We’ve highlighted before how bond yields for European periphery nations such as Ireland, Greece, Spain, and Italy have been rising, even though their problems haven’t been making international headlines like they did a few months ago.
Even though these troubled European nations have all announced austerity measures, markets are realising that A) austerity can be politically-impossible to implement and B) austerity plans as announced won’t be enough.
Ireland in particular has been under renewed scrutiny lately. The nation’s sovereign debt was downgraded by S&P just a few weeks ago, and the government clumsily rushed to contain the PR damage. Then just last week the economist Simon Johnson called the nation insolvent.
Ireland, simply put, appears insolvent under plausible scenarios with current policies. The idea that Ireland, Greece or Portugal can cut spending and grow out of overvalued exchange rates with still large budget deficits, while servicing all their debts and building more debt, is proving – not surprisingly – wrong. Such policies leave nations burdened with large debt overhangs that effectively tax businesses and borrowers – because interest rates must stay high to reflect risk.
Investors must wonder whether businesses and homeowners can afford these higher interest rates, so banks and investors cut credit lines and reduce lending. This strangles economies, even when the fiscal authorities take tough steps needed to cut deficits.
As if to underline Mr. Johnson’s point, this week the expected cost of bailing out troubled Anglo-Irish bank is exploding.
The bank has recently announced that it will probably need some €25 billion in fresh capital, equivalent to a full 19 per cent of the country’s GNP. Credit rating agency Standard & Poor’s has said that it believes this to be low-balling the true figure, estimating that the real cost could come to €35 billion.
Once again the Irish government is in damage control mode, via Irish finance minister Brian Lenihan:
Mr Lenihan stressed that it is “simply not the case” the bail-out could bankrupt the state and that the debts that have effectively transferred from private hands to the public were “infuriating but manageable.”
“Management have put forward a case that if the bank were allowed to engage in lending, it might reduce the cost to the taxpayer further,” he said.
Yet according to Mr. Johnson, Ireland’s current path will leave each Irish family of four with 200,000 euros of government debt by 2015. Even if the Anglo-Irish bailout is cheaper than expected, the Irish taxpayer will be buried under massive future liabilities. So far, Mr. Johnson’s view of Irelish finances seems far more compelling than the government’s.