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Aftershocks of the Ireland Bailout

Author: Roya Wolverson
November 30, 2010


Investors' fears about a spreading European debt crisis only intensified after European finance ministers agreed to a 85 billion euro rescue package for Ireland on November 28. Yields on government debt (WSJ) in Spain, Portugal, and Italy rose after the group announced the details of the package, and the euro fell to a two-month low (Bloomberg) against the dollar. In their weekend meeting, ministers agreed to consider extending (Economist) the three-year repayment period for Greece's bailout in light of certain softer loan terms granted to Ireland, and they attempted to appease European government bondholders by promising that their investments would be safe under the existing euro bailout fund.

Still, many investors viewed the terms of Ireland's bailout with foreboding. The interest rate Ireland will pay is about 5.8 percent, compared to the roughly 5 percent given to Greece. That could indicate the reticence (FT) of some governments--particularly Germany--to support more bailouts for other troubled eurozone countries.

The EU and IMF may also not be able to afford rescuing other peripheral members. Lenders to the Irish rescue package include Spain, Italy, and Portugal, which are themselves heavily indebted and may also need bailouts, writes Robert Samuelson in the Washington Post. With German and French debts amounting to 76 percent and 86 percent of their economies in 2009, he writes, "How much new debt can be piled atop old debt?" A bailout for Spain, the world's ninth largest economy, would prove especially difficult (WSJ).

Bundesbank President Axel Weber said last week that the various bailout funds total 925 billion euros and that financial risk in the eurozone could add up to as much as 1,070 billion euros, suggesting European policymakers think they can "somehow find the petty cash to make up the difference in a worst-case scenario," writes Wolfgang Munchau in the Financial Times.  Covering such costs could involve a continued push by France and Germany (Bloomberg) to include so-called "bail-ins" (Economist) as part of a permanent bailout fund under negotiation, whereby bondholders are required to take a pre-set loss when a lender collapses. But at least one member country--likely Spain or Italy--would surely reject these proposals, says Munchau, since it "would be like turkeys voting for Christmas."

Feeble European demand may also stymie the U.S. recovery, which relies on Europe to buy roughly 25 percent of its exports. The EU announced its GDP growth would shrink (Bloomberg) from 1.7 percent this year to 1.5 percent in 2011, given global belt-tightening that cuts into consumer demand. But a big advantage for the U.S. recovery compared to that of Europe is the flexibility of its currency, writes Paul Krugman in the New York Times, since eurozone countries like Spain cannot manage their exchange rates to boost competitiveness. Warwick University's Nicholas Crafts and Peter Fearon note that leaving a fixed exchange rate system was critical to recovery for the United States and Britain in the 1930s. Krugman argues the United States should embrace the Federal Reserve's power to devalue the U.S. dollar as a way to promote economic recovery, and he warns against fighting "imaginary risks of inflation," which would "voluntarily put ourselves in the Spanish prison."

Others, including FDIC chair Sheila Bair, say events in Greece and Ireland should serve as a warning for the United States to rein in spending now. "If investors were to similarly lose confidence in U.S. public debt," she writes in the Washington Post, "all of us would pay more for consumer and business credit, and our economy would suffer."

More Analysis

The Peterson Institute's Jacob Funk Kirkegaard says Europe can cope with its latest crisis, since the European Financial Stability Facility and the Stabilization Mechanism "have sufficient capital to assist on short notice."

In this Roubini Global Economics report, Nouriel Roubini argues for an orderly restructuring of eurozone sovereign debts to avoid the costs of merely "kicking the can down the road" with more bailouts.

In the Weekly Standard, the American Enterprise Institute's Lawrence Lindsay says quantitative easing won't solve our deeper problem of slow growth and will probably be part of Fed policy for quite some time.

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This Wall Street Journal editorial argues that the permanent crisis-management fund will only make permanent crisis more likely.