Did joining the eurozone bust Ireland?

As I have said in prior posts, I am a bit of a eurosceptic. It is my view that the Euro is a political construct just as the expanded European Union has been and just as the reunification of East and West Germany on a 1 for 1 currency basis was. When politics come before economics, bad things happen.

And so it is for Ireland. But is the bust actually the Euro’s fault? And if so, is that a bad thing?

The EU is too big
One reason the Irish rejected the Lisbon Treaty is that the European Union is becoming an unwieldy bureaucracy of 27 countries. What started as a union of the six members of France, West Germany, Italy, the Netherlands, and Luxembourg, all with compatible economies, has become a free for all that includes countries as dissimilar as Bulgaria and Sweden. The last time the EU added a group of roughly similar economies was in 1995 when Sweden, Austria and Finland joined.

Since then, purely for political purposes, and creating great enmity in Russia, a barrage of former eastern bloc nations has joined the EU. While the eurocrats might think all is well with enlargement because the ‘United States of Europe’ is a good counterbalance to the United States of America, in truth, the EU is like putting together Canada, the US, Mexico, Guatemala, El Salvador, Honduras, Belize, Nicaragua, Panama and Costa Rica. That would never fly.

No wonder the Irish said no.

The eurozone is also too big
Then you have the eurozone. As with everything in the EU: EU membership itself and the Maastricht treaty in particular, eventually any- and everyone could join. The Eurozone now comprises 15 countries: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, and Spain.

This union gives bond markets liquidity and obviates the need for foreign currency exchange, reducing costs. However, high growth Ireland and Spain are very different from Germany and France. Harmonizing these 15 economies will take decades, if it ever happens.

The politicians said they would harmonize through forcing fiscal discipline. You remember the Germans, in their arrogance, talking about strict adherence to a 3% deficit rule and penalties for slackers? They chided the Italians until they themselves broke their own rule and now no one talks about it anymore. Since then, it has been an orgy of deficit spending across Europe.

Interest Rates
And yet, when the European Central Bank sets interest rate policy. It has been fairly hawkish (at least as compared to the Fed) with Wim Duisenberg and Jean-Claude Trichet following well in the path of the Bundesbank. But, they have not been hawkish enough.

When the Germans and the French were struggling after the tech bubble crashed, the EU started to print money and lower interest rates. Unfortunately for the Irish and the Spanish, where things were just fine, this meant overheating and bubble economies. Now that inflation is spiraling out of control, the ECB wants to slam on the brakes again, just when Ireland and Spain might want relief.

The ECB will never run its monetary policy for the Irish or the Spanish and that’s the problem.

In an article entitled, “Why a recession is exactly what the Irish economy needs,” Money Week spells this out very well:

The Irish economy, as we’ve pointed out before in MoneyWeek, was ticking along just fine before Ireland joined the euro. In 1998, GDP growth stood at 8.7% and inflation at a dreamy low of 2.2%. Interest rates meanwhile, were at over 6.2% and on the rise. Then, as if fourth gear wasn’t enough for the economy, the Irish government strapped a super charger to the engine and whacked it into sixth. Ireland joined the Euro.

On joining the euro, interest rates dropped, and by 2000 stood at 4.5%. House prices soared, the building sector boomed and emboldened by the strength of the economy, the Irish binged on the cheap credit made available by the mandarins at the European Central Bank in Frankfurt. Timber decking was slapped onto the back of new build houses in the suburbs and wide screen plasma TVs became a feature in living rooms up and down the country. All of it fuelled by the housing bubble.

Had Ireland had an independent monetary policy, it could have set its own rates, and stopped the madness before it began – though judging by what happened in Britain, perhaps not. In any case, what actually happened was that Irish people borrowed enthusiastically against their homes, as the ECB looked to waken the sleeping German economy from its prolonged slowdown. The slumbering factories of the Ruhr Valley, were more important to the ECB than the booming car sales showrooms that ring the outskirts of Dublin city.

Now, Ireland is facing a jump in unemployment form 4.5% to 7% as high interest rates dampen the construction industries prospects and 20,000 people are expected to emigrate this year.

But is the recession such a bad thing? As John Stepek, Deputy Editor at MoneyWeek pointed out on Newstalk Radio, the Irish radio news station on Tuesday, not at all. In fact, it’s probably exactly what Ireland needs right now.

Recessions, as the economist Joseph Schumpeter pointed out, are a necessary evil in a capitalist economy. They clear out the unnecessary fat that’s built up over years of prolonged economic growth, and are thus the price we must pay for that growth. That’s not to say it won’t be painful. The bust which follows a particularly wasteful and overblown boom like this one will hurt badly. Plenty of people will lose their jobs.

But gradually, the saving rate will go up and consumers will repair their balance sheets. First-time buyers will relearn the habit of building up deposits rather than stretching themselves on 100% mortgages, and will be able to buy houses at reasonable multiples of their income.

And with national debt standing at 30% of GDP, compared to 130% in 1986, the Irish public finances are in much better shape than they were back then. Unemployment might rise above 7%, but in 1986 it stood at a jaw dropping 17%. The Irish economy is slowing, like the rest of its western counterparts. But overall, it’s far from being the European country in the worst position to weather a downturn.

The Euro is flawed because it subjects countries like Ireland to inappropriate monetary regimes that causes their economy to overheat and bust. However, one cannot say the Irish economy would have maintained an even keel had they not given up the Punt. Just look a the mess in the UK, where the British have their own currency. So, don’t blame the Euro for a housing bubble.

However, at a minimum, interest rate policy could adjust more closely to the needs of the Irish economy with their own currency. This is the price paid in order to be part of the Euro.

That said, a recession may well be what the Irish economy needs right now anyway, as recessions are where economies purge the excesses of the previous boom in order to set off again on the path of economic growth. Ireland needs to purge a tremendous amount of debt and leverage before moving forward again. They should use the recession to do so.

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