Bailouts Could End With Ireland

There is a broad expectation that contagion will rise as Ireland is bailed out by EU nations and the IMF. Much like Greece, Ireland could not afford to finance its debt. Fears about default became too great and Ireland said it could not handle the payment of 7% or 8% interest rates on new debt although it claimed to have enough money to finance its economy until mid 2011.

The amount of the Ireland bailout is now fixed at about $150 billion for a three-year period. The UK, which has its own troubles, will provide some of the aid.

Greece was not so lucky as Ireland. It was about to run out of funds when The IMF and European nations came to its rescue with nearly $150 billion. Many global capital market investors still think Greece cannot finance its national debt long-term and will face default three years from now. The opinion about Ireland’s debt seems a little more optimistic.

Contagion is expected to bring down the financial fortunes of Portugal and Spain now. Each has a high burden of debt and large deficit-to-GDP ratios. Each has high unemployment and tax systems which are considered infective. Each has plans to put into place significant austerity measure that will slash government expenditures and raise taxes. These kind of programs can be regressive because they remove government stimulus and the levies they increase can hurt consumer spending and business profits.

But, the bailout of Ireland may create a firewall. The general assumptions about the Greek and Ireland aid packages is that they cause a moral hazard. Nations with debt problems believe that they will be rescued by their neighbors and do not take their budget and debt problems seriously. The opposite may end up as the case. Portugal and Spain do not want to live under the de facto economic control of the EU or IMF.

Germany is the most important player in all of these bailouts because it has by far the largest GDP in Europe. That means Portugal and Spain face the prospects of a powerful neighbor who can weigh in on whether their budget cuts are severe enough. Germany has already said that nations which do not comply with budget provisions should be expelled from the EU. The Guardian recently wrote of Ireland “its coalition government is now struggling to retain remnants of economic sovereignty in a battle of wills with Germany, the paymasters of the eurozone. It is a battle Ireland will lose.”

Spain and Portugal do not want to lose that same battle. They have a modest amount of time to convince the global capital markets that they can get their houses in order in a way that will not require bailouts and that their treasuries are full enough to tide them over to better economic times. That may mean they will need steep cuts in spending and sharp increases in taxes, especially to businesses. Each of the countries is dependent on tourists. Can they  tax visitors more? It will be an attractive temptation.

Portugal and Spain may avoid turning to the EU and IMF because they are desperate not to. Ireland could not avoid that fate, which means that other countries in the regions will rush to remain independent.

Douglas A. McIntyre