Depressionary bust in Ireland is echoed in California

For quite some time now I have been of the view that there are a number of striking similarities between the goings on in Ireland and those in California, none of them good.  Both locations have seen extraordinary rises in home prices turn to massive busts. As a result, both locales have seen depression-like collapses in consumer demand and the local economy. Unemployment and government deficits are surging in both California and Ireland.  But, both California and Ireland have zero control over monetary policy and this is the crucial connection.


Let’s rewind a bit to 1999 when the Euro came into being.  Ireland was a founding member of Euroland. So, on January 1st of that year, the Irish fixed their currency the Punt to the Euro for good at a rate of 0.7876. From that time forward, Ireland effectively had no control of the monetary spigot.  By 2002, Punts ceased to exist as money in Ireland and the Euro was ushered in.

What this change meant for Ireland is that it had the many benefits that go with being part of a large single currency market. Among the many advantages of a single currency are reduced foreign exchange costs, less currency volatility, less chance of a run on the currency, and a greater certainty in business planning that results from those benefits.  And these benefits can be huge in times of crisis – just ask Iceland.

There is a problem though which I mentioned before, namely the Irish have no control over their own money.  To be sure, hard money types probably see this as a good thing as it prevents countries inflating to get out of an economic pickle. But, the alternative for the Irish has been depression.

Back in February, I mentioned this problem in a post called “The European Problem.”

The Eurozone members have decided to forgo independent monetary policies. Individual member nations have free capital movement and a fixed exchange rate but zero control over monetary policy. That rests with the European Central Bank (ECB) in Frankfurt.

The problems mount in recession. Some members are getting devastated. Spain, for instance, is in depression already with unemployment at 14%. Ireland’s national budget is imploding with estimates for deficit reaching 10-12% of GDP. If you are Spain or Greece, you would like to print money– a lot of it. But that’s not happening in the Eurozone yet.

The result is a potential national bankruptcy for the likes of Ireland, one reason their credit rating is suffering. Will Ireland go bankrupt?  Perhaps.  It is unclear how willing other Eurozone members would be to support the country were it to run into that kind of difficulty.  The Germans are furious for having abandoned the Deutsche Mark for the Euro, which they see as a ‘weak’ currency.  Bailing out a Eurozone member would come with many strings attached.

Then, there is the case of Austria.  They too are in the Eurozone.  They have a weak banking system because of excessive lending to Eastern Europe — reaching a full 85% of Austrian GDP.  (Whether the Austrians were mentally re-creating their lost Empire, stripped after World War I, is a case for the Austrian psychologist Freud). If the Eastern Europeans run into problems, Austrian banks will fail en masse, requiring help from other Eurozone members (read France and Germany).

So, Ireland, having no other choice, must cut spending…drastically.  Ambrose Evans-Pritchard reports.

Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15pc of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous debt compound trap.

A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12pc and heading for 16pc next year.

Education must be cut 8pc. Scores of rural schools must close, and 6,900 teachers must go. “The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb”, said the Teachers Union of Ireland.

Nobody is spared. Social welfare payments must be cut 5pc, child benefit by 20pc. The Garda (police), already smarting from a 7pc pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc.


I hope this sounds familiar to American readers because this is exactly the scenario faced by California.  The state does not have the option of going out to the California Federal Reserve Board’s backyard to pick a few ten billion dollar notes off the money tree. This is a privilege reserved for the U.S. Federal Government, one I would add that has the Chinese worried.  Effectively, California is to Ireland as the United States is to the Eurozone.  And that spells depression for California.  Here are a few headlines:

Welcome to Reykjavik on the Pacific.  Don’t think this train wreck happened overnight. It has been building for months.  I first asked in October of 2008 is the State of California bankrupt.  Technically, they are not.  But, when a state refuses to honor its bills by handing out IOUs, that’s bankruptcy to me.

It is going to get worse for California. That is for sure. The problem here again is the depressionary bust that is likely to take hold as California starts firing workers and cutting spending. Remember, people with no jobs have little income. And having little income means foreclosure, which also means a surge in housing inventory and falling prices. That’s a recipe for still more foreclosures, continued house prices declines and a deflationary spiral.  I imagine Wells Fargo and Bank of America would be rendered insolvent by such a scenario.  So why is Obama balking at lending a helping hand?

I anticipated a bust in California and a helping hand from the Obama Administration, because I figured they wanted to mitigate worst-case outcomes. As far back as January 2nd, I was already saying this was the likely scenario.  I asked “Will federal largesse be countered by state and local cutbacks?

There has been a general outcry for economic stimulus on the part of the North American, U.K. and Eurozone federal governments to counteract the fall in private sector consumption.  In the U.S. and the U.K. in particular, this message is being heard and largesse will be delivered in spades.

But, in the United States, there is a bit of a problem: state and local governments.  They will not, and often cannot, spend.  In fact some will be cutting.  Will local government budget cuts undercut federal fiscal stimulus?

Yes. Yes. Yes.  Doesn’t the Obama administration see this?  I would argue they did not understand this in January or the stimulus bill would have been larger and more front-loaded. But, perhaps they do now, but have chosen not to act because every state and municipality in America would be looking for a handout if they did try to act in California.  So, we’re in bit of a pickle here.


The foregoing analysis can’t leave you feeling like recovery is imminent in Europe or in America.  Certainly, it is not in Ireland or California.  The problem is the Impossible Trinity of a fixed exchange rate, independent monetary policy and free movement of capital. You cannot have all three. And California and Ireland both lack the monetary escape hatch. Depression will set in.

I see only three choices to solve this problem.

  1. Bailouts: Of course, we are going to see requests for transfer payments here. Will Obama bite?  Will the Germans block this, afraid that the Austrians and Spanish would be next?  Obviously, transfer payments are part and parcel of a monetary union in order to achieve economic harmonization.  In the U.S., California gets less in federal largesse than it pays in taxes. This is a fact.  However, it is looking ever less likely that this fact will help Schwarzenegger receive the help he wants.
  2. Backdoor currency: Marshall Auerback has argued that the IOUs in California are a backdoor currency system. No, they are not legal tender.  But, in a note to me, he said “California can turn its warrants into sovereign currency by agreeing to accept them in payments to the state. Note that I AM NOT arguing that California should make them “legal tender, payable for all debts public and private”—this is something it cannot do. But you could basically reduce the cost of CA’s borrowing substantially via this device and essentially reduce the need for muni bond issuance.  In fact, the implication that flows from my analysis is that you’d want to buy every single muni bond in sight as the IOU, by giving it an intrinsic value to pay state tax, effectively eliminates the need for muni bond issuance.”  Could Ireland do the same?
  3. Immigration:   People are just going to have to move.  As jobs disappear in Ireland and California, the Irish and Californians will need to emigrate elsewhere. They have a huge market to chose from in both cases.

None of these are great options. I wish I had something more uplifting to say here. But, that is the situation we face.

  1. the Jim Gaudet says

    Sorry, but what about Marijuana? I just read an article from the AP about 50% of the citizens in California are for the legalization of it. And that the companies that would profit from it are enormous, not to mention the article read the marijuana is the most profitable crop in California…

  2. Anonymous says

    This is a clever connection, congratulations.

    What do you think about the larger point that Evans-Pritchard was making that not only is fiscal stimulus leading us towards the Irish (California?) dilema but that the only road out is monetary stimulus coupled with multi-year cuts in national spending?

    1. Edward Harrison says

      I don’t really buy it. His last line was essentially inflationary: “The imperative for the debt-bloated West is to cut spending systematically for year after year, off-setting the deflationary effect with monetary stimulus. This is the only mix that can save us.”

      I see excessive monetary stimulus as poison to judging risk, asset allocation and longer-term inflation. In general, I would prefer an Austrian approach of consolidation both fiscally and monetarily. But to the degree depression is the outcome, and the spigot needs to be loosened, I think it is the fiscal spigot first (initially through automatic stabilizers and then through other temporary means).

      His argument is just the opposite.

      Depression IS a potential outcome and I do think it has been forestalled/averted – in part because of stimulus. Ultimately, I see this is a philosophical question more than an economic one because it is very difficult to tease out the individual factors responsible for economic success or failure when so much has been done.

  3. aitrader says

    I’d say door #2 is the most likely outcome for California. The US Federal Gov will threaten and cajole, most likely withdrawing highway funding (as Reagan threatened to do to states who did not raise the drinking age to 21 in the 1980’s), but in the end they have two choices – either bail California out or let them print their own currency.

    The problem with bailing out California is that every other state in financial trouble will expect the same help. Allowing the California IOU’s to be treated as currency will open the door to other states following suit as well.

    In the end I expect California and the Federal Gov to make a deal where California limits the exchange of IOU’s to something that does not compete directly with Federal Reserve dollars.


    Now here’s a curve ball for ya: what would happen if a state or even a private bank were to issue currency redeemable in gold or silver? What would the implications be for the US Federal Reserve? This was the situation for many years in the US. Private banks often issued their own paper currency redeemable in gold and silver. There is nothing illegal about this, though one would assume a new law would be crafted and passed to prevent this from occuring. On that note here is what happened recently to a private currency issuer,

    Interesting times…

    1. Edward Harrison says

      aitrader THAT is a very interesting idea – the addition of gold into the concept. I have some further ideas based n this that I will hopefully make into a post later today or tomorrow. Thanks for the idea.

  4. Anonymous says

    California’s IOUs are currency, for all practical purposes–not dollars, but currency of some kind. We’re printing our own money–not borrowing it, but printing it. However, one common theme that I have read from many leading economists (notably Krugman) is that the government needs a second stimulus package to get us through the depression, even though this is not politically feasible. One of the pressing needs to be addressed by this stimulus would be aid to the states, which would otherwise be forced into the kind of brutal, massive spending cutbacks that are exactly the kind of thing that you want to avoid right now.

    Might not letting states issue IOUs, and treating them as currency, amount to much the same thing? If we had, say, a $200 billion dollar stimulus package for giving aid to the states, which the feds would pay for by printing money and then going to the bond markets, how different is that from letting states issue $200 billion of scrip?

    1. Edward Harrison says

      eric, good point regarding the effect of issuing the IOUs. I’m sure this is an issue which could eventually make it into the courts because it has serious legal ramifications.

      I agree that the Federal Government turning ‘a blind eye’ to this is the equivalent of added stimulus for states.

      Very interesting.

    2. OregonGuy says

      Eventually the script needs to be redeemed in something other than script, unless CA allows state taxes to be paid in script. Allowing the remittance of both script and dollars to pay state taxes at 1:1 equivalence would establish the rate of exchange. CA would receive 100% of the script in circulation for tax remittance before it receives a Federal Reserve note. Gresham’s Law in action.

      So establishing confidence in script requires backing. CA wouldn’t have Au or Ag to do the job – if the State had the cash to buy the metals it wouldn’t need script. CA could use State-owned land, offshore drilling rights, etc. to back the script. It worked for Schacht at the Reichsbank after hyperinflation.

      This could be fun.

  5. Mark Wadsworth says

    As a free market small government type, I find this all very uplifting. I just hope that countries learn the lesson for next time.

  6. anon of the moment says

    This really is a bad comparison. California’s problems are essentially political. The budget gap amounts to about 1.5% of gross state product, which would be possible (if not pleasant) to overcome were it not for California’s deeply flawed constitution. Ireland’s gap is 10-15% of gross domestic product, which will be nearly impossible to overcome without devastating existing services.

    Writing a whole article without mentioning the political situation in California tells me that you are attempting to shoehorn the situation there into a pre-existing conclusion.

  7. Anonymous says

    Interesting and well thought out post. I would add one difference between Ireland and California. California’s budget is hobbled by state law. Roughly 67% of California revenue is committed before the legislature and the governor decide what to spend.

    Compounding state law is a gerrymandered legislature, which effectively ensures the maintaining of status quo. Thus, the legislature is never beholden to anyone. Many state legislatures have this problem (see New York). As if these two issues were not enough, state government cannot raise tax without a vote of the people.

    California has created a toxic stew of its own making. As far as I know, and I will admit freely if contrary evidence is presented, no other state or Ireland has created such a doomsday scenario. Given the self-inflicted nature of this wound that is killing the state, I have little sympathy for the state legislature or its citizen.

    They made the mess. They can clean the mess up. As a non-resident, I should not and will not provide a bailout.

  8. Anonymous says

    The public pay bill and social welfare system in Ireland is far too generous and needs to be cut drastically. One third of the national tax take is eaten up by welfare payments! Although politically unpalatable, slashing welfare would therefore significantly bridge the budgetary gap. Here’s a few of the more egregious examples of the public sector and welfare-gone-mad; public servants, such as teachers, earn around Us100k per year, depending on period of service. Meanwhile, unemployed school-leavers get over Us$250 per week unemployment benefit, regardless of social insurance contributions! Every family, regardless of means, gets almost US$200 per month for each child they have (children’s allowance) and if you have 3 or more, you get over Us#250 per additional child! Welfare is far more generous than in comparable European countries. We can’t afford it and it’s a breeders’ charter for the idle, feckless working class. And I’ve had quite enough.

Comments are closed.

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More