Irish Finance Minister Brian Lenihan answers reporters' questions at the end of a European Union finance ministers meeting at the European Union Council in Brussels on Nov. 28, 2010.THIERRY ROGE
Ireland has been saved and the euro has been saved. So loud are the trumpets from the France, Germany and the IMF that you might think the euro zone's troubles were over until you took a cold look at what actually happened at the end of last week when the EU and IMF erected an €85-billion rescue fund for Ireland. It is also worth looking at how the markets reacted this morning to the bailout.
The euro saluted the rescue with a brief and tiny nod, gaining a cent against the dollar. It then fell back. Meanwhile, yields on Irish bonds barely changed, narrowing a few basis points but not enough to suggest that the medium to long-term risk of an Irish government default has lifted. Meanwhile, the cost of insuring Spanish and Portuguese bonds rose on Monday morning and the cost of borrowing is rising sharply for the Italian government. An auction by the Italian treasury of €6.8-billion in bills reflected the less-than-confident market mood. A €3-billion tranche of 2021 notes was sold at 4.43 per cent compared with 3.89 per cent a month ago while short-dated 2013 bonds were priced to yield 2.86 per cent compared with 2.32 per cent, last month.
If you believe the politicians it is only a matter of time before the short-selling bond market lemmings commit suicide by leaping over a cliff. Wolfgang Schaeuble, the German finance minister expressed hope that "a little more calms and a reality" would be restored to market valuations, while the IMF's Dominique Strauss-Kahn expressed confidence that Ireland would honour the deal despite irrational market speculation, and Christine Lagarde, the French finance minister, said irrational and "sheep-like" markets were not pricing risk correctly.
Irrational, sheep-like? If one recalls the irrational behaviour of bankers in valuing subprime mortgages over the past decade, you might think that the politicians have a point. Except that they don't.
What is happening is not so much speculation as an attempt by bond funds to reduce their exposure to peripheral euro zone sovereigns. This is a flight to safety; you might argue that it is excessive in the short-term, but there is nothing irrational about avoiding exposure to longer-term risk. Not least when the risks are real.
Does anyone truly believe that Ireland can afford to repay €85-billion at an interest rate close to 6 per cent? The Irish rescue is predicated on its government's four-year fiscal reform program, which itself assumes that economic growth in Ireland will average 2.75 per cetn from 2011 to 2014. Even assuming that were correct (and Standard & Poors reckons Ireland will flatline for several years) it leaves Ireland paying an extremely high real interest rate unless you believe inflation is about to rip. That seems unlikely in a country that has been bludgeoned with debt and is facing mass unemployment. The truth is that the euro zone gave Ireland the wrong interest rate during the boom, too low. Post-crash, the euro zone is imposing on Ireland too high an interest rate to allow recovery.
The market view of what Ireland should be paying for its money is close to 10 per cent, a rate that still assumes default in the medium term. Worse still, a political revolt is brewing over the decision, forced on the Irish government, to raid the nation's pension fund reserves to contribute €17-billion to a €35-billlion bailout of the Irish banks. This is politically unsustainable.
In a bid to appease the bond markets, Germany has retreated on its demand that bondholders take some of the pain in restructuring euro zone debt in the future. Instread of compulsory haircuts, there will be a process of collective decision making in which the European Council will take a unanimous view on a member state's insolvency. It's more evidence of the weakness of euro zone decision-making. Without Germany's retreat, there would have been a rash of selling on Monday morning, but morally and politically, the punishment of the Irish people for the sake of protecting banks and bondholders is a clear signal that the euro's days are numbered.
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Carl Mortished