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Belmont Club

by Richard Fernandez

Haircuts Verts

November 26th, 2010 - 2:15 pm

Bloomberg says the “day of reckoning” is nigh. Despite the Irish bailout, the markets are punishing the PIIGS across the board with higher interest rates.

Borrowing costs for Europe’s most indebted nations are at record highs as Ireland’s capitulation in accepting a bailout of its banking industry stokes concern that other countries also will have to seek aid.

The average yield for 10-year debt from Greece, Ireland, Portugal, Spain and Italy reached 7.57 percent today, a euro- era record. The average premium investors demand to hold those securities instead of German bunds widened to as much as 492 basis points, the highest level of 2010. The average cost of insuring against default by the five nations using credit- default swaps reached a record 517 basis points on Nov. 23.

The Wall Street Journal says that Spain is working to quell rumors that Spain may be next. “Spanish shares tumbled, leading a fall in European stock markets, as investors questioned whether Iberian nations would be the next members of the euro zone to seek a bailout.” Prime Minister Zapatero assured investors that the rain in Spain will never cause great pain.

Spanish Prime Minister José Luis Rodríguez Zapatero, in an effort to quell markets and prevent the spread of the euro zone’s sovereign-debt crisis to its fourth-largest economy, said there is “absolutely” no chance Spain will join Greece and Ireland in seeking a bailout from the European Union. The European Commission isn’t putting any pressure on Portugal to request financial aid, its president, José Manuel Barroso, said.

But the markets were not so sure. The Daily Telegraph noted that Spain had to pay record-high percentages on the bond market. “The premium on Spanish government bonds over benchmark German debt hit a new euro-lifetime high on Friday, as markets targeted larger eurozone periphery states while policymakers scrambled to deny reports Portugal was being pressured to seek a bailout.” Although public confidence in the stability of both the US dollar and the Euro remain high, just what would a “day of reckoning” mean? What happens when a state can’t pay?

Some experts believed the day of reckoning would never come.  For example, Credit Suisse maintained that the European crisis was “not systemic”; that Europe could afford to bail out Ireland, Greece and Portugal, but even from the beginning it was understood that Spain would be a burden too far. The method for dealing with Spain was to make it unthinkable, to assume that the inevitable would never happen. The endgame for Ireland, when it came, was surprisingly sudden. After appearing manageable for months, things began to fall apart suddenly and irrevocably in October.

The Rising

Sovereign default is suddenly thinkable. In the Euro’s case, Germany suggests the day of reckoning could mean a “haircut” for investors as Euro debts are restructured. That means investors who loaned money to sovereign nations could only collect a fraction of their debts. “Practically, Germany wants private investors to face ‘haircuts’ or other debt payment restructure measures. In order to include them, newly issued euro zone bonds would include collective action clauses (CACs). The CACs would allow for a country to restructure its debt repayments should it be unable to meet them, either by extending the maturity of bonds, by reducing interest payments or by a so-called ‘haircut’ — or writedown.”

In plain language some people are going to get poorer, in cases very much so. Nomura Chief Economist Stephen Roberts spells it out in euphimistic terms. “Over time the work-life balance could change”. That means work till you drop, dream about things once called holidays or heating or entertainment and hope you can afford macaroni and cheese — and not the premium kind either.  This sudden poverty is likely to unleash a tsunami of anger among voters who will feel betrayed, who believe they have ‘paid into the system’ and are now told that it’s all gone, spent, gone.  As Nomura economist Roberts so felicitously expressed it, “unfortunately they’re being forced into it, which always makes it politically more difficult.”

What probably worries the Euro-peans more than anything else is that the cure is now viewed as part of the disease. The Financial Times writes that the Irish bailout “has spooked” investors.  Even though the size of Spain’s debt has remained relatively low, the interest it has had to pay to service its debts has climbed.

The Rain in Spain

The world economy is venturing into uncharted territory. A failure of the Euro and debasement of the dollar no longer seems unthinkable. The piper will have to be paid and Leftist circles  cannot understand why the United States isn’t turning Left.  Now is the time for more government, the Left believes, to spread the wealth that has been concentrated in fewer and fewer hands.  Now is the time for stronger, not weaker, government. Few of them believe that the destruction of the American middle class is correlated with the rise of regulation which has enabled a few mega-industries to extract rents while making the rest unsustainable. The contrary narrative, articulated by the Tea Party, holds that the great middle has been systematically destroyed by making it impossible to develop energy sources, innovate without legal consequences, go into business without a crushing regulatory burden or market distortion, or even to close the border. The Left dismisses the Tea Party interpretation of events as the ravings of know-nothings.

So they will pursue a different path.

To anticipate how the American Left will react to the US crisis, it is only necessary to observe how the European Left will react to the collapse of the old continent’s welfare states.  They will unabashedly proclaim the crisis has come because the continent hasn’t gone far left enough. Ireland, for example, is being cast as an example of private enterprise gone wrong and therefore the solution is to “rein in the greed”. There’s a good chance the Left will succeed in the short run. The Spectator notes that the incumbents are hated so badly that the Irish are now turning in droves away from the Fianna Fail to Sinn Fein. “The moral nadir of any state must surely have come when Mr Gerry Adams MP announces that he is its white knight. Yes, this IRA butcher and architect of countless bombings and killings is abandoning Northern Ireland politics, and even his empty seat in Westminster, to stand in Ireland’s general election next year. He actually thinks that he is entitled to berate the politicians of the Irish Republic for their conduct … And by God, he could well have a point.” But the point isn’t that Sinn Fein will do better. The point is simply that it isn’t Fianna Fail.

It is this “false choice” — to use the favorite expression of Barack Obama — that Irish politicians are at pains to conceal from the public, argues the Specctator: that government, not the private sector, is at the heart of the problem. That by putting Gerry Adams and his crew onboard they are simply rearranging the deck chairs on the Titanic. Adams has not come to dismantle the Castle. He has come to claim its throne.

There are two economies in Ireland: the private sector, which is still doing extraordinarily well — industrial output up 12 per cent in the past year, with Irish exports per capita nearly matching those of Germany. And then there is the tragedy of the public sector, an economic Chernobyl, endlessly spewing out toxic clouds of debt, and its adoptive cousin, the banking sector, which two years ago under the bank rescue scheme (obligatory under EU law) effectively became an arm of government.

There are two cultural explanations for the folly that is Ireland. The first is the who-you-know politics that is key to Fianna Fail’s style of government. The second is the other survivor from the pre-modern age: a tradition of flaithiúlacht, which means ruinous generosity, especially with someone else’s money … a political tribe that has no equivalent in Britain — well, not since the Highland Clearances … Fianna Fail’s culture has brought the Republic to the point of ruin unprecedented in Europe since the Weimar Republic defaulted on war reparations in 1930. The Irish government’s borrowings were €80 billion (as of last weekend: who knows today?), which is nearly €25,000 for every man, woman and child in the state. But the government is frantically adding millions to that figure every week, in order to maintain outgoings on a public sector.

The coming year may see both sides of the Atlantic going in opposite directions in response to the collapse of the giant state. Europe may react instinctively by increasing the size of the state, turning reflexively to government to solve the problem of too much government. But the US, drawing on a different political tradition, may react by shrinking the state. Which of these solutions will prove most effective only time will tell. Both America and Europe are preparing to sail into terra incognita in their own different ways.

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