Return to the punt is our only hope
Unpalatable as it may sound, reverting to our own national currency could at least offer a ray of hope on an otherwise bleak economic horizon, writes Dan White
18 November 2010
With next month’s budget set to be even tougher than previously forecast, serious questions need to be asked about the future direction of our economic policy. It is now becoming increasingly clear that, unless accompanied by other measures that will stimulate the economy, deep public spending cuts will condemn us to a decade of deflation and depression.
When the government announced at the end of September that the “final” cost of bailing out Anglo could be as much as €34bn, the scale of public spending cuts and tax increases required in next month’s budget, which had previously been estimated at €3bn, rose to €4bn.
Since then the outlook for the 7 December budget has grown steadily worse. The €4bn figure quickly became €5bn. The government now concedes that it will take at least €15bn of spending cuts and tax increases to reach the EU-imposed target of cutting the budget deficit to 3% of GDP by 2014. With Ireland locked out of the bond markets these spending cuts and tax increases will have to be “front-loaded” meaning that we could be facing up to €7bn of cuts and tax increases on 7 December.
When you consider that that government has already taken approximately €15bn out of the economy in its three budgets since October 2008, that would bring the total to €30bn.
That’s the equivalent of 19% of GDP. However, most observers have long since concluded that, when measuring the value of Irish economic output GDP, which includes repatriated multinational profits, it is meaningless. The only accurate gauge is GNP, which excludes multinational profits.
The Central Bank is forecasting that this year’s GDP will be about €157bn but that GNP will be a fifth smaller at just €125bn. If you measure the required €30bn fiscal adjustment against GNP rather than GDP, then the government will have to take the equivalent of 24% of the value of our total output out of the economy in the space of six years.
Is cure worse than disease?
You don’t have to be an old leftie to suspect that such a drastic “cure” might be worse than the disease. While such a draconian fiscal programme might, initially at any rate, win us brownie points in Frankfurt and Brussels, the consequences for the Irish economy would be dire. Far from contributing to recovery the most likely outcome would be a decade or more of grinding deflation and depression with unemployment climbing even higher and the return of emigration on a massive scale.
Depression not recession
When analysing the extent of the economic calamity which has overtaken this country since the international credit markets first froze up in August 2007, the conventional descriptions such as “recession” or “economic downturn” don’t even come close to capturing the full enormity of the disaster. Since the end of 2007 the Irish economy as measured by GNP has shrunk by 22% in nominal or cash terms and, when the impact of deflation is filtered out, by at least 17% in real terms.
That’s not a recession but a full-blown 1930s-style depression.
Sticking with our current economic policies will make things even worse. Yes, public spending does need to be cut and the cost of running the public sector reduced to reflect the likely level of tax revenues for the foreseeable future. Yes, bloated public sector numbers and some of the highest pay rates in Europe need to be reduced to more manageable proportions, Yes, social welfare rates more than twice those prevailing across the border in Northern Ireland are utterly unsustainable.
Get economy growing again
Taking the axe to extravagant public spending is only part of the cure. If we are to ever extricate ourselves from our current predicament we have got to get the economy growing again. Taking the equivalent of almost a quarter of total output out of the economy doesn’t strike me as the best way of doing this.
Such a course of action is far more likely to deepen the depression in which the Irish economy is now mired. As the economy shrinks further not alone will tax revenues keep falling, unemployment will rise pushing up spending. This will result in higher rather than lower deficits, further adding to the level of the national debt. At the same time deflation will push up the value of existing debts in real terms.
This combination of a shrinking economy, increased deficits and the rising real level of existing debt, is what makes deflation-induced economic depressions, such as the one we are now enduring in this country, so pernicious.
No matter in which direction we turn, we seem to be blocked. Cut spending and the deficit rises. Don’t cut spending by enough and the bond markets won’t lend us any more. Repudiate or renegotiate our debts and the continuing contraction in the economy will have us back where we started in a few years. Quite clearly something’s got to give.
Is it time to leave the euro?
That something is almost certainly going to be our membership of the euro. It is the euro, by facilitating a credit-fuelled property bubble for more than a decade, which is largely responsible for our current situation.
If we had retained an independent national currency interest rates would have remained much higher and bank lending would have grown at a much slower pace. This in turn would have meant that both property prices and property-based tax revenues would also have risen much less quickly leaving us far less vulnerable when the credit crunch first struck in 2007.
Reverting to the punt
By reverting to our own national currency, which would trade at a significant discount to the euro on the foreign exchange markets, the Irish economy would at least have a fighting chance to grow as our exports became more competitive and Ireland became a cheaper country for overseas investors to do business in. The higher inflation that came with having our own national currency again would also reduce the real value of the domestic debt burden which is crippling the Irish economy.
Finally, this higher inflation would allow us to cut real wages and prices in a far less painful and politically disruptive manner than would happen if we tried to cut nominal wages and prices by way of deflation.
Restructuring national debt
Of course leaving the euro would not be without problems. Such a move would have to be accompanied by a major restructuring of the national debt and the overseas borrowings of the Irish banks. Such a restructuring would almost certainly have to involve a major write-down of these debts, perhaps by as much as 50%, to reflect the fact that the value of external debt would rise in Irish currency terms.
However, despite these potential problems, returning to the punt at least offers us a ray of hope. Better to do it now while we are still at least partially masters of our own destiny rather than have such a course of action eventually forced upon by the markets.