at paying up, down the line.

Which is one reason Ireland won’t even get the foreign loans until after it has tapped its own pension funds and spent whatever other spare change it can find under the bar stool.

The alleged rescue reminded New York Times columnist Paul Krugman of Jonathan Swift’s “Modest Proposal”, except that modern Irish youth isn’t likely to stick around to sustain Ireland’s creditors.

The discredited Irish government of the moment won’t be sticking around for long either, so the only question is how the next one might appease popular opinion in favor of letting the country’s zombie banks default. Europe wanted Ireland’s funds used first to foreclose that possibility. But with bailout-mandated austerity threatening continued depression, the next government will have every incentive to seek better terms, just like Weimar Germany did repeatedly.

Ireland could really use a bank debt default, to discover how accommodative foreign creditors might be when the alternative is that they get nothing. It could also use a currency devaluation via a return to the Irish pound, to boost exports.

Looking Up at Iceland
That’s the kind of bold action that saved Iceland and before it Argentina a decade ago. Argentina’s experience is especially instructive: It spent several years as an international financial pariah after abrogating its sovereign debt, yet now has foreigners throwing money at it on terms that Ireland can only dream of. And how did it get so fashionable? By growing faster than it ever could have had it been servicing an unsustainable debt load.

In contrast, Ireland will have none of those advantages under its current deal. Instead it will slide deeper into a debt trap, much like Argentina did with the connivance of the International Monetary Fund.

Eventually, when the pain becomes politically intolerable, the inevitable day of reckoning will come. This is what all the people betting against European bonds know, and why contagion has now spread to the prosperous core of monetary union. Because when Ireland’s had enough Germany and France will have to pay up, whether to give Ireland better terms or prop up their own banks after an Irish default. European banks have $500 billion of Irish debt on their books, with German and UK institutions on the hook for more than half of that amount.

This is why the European Central Bank has suddenly changed its tune, shifting from hawkish plans to drain excess liquidity to rumored purchases of sovereign bonds suffering from a lack of private buyers. But talk is cheap and efforts to soothe markets can prove expensive, especially when carried out by the people who’re acting against deeply ingrained principles and whose commitment is in doubt as a result.

China Surveys Bullish
Fortunately, Wednesday’s global rally didn’t depend entirely on a wink from ECB chief Jean-Claude Trichet. There were also the upbeat surveys of Chinese manufacturing, which showed the world’s growth engine roaring on, even if some of the upside came from a notable surge in input prices. A similar survey from the UK proved even more of a pleasant surprise by jumping to a 16-year high. French and German manufacturers also cheered up.

And if Australian retail sales lagged a bit, and if  UK consumers have been demoralized by plans for deep budget cuts, well, life is tough. But not as tough as it is in Ireland.

Flying in Opposite Directions
Speaking of tough, it takes conviction to recommend a stock that’s had it as tough of late as music retailer HMV Group (London: HMV). John Snowden’s undeterred by the ugly chart, and neither apparently is a Russian billionaire who’s been sniffing around. Still, even if the 16% trailing yield were to hold up, there might be easier ways to make money in this market.

China Southern Airlines (NYSE: ZNH) is nearly 20 times as valuable as HMV and has a much healthier growth profile and stock chart. Yet rapid revenue growth and a price/earnings ratio of seven hardly make it expensive, Paul Goodwin points out.

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