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The Globe and Mail

God save the Irish - their government didn't

Protestors calling for an immiediate general election demonstrate outside the Irish Prime Ministers office in Dublin on Nov. 26.

BEN STANSALL/Ben Stansall/AFP/Getty Images

Harry Swain is a former federal deputy minister of Industry Canada and Indian and Northern Affairs Canada

Another day, another bail-out. The EU and the IMF have come to the rescue of Ireland's awful finances in the second big bail-out of a Euro-wreck. Why was this worse than Greece or Iceland, and why is the Government about to fall? After all, it's a familiar story: prosperity, then boom, property speculation, wild lending by banks who funded themselves from incautious continental lenders, inattentive and unwise regulation.

The difference is that when the balloon went up, the Irish government decided overnight to guarantee the debts and deposits of the Irish banks. Suddenly the burden of private banks was socialized and made a call on the hitherto relatively sane finances of Irish households. No haircuts were to be imposed on the shareholders or creditors of Ireland's out-of-control banks. Private failures and bad regulation got privatized. Paul Krugman tells the story succinctly in Friday's New York Times.

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Of course, a failure this large at the heart of the financial sector would, as it did elsewhere, cause ripples everywhere in the economy, but in the Irish case the Government decreed in mid-crisis, to the horror of its European partners, that the first and heaviest blow would fall on the ordinary citizens it was elected to protect. For this the Cowen government deserves to fall.

The next chapters in this story will be no prettier. Portugal trembles at the brink, but at least it's a small economy. Looming behind it is Spain, where a rescue might be quantitatively beyond the capacity of the EU-IMF group. In either case, the euro as a currency is shaking. The Germans, remembering 1923, are believers in a sound currency and do not relish being bankers of last resort to foolish countries whose free rides end in disaster.

Chancellor Merkel has little room to manoeuvre in the face of increasingly stiff popular resentment. Germany's proposals for a formal restructuring regime for bankrupt countries, in which incautious lenders to the overly exuberant would pay for their foolishness, means that countries would be subject to an insolvency regime that would look a lot like that applicable to corporations-and raises questions about who the "receiver" might be, and even the meaning of national sovereignty in the modern world.

It would also mean that feckless nations and their financial institutions seeking to borrow in euro (and dollar) markets would face much more strongly differentiated rates, with predictably depressive effects on economic recovery. Not pretty.

The underlying problem is that the euro was created with a central bank to take care of monetary policy, but without fiscal discipline to ensure that national public finances were kept whole. This was considered too much of an imposition on sovereignty at the time. The result was all-too-frequent surrender to the temptation to run up national debt under the umbrella of the saner countries, like Germany. Now the debauchees face a long, slow recovery (indeed Greece may never get out of the hole under current arrangements) without the ability to devalue their currencies to a level their productivity will support. It is all rather like the decision of the British in 1925 to go back to the gold standard at the pre-war level of $4.86, which so seriously overvalued Sterling that more than a million were unemployed for the rest of the decade and ensured that the U.S. dollar, not the pound, became the world's reserve currency for the next century. Eschewing monetary tools for adjustment means that the whole burden falls on wages, employment, asset values, and migration.

So: will some countries drop out of the euro, or be forced out? Will the grand experiment of a single currency founder with the re-invention of the Deutschmark? Or will the re-imposition of fiscal discipline-in the hangover of the biggest piece of Keynesian stimulation the world has ever seen-bring a united Europe back from the brink? Stay tuned, and keep your hands on your wallet.

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