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Into the Euro Danger Zone

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EUROZONE BREAKUP
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As Europe is warned of pending recession by analysts and credit raters and as its leaders seem unable to halt the spread -- what happens to the initial assumptions behind the bailout of peripheral economies like Ireland? A basic reality appears to have not yet hit the Irish government or media -- the logic behind Ireland's current position in the Eurozone bailouts no longer applies.

A year ago, Ireland effectively gave up its economic sovereignty to the European Union. Today, Ireland is only now beginning to feel the lasting pain of the austerity as the domestic economy remains in deeply negative territory and minimal export growth is threatened by looming recession in Europe -- and even more deep cuts are coming in December. Ireland is on the cusp of the most dangerous phase of its economic crisis which will likely get much worse before it gets better. A simple question that the nation needs answered -- and quickly -- is "What is Plan B" if all goes haywire in the Eurozone? -- especially as the initial logic behind the Irish bailout -- containment -- no longer applies?

The bailout of the Irish banks that began in late 2010 was never about helping the Irish people. It was necessary as the nation would have been insolvent by mid-2011. However, the premise of the bailout was containment of exposure to Ireland's toxic banks -- to prevent a contagion effect moving into the larger core European economies. The premise was to use Ireland to send a harsh message to Italy and Spain that they had to get their fiscal houses in order. The logic behind the Irish bailout ended about a month ago when Italian 10 year bonds reached near 7 percent. The worst case is upon us -- as we now see proliferating downgrades, uncertainty in Italy and a high degree of exposure that France has to Italian debt. There are major growing doubts as to whether Germany will, or even can, sustain the status quo.

There is good news in that a year later, the story is not about Ireland but rather the entire Eurozone. There is also good news in that the Irish banks have been stabilized as a result of capital infusions. A good indicator is that Irish 10 year bonds have dropped by nearly half since July. That said, they are only back to where they were when the bailout was required -- over 7 percent. Ireland cannot survive economically on its own -- and stories in the international media about how well the Irish are taking austerity falls on deaf ears on a suffering population that did not cause the crisis.

The emerging trends over the last several months represent a serious danger zone as scenarios that were once unthinkable are now realistic -- so what, then, becomes of Ireland and the other first round of bailout countries (Portugal and Greece)? As Peter Boone and Simon Johnson warned over the weekend: "Greece, Ireland, Portugal, Spain, and now Italy have large amounts of short term debt that they can't roll over at low cost. Leading European banks are in the same situation. None of these countries or banks can long bear the burden of their current debt levels at reasonable risk premiums." They noted in particular that Ireland's Finance Minister Michael Noonan is "at odds with reality when he claims that Ireland should return to the markets in 2013. This is a country with 133 percent of gross national product in public debt and about 100 percent GNP in additional contingent liabilities to the banking system."

Germany could take bold action to save the euro -- but that will require massive sacrifice by the German people who themselves have become fed up with upholding the weak peripheral economies of Europe. It might also mean abandoning a fundamental political culture in Germany about printing money. It is increasingly dangerous that Germany, the Netherlands and Finland are suddenly a minority grouping in how the EU is approaching its crisis, as they hold all the cards. Boxed into a corner, the financiers could pull the plug -- and embrace a radically reduced Eurozone focused on leveraging up Italy rather than the peripheral economies. While they deny publically there is consideration of a caucus among the stable countries, it would be bad business for the Germans to have not at least thought such a scenario through.

Germany could then insist on treaty changes in decision-making in the European Union -- thus requiring a referendum in Ireland -- which most analysts there assume would fail, given past votes with less at stake. The main problem, however, is that it would take too long to achieve the necessary treaty changes to affect economic outcomes to save the Eurozone. Thus, alternative approaches are now being considered that would be less binding among the Eurozone members. Ironically, while this would save the Irish government from having to shepherd through a very difficult referendum, it would also mean that Ireland loses any remaining leverage in shaping the Eurozone debates.

If it is to get worse before it gets better, it seems that the Irish people merit a direct discussion of how the next stage of the crisis will affect the nation. If the logic behind the Irish bailout no longer applies in systemic terms of contagion prevention, then what should the Irish and others do? The troubling answer is that all "Plan B"s look really bad. Staying the course is a very high risk gamble. Default would pulverize the Irish economy and stain its international reputation. Leveraging the threat of default to restructure a better deal from Europe no longer is an option, as Europe can now say, OK -- good luck. Leaving the Eurozone would be a possibility -- requiring printing new money and linking it to the British pound. In all of these scenarios, Ireland would be sunk just by the existing debt it already owes making today look like the good old days as debts come due, contracts are broken and capital flees. Ultimately, Ireland needs to get a much longer term deal on its bailout -- likely at 30 years at 2 percent to have any hope of recovery. How it gets even to that at this stage is very unclear.

Missing from the picture in Ireland -- and throughout the Eurozone crisis -- has been a serious dialogue between the governments and the people about what is to come -- even if the best of all bad options is to stay the course. The only certainty the Irish people are getting now is uncertainty and that is no way to live. In the long-run, Ireland has the fundamentals to grow its economy again and lead the world into a new positive era of globalization. But that will take investing in the greatest asset it has -- the Irish people -- and this continually seems to be the lowest priority in each course that the nation might pursue.

Sean Kay is professor of politics and government at Ohio Wesleyan University and a fellow in foreign policy at the Eisenhower Institute in Washington, D.C. He is the author of 'Celtic Revival? The Rise, Fall, and Renewal of Global Ireland.'

This post has been modified since its original publication.

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