A Ground View of Ireland

10/18/2011 8:30 am EST


John Mauldin

Chairman, Mauldin Economics

As one of the PIIGS (Portugal, Italy, Ireland, Greece, and Spain), Ireland's story gets wrapped up with its woe-begotten brethren, but that's unfair, writes John Mauldin of Outside the Box.

This was my first visit to Ireland, but it won't be my last.

In an odd way, I felt more at home than I do in some US cities. And the views! I was charmed enough to agree to go back next month to speak at one of the most unusual economic "festivals" I have ever been to, when the last thing I want to do is get on another plane.

First off, even though we think of Ireland as a country, it is in reality a nice-sized city. Ireland is a little under 4.5 million in population (with another 1.8 million in Northern Ireland).

I was lucky, in that I have a number of readers in Ireland who offered to introduce me to people. Remember the old game of six degrees of separation (from Kevin Bacon, the actor)? In Ireland it is more like two degrees. It turns out they all had cousins or mates who knew someone I should see. No one was less than a few introductions away.

Ireland is an interesting contrast to Greece. Greece used its access to low rates that came along with the euro to borrow and increase the wages of government workers, until the Greek train system, for instance, had €100 million in revenue and €400 million in salaries, with another €300 million in expenses. A government-sponsored retirement plan for some 600 different "hazardous" jobs (like hairdressing and radio work) was available at 50 years of age.

Greek banks are going to go bankrupt not because they lent money to finance too many homes, but because they lent money to the Greek government. That is the opposite of Irish banks, which—while they bought modest amounts of Irish government debt—facilitated a construction boom of epic proportions...a bubble that imploded.

I have written about Irish housing woes. They built 300,000 too many homes, which would correspond to about 15 million too many homes in the US (we "merely" overbuilt by 2.5 million). The resulting crash in building has been a monstrous drag on the Irish economy.

And the same happened in commercial construction—a taxi driver took some delight, once he knew I was a financial writer, in pointing out buildings that were empty. "But they are probably a good buy now!"

And the construction boom helped finance a huge boost in government revenues. In 2004, the Irish Home Builders Association calculated that 40% of the price of a house went straight to the government in taxes. The government of that time protested that the figure was only 28%!

And the Irish willingly took on the debt of banks that went bankrupt. If Anglo Irish Bank were a US institution, the equivalent debt would have been about $3.5 to $4 trillion (depending on the exchange rate).

Can you imagine trying to get a bailout for one bank for that much? And in Ireland there were three of them (!), though the other two were somewhat smaller. The Irish government guaranteed the bank debt for ECB loans, for money that then went to European banks that had loaned the Irish banks the money in the first place.

Michael Lewis, in his just published book Boomerang! (I saw several people reading it on the plane coming back—soon to be downloaded to my iPad), noted that he thought it was interesting that the Irish people did not seem all that aware of the rather crushing nature of the debt they had assumed.

I heard time and time again that Ireland is different from Greece and other Mediterranean countries. The Irish willingly undertook an austerity program, without major public protests, and have actually begun reforms. They cut public salaries (around 15%), pensions, and other "untouchables." Other government budgets were slashed. And they acknowledge the need for even more cuts.

That being said, a clear backlash is beginning to brew over cuts to government social programs. (I should note that, even though this is about the Irish, I hear this complaint everywhere in Europe and the US.)

And from my understanding, this is on top of health care. Which is another thing that I was told needs reformed. Which of course you hear in the US and all over the developed world, so the Irish have no corner on politicians who like to hand out a lot of benefits when times are good. But now the bills are coming due.

So, Ireland is not without its issues that must be dealt with. But I did come away with some positive views.

An Irish Haircut
Michael Lewis noted from his time in Ireland that the Irish seemingly went along with the Irish government taking on the bank debt. The large majority were not aware of the nature of the impending crisis. In the last few years, that has changed.

I have written extensively in the past about how the Irish have figured out they are taking on debt for banks that no government should have touched. It was just too much.

It's simple arithmetic: the Irish cannot repay that debt under the current terms (even after the ECB and Europe gave them lower interest rates in July) and ever hope to get out of debt in the next 30 years. They have consigned themselves and their children to decades of toil to pay back English and German and French banks (among others).

And that fact dawned upon them. They voted out the government that allowed the debt to be assumed. It was a clear message, but the government has not yet done anything to rid itself of the debt.

Some favor doing it outright. Others truly believe they will be offered a haircut when Greece and Portugal get theirs. They fully expect it.

In a meeting with an establishment-insider economist (off the record), who was at the table when the first deal was done, he said there was an implicit understanding with the IMF (and ECB) that whatever was offered to Greece, et al. would be available to Ireland. So Ireland went along with the bailout to keep from imploding the euro and averting a crisis that would have been biblical in proportions.

The future of the euro is now not in their hands, because by taking on the debt they did not blow the euro up. Which could have happened, because European politicians were not ready for such a crisis.

So rather than having to kick the door open for a haircut, they expect the door to be opened for them by the IMF and the ECB. A far more respectable path for those who are very pro-Eurozone.

But Irish leaders clearly get that voters expect that something will be done. They have time, as it will be another three-plus years before elections. By then, the crisis will have fully evolved and resolved itself, as far as the political public is concerned. And politicians will take the credit, as they always and everywhere do.

But here is the issue for Europe: The amount of money needed for Ireland is going to be a lot more than they now think, or at least are willing to admit.


When Eurozone politicians worry about "contagion," or one country wanting the debt relief that another country gets, it is a very real worry. And rightfully so, as voters in Portugal or Spain or (gasp) Italy who are burdened by debt that is seemingly intractable will also want relief. It is not just an Irish condition, it is a human trait.

And the money that Europe needs will overwhelm the €440 billion ESFS fund. Stratfor and others think it will take at least €2 trillion. The Boston Consulting Group put out a report that suggests the total number, at the end of the day, will need to be (drum roll, wait for it) over €6 trillion ($8.23 trillion). I don't like their proffered solutions, but their analysis of the debt and the need for relief is sobering.

Whatever the figure, it is staggering. And one the Eurozone is not willing to pay, at this moment. When the crisis hits, who knows? But now, that much is not on the table.

There is talk of leveraging the ESFS up to €2 trillion, but that seems odd, as normally you have to have equity to leverage more debt. The ESFS is debt created by promises to pay by the member governments.

Are we now at the point where we need to leverage our leverage? It seems to me that is what got us into the problems to begin with.

France is at risk of losing its AAA rating. From my far-removed seat, I think it is almost a certainty they will, as the amount they will have to raise for French banks is enormous. Add another few hundred billion euros for bailout funds for Spain and Italy, and the idea of AAA euro debt goes right out of window.

To keep the current AAA, a majority of guarantees needs to be from AAA countries. That is a very touchy issue right now.

Read the following quote from Angela Merkel, Chancellor of Germany and someone who is a believer in a strong, united Europe. This is from a supporter of Europe, mind you.

While stepping up her rejection of a Greek default, she [Merkel] said that issuance of shared debt by euro countries isn't the solution to the problem spilling from Greece, even though some may long for the 'big bang' to end the debt crisis.

"Whoever believes that has no clue about the economy," she said. "No one can say with certainty" what would happen if Greece defaults, she said. "Before I make a nifty step into an adventure, I have to ask whether we can really handle this and can we oversee what we are doing?"

Merkel said that her "entire council" of economic advisors says Greek debt should be restructured, advice that she is not prepared to take.

"If we tell a country 'We cancel half of your debt,' that's a great deal,” she said. 'Then the next guy will immediately show up and say he wants the same.

"Solidarity is always cheaper than if we were to go it alone and wind up with the problem Switzerland has—that the currency level is so high that you can't export any products anymore. Today, going it alone is no path to a better future." ( Bloomberg)

Greece will only get more promises and more funds until Merkel gets a call from her accountants, who tell her they have figured out which banks need government funds. The next day she will call Papandreou and tell him to hold a conference announcing the haircut that Greece will get. It will all be orchestrated to the color of their socks.

From what I heard, Europeans banks are worse than even the dire reports you read in the papers. Spreads are widening and liquidity is drying up. Dexia is the tip of the iceberg.

I really have to wonder how much France can do in regards to its bank debt. Will the ECB lend them enough money? The answer is yes. But we are talking a great deal of debt for a country with serious fiscal deficits and where government spending is already 55% of GDP, with rising health-care and pension costs.

Think French politicians will try and get their unions and public workers to take a 15% pay cut? The French will not be civilized and stoic, like the Irish. They will take to the streets.

We are now in the final innings of the Endgame. Greece is likely to default no later than the end of this year, if not by the end of this month. Which for all intents and purposes they have already done. If you can't get the market to finance you, that means you can't pay your bills without the kindness of strangers.

If Greece were an individual or a company, it would be in bankruptcy proceedings. It is now just a matter of time.

Can the euro survive? The short answer is yes, but not without a lot of pain on the part of a lot of people. The drive for a united Europe is strong, and may indeed overcome the drive that would tear the union apart.

I actually hope so. But it will not be done without a lot of sacrifice.

I think the valuation of the euro is at serious risk. And while European markets look cheap on a relative and historical-valuation basis, one needs to ask, compared to what? Long European stocks, short the euro?

Maybe, especially if the Germans turn the ECB loose as a way to keep (and pay the price for) the European Union.

I heard no consensus. There are dozens of different plans, enough to make any politician's head swim. Stay tuned.

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