Saving the euro

Rum,solvency and the crash

On the first question,the original sin lies with Ireland. The Celtic tiger roared ahead,but it paid too little attention to its gung-ho banks and asset markets. A property bubble blew up,and Ireland became dangerously dependent on the revenues that flowed from it. The countrys financial regulators were incompetent at best,cronies at worst. And at the first sign of trouble,the government made the mistake of issuing a blanket guarantee for all its banks debts,which now means that taxpayers have to bear the catastrophic losses on property bets made by Anglo Irish Bank and others,pushing the budget deficit to 32 per centof GDP this year.

So Ireland has long been flirting with a debt crisis of its own. But it has not been helped by the other euro-zone members. To begin with,the rescue of Greece was a botch: it fudged the obvious issue that Greece will never fully be able to repay its debts on time. And the temporary support scheme cobbled together for the rest of the euro zone was equally flawed: in particular,it was too easy on private creditors. But although all this was troubling,Angela Merkels attempt to fix it has been spectacularly clumsy.

At an EU summit at the end of October the German chancellor won agreement that any future euro-zone rescue scheme should include a mechanism for an orderly sovereign-debt default. The principle was absolutely right: unless default is a possibility,bond investors have no reason to distinguish between good and bad credits. But the idea of making bondholders lose money when sovereign credits turn sour was aired without any guidance about how and when it might apply. Astonishingly,the Germans failed to put together a detailed proposal for the summit.

The timing was dreadful,with Ireland,Greece and Portugal trying to fashion austere budgets for 2011. Bond investors were invited to fear the worst. Ever since,the Irish have been on the run,and the Greeks and others on tenterhooks. An Irish problem has quickly become a euro-zone problem 8212; and a British headache,too,given the close links between the neighbours.

The second question 8212; the solution 8212; shows how different Ireland in fact is from Greece,which was pleading for money from a reluctant Mrs Merkel. This time the argument is between the Irish,who have insisted they do not need a bail-out,and large euro-zone countries which insist they must take one.

Both sides are being disingenuous. The Irish are right that they have enough money to last until the middle of next year the treasury has around 20 billion of cash squirrelled away. But they could face bank runs long before then.

On the other hand,the Irish are also right to be suspicious of intentions in Brussels and Berlin. Too much of the EUs motivation seems to be to punish Ireland for its Anglo-Saxon ways 8212; especially its highly competitive 12.5 per cent tax rate on corporate profits,which helps it attract foreign firms. Raising this would be madness. Ireland is planning budget cuts for next year of 3.8 per cent of GDP; any economy would struggle against that headwind. But its hopes are anchored in those new foreign arrivals. The sort of foreign direct investment FDI on which the prosperity of the 1990s was built is flooding in once again. IDA Ireland,the agency that targets such investors,says FDI in 2010 will be the best for seven years. A new generation of firms,including computer-gaming outfits like Activision Blizzard and Zynga,are joining the established operations of Intel and Google. Irelands workforce is young,skilled and adaptable. Rents are coming down even faster than wages.

If only both sides gave up posturing,they would agree that the European rescue funds should be used to stabilise Irelands banks,insisting only on certain budget targets in return. Such a deal should satisfy Irelands euro-zone partners,which want an end to the uncertainty,and the European Central Bank ECB,on which Irelands banks have become overly reliant for funding. It would also be wise to offer a similar deal to Portugal. Its banks are dependent on ECB support,and it too is in the bond markets sights.

Green and bear it

That leaves the third question: the euro. For all the talk of the euro failing to survive this sovereign-debt crisis,it should struggle through. Despite the troubles on its periphery,the public debt of the euro zone as a whole is not notably high by rich-country standards. The real problems are the absence of a credible plan to deal with errant countries as the Germans have recognised,the structural imbalances between Germany and the less competitive southern members and,most of all,the miserable growth prospects for those poorer,weaker southerners,made worse by their fiscal retrenchment. Denied the possibility of devaluation,slow-growing countries like Portugal and now Spain should be looking for structural reforms that can reduce their labour costs,enhance enterprise,stimulate competition and regain competitiveness.

Ironically Ireland looks more likely to find that growth than the Mediterranean countries. None of that excuses the mess it has made of its banking system. But the real question for Europe is whether it wants a slow succession of Greeces and Irelands 8212; or whether it is ready to move beyond government rescues and focus on growth.

The Economist Newspaper Limited 2010