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Cormac Lucey: Can We Exit the Eurozone?

29-04-2014 10:45

People can foresee the future only when it coincides with their own wishes and the most grossly obvious facts can be ignored when they are unwelcome - Orwell

There are several myths that currently dominate our thinking about the economy and which impede our capacity to see clearly where our best interests lie.

Myth 1 – Bertie Blew It

It appears to be widely believed that nearly all of Ireland’s economic ills can be attributed to Bertie Ahern, Brian Cowen and Sean FitzPatrick. It is certainly the case that at the 2011 general election, Fine Gael and Labour sought to propagate the notion that “it was Bertie that blew it”. But, while that argument may have been good politic, it is a myth.

The reality is that the Eurozone never fulfilled the conditions of an effective monetary union. The key symptom of its inappropriateness for Ireland is that, since its foundation, the European Central Bank (ECB) has given us interest rates that are quite inappropriate to our national circumstances. This meant that Ireland “enjoyed” interest rates that were far too low for its particular circumstances between 1997 and 2007. Those ultra-low interest rates spawned a credit bubble, a property bubble, a bubble in economic activity and a bubble in costs.

The reality is that it was the EU, or more particularly the Euro, that blew it not Bertie.

Myth 2 – Economic Authorities Know What’s Going On

Economic experts speak in a carefully modulated tone that suggests they know what they are talking about. But do they? In particular, did the expert economic bodies issue warnings

After the crash, it was reported that the Department of Finance ‘had warned the [2002–7] government about the dangers of the economic policy it was following, but that its advice was overruled by the Cabinet’. This report was based on the Wright Report, which was commissioned by the Department. It certainly fits into the popular belief that the dogs in the street knew something was wrong and that then Taoiseach Bertie Ahern wilfully ignored official advice as he drove the economy over a cliff.

But is it true? It is telling that not a single direct quote from any departmental document was offered in support of the report’s central conclusion. Instead, the report lamely asserts, ‘There are examples of where such advice was tendered in writing. We have also been advised of some important oral briefs that reinforced the Department’s concern about pro-cyclicality. But these are not part of the official record.’ How can they not be part of the official record? Why not reprint this written advice? And why not tell us who orally warned whom of what and when?

In August 2006, the IMF underlined its complacency regarding Ireland’s banking system when it reported:

The Irish financial sector has continued to perform well since . . . 2000. Financial soundness and market indicators are generally very strong. The outlook for the financial system is positive.

As late as March 2008, the EU Commission published its Macro Fiscal Assessment of Ireland. Its conclusion gave no indication of the crisis that lay just around the corner:

Despite the weakening in the budgetary position in 2007, the medium-term objective, which is a balanced position in structural terms, was reached by a large margin.

Other experts – the ESRI, the OECD, Professor Patrick Honohan - performed little better. But in a crass example of Gresham’s Law (where bad currency drives out good currency) it is bodies which failed to predict the crisis that has won increased influence as a result of the crisis!

Myth 3 – Our Debts Are Sustainable

The government would have voters believe that Ireland’s current debt level is sustainable. In my opinion, our debts are unsustainable. People may believe that we are in a debt crisis and are making sacrifices so that our debts can be repaid and reduced. But the reality is that debt levels are increasing, not decreasing. Consider the facts:

1. Ireland’s extraordinarily large debt levels have continued to grow (and not decrease) since 2008.

2. Irish debt figures should be compared to GNP (gross national product) rather than GDP (gross domestic product) as GDP includes the Irish profits of foreign multinational over which we have no real claim. As a result GDP significantly exceeds GNP. So comparing Irish debt levels to an elevated GDP figure has the artificial effect of making those debt levels look smaller than they really are. Irish total debt levels of circa 400% of GDP shown above are equivalent to circa 500% of GNP!

3. Official debt figures do not include Ireland’s gargantuan PRSI liabilities (estimated to be €324 billion) of public sector pension liabilities (estimated at €98 billion).

Myth 4 – We Should Not Seek to Restructure Our Debts

The authorities would have us soldier valiantly on in the face of sustained economic underperformance and debt levels that are rising – not falling - relative to income. In my opinion we need a debt restructuring (i.e. debt write-down) of the sort which occurs regularly in business through the Examinership process. Debt restructuring is also quite often undertaken by countries. There is even an international body – the Paris Club, of which Ireland is already a member – which exists to organise sovereign debt restructurings.

Myth 5 – Plan A Is Working

The authorities across Europe would have their peoples believe that their plan, Plan A, is working. Just be patient and everything will turn out alright. But tell that to the young: youth unemployment exceeds 50% in Greece and in Spain; it exceeds 25% here.

Normally if a country suffers a severe economic downturn such as Ireland is experiencing) its currency will drop. That gives the domestic economy a boost as it makes its exports cheaper and its imports more expensive. But since 2007 our currency, the Euro, has risen 25% against our main currency competitor, Sterling.

Back in the days when we had our own national currency, the Punt, we would anxiously check its exchange rate against Sterling. If the Punt rose above 90 pence sterling we would start to get anxious fearing for our export competitiveness. If you apply the original Punt-Euro exchange rate (IR£1.00 = €1.27) to the current Euro-Sterling exchange rate (£1.00 = €1.22), you can see that the old Punt is now worth 1.05! That is clear evidence that despite nearly six years of crunching austerity, our cost base remains too high.

Consider a recent finding by the National Competitiveness Council. It found that in 2012 Ireland was the 3rd most expensive location in the euro area for consumer goods and services. Yet, without the scope to devalue, the only way we can restore competitiveness is by further austerity and by yet more belt-tightening.

Or consider recent remarks by the OECD that Ireland’s overly generous social welfare system is acting as a barrier to unemployed people going back to work. Those comments echoed earlier statements from the IMF about welfare benefits being too high in Ireland. Without the scope to devalue, the only way we can bring our welfare rates into line with other countries is by further austerity and by yet more belt-tightening.

Myth 6 – If Plan A Doesn’t Work, there’s Always Fiscal Union

I lived and worked in eastern Germany shortly after German reunification. Like Ireland today, eastern Germany had an effective exchange rate which was far too high for its circumstances. The result was a massive deindustrialisation that was far more severe than that experienced by countries in similar circumstances which had retained their own currency, like Poland.

But eastern Germany had the benefit of Fiscal Union and welfare transfers from western Germany. But that hasn’t prevented demographic devastation across the old DDR. Since 1989 the population of the town where I worked (Weissenfels) has dropped by 20%. The population of Angela Merkel’s constituency (Templin) has dropped by 15%.

Bottom line: fiscal union may appear like a solution. But it would come with a very heavy price.

Myth 7 – We Cannot Exit the Eurozone

It is argued that we cannot leave the Eurozone as there is no legislative provision for this. But in 1916, there was no legislative provision for Ireland to exit the Act of Union either! As the former French president Charles de Gaulle once said “treaties are like maidens and roses – they each have their day”.

Myth 8 – We Should Not Exit the Eurozone

Today there are three central reasons why we should seek to leave the Eurozone:

• Reason 1 - The Eurozone will nearly always give us interest rates inappropriate to our circumstances. Between 1997 and 2007 those rates were too low. Since 2008 they have been too high. The result has been an Irish domestic economy that has swung from a decade of binge-eating to crash-dieting. To get appropriate interest rates for Ireland we must exit the Eurozone.

• Reason 2 - By ceding control of monetary policy to Frankfurt, we forego it in Ireland. That means that the monetary policy which has been successfully followed in the US and in the UK (QE - quantitative easing) is denied Ireland. Although like us those countries have very large debt problems, they have suffered far less economic stress than Ireland as a result of applying QE. To follow the US and the UK in this regard we need to seize back monetary independence from the sado-monetarists of Frankfurt.


- By exiting the Euro we can allow our currency find a new and lower level that will be much more likely to stimulate economic growth and employment. If you do the sums on current exchange rates, you can compute that an old Punt is now worth £1.05 sterling. This is an alarmingly high exchange rate for an Irish economy that remains so weak.

The alternative to correcting these cost and exchange rate imbalances by exiting the Euro (external devaluation) is to correct the imbalances by more of Plan A i.e. the internal devaluation of cost cuts, wage cuts and more economic sacrifice. The implications of Plan A were spelt out recently in Dublin by Dr Pippa Malmgren.

But you have to accept 20 years of no growth. That’s the only other option. It’s what European policymakers expect Ireland to do. The question is, do the Irish people have the tolerance to take that much pain?

Cormac Lucey

Cormac Lucey teaches finance at the Irish Management Institute, University College Dublin and Chartered Accountants Ireland. He is a chartered accountant and has worked in various financial roles in banking and in industry in Ireland and in Germany. He lives in Dublin with his wife and son.


Plan B. How Leaving the Euro Can Save Ireland is published by Gill Books - now available in all good bookshops nationwide. Also available as an ebook on Amazon.


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