Should Ireland leave the euro and devalue the punt?

I listened to David McWilliams at the Irish Skeptics last night. He ego-tripped for around an hour on the interesting people he met and corrected and the funny incidents and how right he was and how unpopular he now is for what he said about Miriam O'Callaghan. He spent around 5 minutes of the total time making the following two points.

1) There are three stages in the "system's" reaction to visionaries like himself:

• Ridiculing of the idea
• Aggressive attacks on the idea
• Adopting it as conventional thinking

2) No other country in the same mess we are in has got out of it, except by devaluing their currency. We have to devalue our currency.

Devaluing the currency forces a reduction in salaries on all of us and devalues our expectations. The alternative is social chaos as the government tries to slowly "grind" a 20% pay cut on us all.

Unfortunately, that was as far as he went.

Listening to him, it was quite clear that we must devalue our currency. The people who run the country and their economic advisors have no idea what they are doing. Argentina refused to devalue, and then after 4 years, they devalued and started booming again.

No other economist in Ireland worth their salt, disagrees with him. Or maybe, all the other economists know this.

I spoke from the floor along the following lines:
His argument seemed coherent to me, but I am not an economist
I would like to hear the other side of the argument.
I would like to hear the point of view of Alan Ahern and Patrick Honohan. I asked if he respected them and he said that they did.

His response was that his record shows that he has been right all along, so by implication, he is correct now as well.

Another questioner said that devluation was a good idea, but it would never be agreed as none of the three big parties supported it. Mc Williams correctly countered that none of the big parties supported free trade until Ken Whitaker proposed it. And eventually they agreed.

Another questioner asked what the downsides were. Mc Williams replied that there would be some pain, but not nearly as much pain as we will experience doing it the slow way.

I would like to see a rational discussion of this issue. I don't want to listen to the ridicule and the attacks on McWilliams.( Feel free to attack his manner in this thread) I don't want to listen to his egotrips - but I do want to hear both sides of the argument.

Let's discuss the point and not the man.

1) I presume that we could actually leave the euro zone? I think it would be difficult, but if we had to do it, we would.

2) I presume that if we do so, the country as a whole must declare bankruptcy.
We will have a massive international loans denominated in euros and we will be trying to pay them off from the punt, which will be worth,say 40% less than it is now.

3) If the country goes, the banks go as there is no point in having a bankrupt guarantor.

4) What happens all our deposits in Irish banks which are currently denominated in euro?
I presume that they become punts on a one for one basis. So they effectively lose 40% of their value.

5) What happens to mortgage holders?
I presume that interest rates will rise to around 10%. They are being kept low by the ECB at the moment. Depositors will want some compensation for keeping their savings in a mickey mouse currency.

Brendan said:

5) What happens to mortgage holders?
I presume that interest rates will rise to around 10%. They are being kept low by the ECB at the moment. Depositors will want some compensation for keeping their savings in a mickey mouse currency.

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So mortgage holders would own the same debt, have smaller wages, and have to try and afford a much higher interest rate? Would this mean that you would have to allow people hand the keys back to the banks?

Why not devalue the euro instead? If the rest of Europe wont allow that, will they really allow one of its member states to go bankrupt?

yankinlk said:

Why not devalue the euro instead? If the rest of Europe wont allow that, will they really allow one of its member states to go bankrupt?

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Dont worry the cuts in the budget will make sure this doesnt happen. This is Irelands own foolishness/greed that created this problem so why should Europe take any responsibility???

Irish people just have to all take a cut in some way obviously I think it should be scaled from the highest down with bigger cuts from the ridiculously wealthy and the wealthy and prices are going to all come down in everything anyway so in real terms the cuts are less than people think its more your wealth than your standard of living are going to fall its all relative like when a lot of people here thought they were rich the last few years they didnt take the higher cost of living here into account....

Well if the choice is between devaluation of 20% or an across the board pay cut of 20%, I`d be in favor of a 20% pay cut.You still have the security of the euro and its guaranteed stability and low interest rates.
I don`t see devaluation of the currency as an option...our foreign debt would be instantly much bigger and the new currency would be very volatile.
Our politicians have just got to get on with it and introduce the necessary pay cuts across the board....It seems they are going for the thousand cuts strategy, backed up by a sophisticated letting off steam P. R. campaign, where no cuts will be made without various critics insisting on them and the unions and opponents screaming blue murder.....by the time the cut is announced all the pent up outrage will have been used up and the cuts will have been seen as inevitable.
Leaving the euro would be a disaster and would solve nothing.

I don`t see devaluation of the currency as an option...our foreign debt would be instantly much bigger

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McWilliams argues that this is not a problem. We just have to write off our foreign debt.

Well our government was terrified of not paying the irish banks senior bond holders...so much so that the government decided to saddle the taxpayer with a 65 billion bet.I don`t think it is possible for the government to actually write off the foreign debt without severe and more painful repercussions.Don`t forget we are still borrowing 400million a week....this would be instantly cut off.The "punts" purchasing power would plummet,so we would be able to buy less than if we had a 20% cut in our euro salary/dole.The perceived advantage is that we could trade our way out by increased exports but we could also do this with pay cuts.
I think the government will be forced to introduce the necessary cuts. There is no external pressure to devalue. I am no economist but I don`t see the point of devaluing.
It is different for argentina which has its own currency and exports a lot of commodities.Presumably they print more money to achieve the necessary devaluation.

The point in devaluing is that we just have to admit that we are bankrupt and cannot trade our way out of it. By devaluing and reneging on our international debts we can start again. Much like a person filing for bankruptcy.

For a year or two, the international markets will be annoyed at us. But then they will respect us for what we have done and start lending to us again.

Brendan

Brendan said:

to visionaries like himself:

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Brendan - I know you said we weren't to say anything about him, so I won't, but I think the above quote speaks volumes...

I think (in the very unlikley event that we unravelled the whole euro project and reverted to the Irish Pound - I presume he's only proposing to go back to decimalisation and not £.s.d.) - that we wouldn't actually need to devalue the currency - because it would be absolutely worthless, what country in their right mind would want to buy a currency of a country that the world perceives to be a basket case, and in effect has just declared itself bankrupt?

While being in the euro probably has its downsides, I think if we were to follow McWilliams stance we may as well take a chisel to the east coast of Ireland to detach whatever connection there is to Europe and let us float out in to the Atlantic - and sink!

BTW - I'm sure you've worked this out already - but I'm not an economist either....

Philip Lane dismissed it on The Irish Economy back in January.

Brian Lucey sets out the arguments against it here. Patrick Honohan, now the Governor of the Central Bank, doesn't want to leave the Euro either.

I think McWilliams himself contributes to the debate on [broken link removed]





Brendan

pjmn said:

I think (in the very unlikley event that we unravelled the whole euro project and reverted to the Irish Pound - I presume he's only proposing to go back to decimalisation and not £.s.d.) - that we wouldn't actually need to devalue the currency - because it would be absolutely worthless, what country in their right mind would want to buy a currency of a country that the world perceives to be a basket case, and in effect has just declared itself bankrupt?

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The new currency would only be worthless if it wasn't backed by something more tangible than an 'I O U Nothing'.

I agree that leaving the € and devaluing the new punt would have a very severe effect in the short term. But just leaving the €, and then setting up a fresh banking system based on central and fractional reserve banking of a fiat currency will only leave the door wide open for future financial crises.
If the solution is to be to leave the € and then set up the following, then I would fully support it:
1) set up a currency fully backed by gold and 100% redeemable at any time (enforced by the a constitutional amendment)
2) banking to be separated into deposit banking and loan banking, where 100% reserves must be held for demand deposits
3) Interest rates not to be dictated by a central body, but rather by the free market based on supply of and demand for credit

If the above were not to be introduced then I would have more faith in the ECB than an Irish Central Bank in control.

Brendan said:

5) What happens to mortgage holders?
I presume that interest rates will rise to around 10%. They are being kept low by the ECB at the moment. Depositors will want some compensation for keeping their savings in a mickey mouse currency.

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10% would be optimistic. I could see us getting into a south american style hyper-inflation.

All the mortgages are secured on foreign funds then everyone mortgage effectively goes up 40% overnight.

yankinlk said:

Why not devalue the euro instead? If the rest of Europe wont allow that, will they really allow one of its member states to go bankrupt?

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Never going to happen , the Germans are paranoid about inflation.

This is totally, totally impractable.

Maybe, just maybe, we could get away with an overnight declaration that all our euro obligations were now in the Irish Punt.

But the real world is that this would need some advance notice. Ergo the total withdrawal of all euro funding of Ireland inc. as investors, domestic and foreign, rush for the exits. This logistical problem of a break from the euro is well documented.

When DMcW profers this solution he is so way off the mark.

Brendan said:

The point in devaluing is that we just have to admit that we are bankrupt and cannot trade our way out of it. By devaluing and reneging on our international debts we can start again. Much like a person filing for bankruptcy.

Brendan

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While the public finances may be near to "bankruptcy", the nation is not.

Indeed, we are fast heading towards a balance of payments surplus, which means our annual income will exceed our annual expenditure, and so we will soon be a net saving nation.

OK, this is after a few years of spending exceeding income, and being a net borrowing nation.

But the country is not bankrupt, although the Govt may be.

Obviously this is all completely hypothetical.

But leaving the euro would be possible without defaulting on government debt.

The government could also default on it's debt without leaving the Euro.

I cannot see any positives to doing either, separately or in combination.

For example, I don't see what problem would be solved by the government defaulting on its debt obligations. The interest payments on the debt are reasonably manageable at the moment. A few more years of 25-30 billion deficits and the cost of bailing out the banks will change this picture but in the short term the cost of meeting the bond obligations is an insignificant drain on the public purse (certainly less than 5 Billion a year). So the benefits to the exchequer would be relatively small while the financial and economic effects would be catastrophic. It's a completely ludicrous idea.

I suppose if Ireland left the Euro and despite much higher interest rates, the new punt lost 80 or 90% of it's value, then this picture would change and default might become attractive. But I'd argue that at that stage (as an open economy this would translate to 500%-1000% inflation), we'd be facing economic Armageddon ala Zimbabwe and it'd wouldn't really make much difference what economic policies the government decided on as every person in the country capable of doing any sort of work would be queuing to get onto the boat out of the place.

I don't even know why I'm writing this; the suggestion is absolute clownfoolery. It's hard to take DMcW ever seriously when he peddles this sort of sensationalist publicity seeking rubbish. He has to know it's stupid. This is unfortunate because I've read other stuff he has written which is reasonably insightful.

Even the claim that there is no historical precedent for economy recovery without a COUNTRY devaluing it's currency is completely bogus. It only stands up because of the novelty of the Euro. Different parts of the US for example have (independently of the country as a whole) gone through economic cycles many times.

Devaluing your currency is only a means to an end. It is inevitable that the levels of pay in Ireland will have to drop significantly but nominally (in Euros) instead of in real terms (in punts).

Protocol said:

Indeed, we are fast heading towards a balance of payments surplus, which means our annual income will exceed our annual expenditure, and so we will soon be a net saving nation.

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[broken link removed]contradicts your assertion, Protocol. It is true that we have a positive balance on visible trade, and have had for some time. But we can see that this is mainly transfer pricing as any surplus goes right back to its foreign owners.

In fact, we know that the private sector is massively in debt to foreigners which shows up in the dependence of the banking system on international interbank support.

So the point is quite the opposite. Even if the Government found some way to alleviate its debt by a devaluation the private sector/banking sector has no such escape valve.

Let's hope all that foreign borrowing has gone into foreign assets and not been blown on mercs and club med.

Another problem with reintroducing the Punt is the large amount of euro cash in the country, and people hording (hard currency) cash with a run on the banks, if the word got out before hand. You would end up with a two tier price system in the shops etc.

Mind you the only actual economist I have talked to was last year predicting very high inflation and advising me stock up in high end consumer goods to use for bartering. This was long before Mr Hobbs jumped from his 'property investment for the punter' bandwagon on to the 'high inflation' one.

Duke of Marmalade said:

[broken link removed]contradicts your assertion, Protocol. It is true that we have a positive balance on visible trade, and have had for some time. But we can see that this is mainly transfer pricing as any surplus goes right back to its foreign owners.

In fact, we know that the private sector is massively in debt to foreigners which shows up in the dependence of the banking system on international interbank support.

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Correct, the balance of payments is currently in deficit, but the deficit is falling fast.

The data is below, with the deficit estimated to fall to under 2bn in 2009 and turn into a surplus during 2010.

[broken link removed]

Year 2007 2008 2009 2010

This is simply bar-stool economics.

Until Iceland's meltdown, it was not uncommon to hear the argument that we would have been better off during the boom with the punt.

The notion of a reckless fiscal policy would have been matched by prudent monetary policy from Dame Street, is risible.

We would of course have countered carry-trade hot money and so on!!

It's not a serious proposal as the downside risks are treated as a politician would rather than considered analytically.

How would a transition work?

The IMF would replace the ECB as lender of last resort; why would control from Washington be better than Frankfurt?

The argument that the economy boomed because of the 1992 devaluation is fallacious.

Have a look at the third chart on this page:

http://www.finfacts.ie/irishfinancenews/article_1016593.shtml

Intel arrived in 1989, Dell 1990, HP a few years later etc.

The devaluation had nothing to do with their location in Ireland but they supported Ireland joining the EMS and today they would be the key constituency on the issue of exiting.

These are global companies and US firms in Ireland today do not operate like their antecedents at the old freeport in Shannon.

According to the US Dept of Commerce, the Irish economy is more dependent on US FDI than any other country in the world.

The Eurozone will likely have 21 members in the next decade.

Irish indigenous exports are still dependent on the UK market.

Why not get costs under control by reforming the housing market including the land rezoning system; the public sector and ending public subsidies of high costs in the private sector - e.g hospital consultants fees via high insurance premia; lawyers, consultants etc?

Why not have full public transparency on public spending?

Bloomberg says New Zealand's dairy group Fonterra accounts for about 40% of the global trade in butter, milk powder and cheese and sells products in more than 140 countries.

The Irish industry has relied on intervention and production of higher value products such as cheese is low.

http://www.finfacts.ie/irishfinancenews/article_1017985.shtml

There are no instant solutions but rather than try to chase dreams of creating a European Silicon Valley or nightmares such as quitting the euro, , why not focus on selling across Europe for a change, with the advantage of no exchange risk?

Brendan said:

I would like to see a rational discussion of this issue. I don't want to listen to the ridicule and the attacks on McWilliams.( Feel free to attack his manner in this thread) I don't want to listen to his egotrips - but I do want to hear both sides of the argument.

Let's discuss the point and not the man.

1) I presume that we could actually leave the euro zone? I think it would be difficult, but if we had to do it, we would.

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We surely could and Ireland Inc's credibility would just as surely be gone.
One of the main selling points of our still too-dear economy - an english speaking door directly into Europe - [as opposed to Britain's half-open door] would also go.

2) I presume that if we do so, the country as a whole must declare bankruptcy.
We will have a massive international loans denominated in euros and we will be trying to pay them off from the punt, which will be worth,say 40% less than it is now.

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I would have thought that devaluing was a way to recognise and deal with a difficulty, as opposed to declaring bankruptcy, but I am not a commercial banker or legal eagle familiar with such things.
It appears that we will go from being a credible part of Europe, albeit having a difficulty selling uncompetitvely priced goods and services to service a huge loan, to being a discredited ex-EU Member State.
This State will have a lack of credibility for borrowers, and while it will be selling more competitive goods and services initially, it will then see these goods and services become less and less competitive as interest rates rise - there will be no "cheap" finance available and we will over-extend ourselves trying to do it all ourselves.
I well remember the late eighties running into 1992, when the commercial lending rate was 22% IIRC.

3) If the country goes, the banks go as there is no point in having a bankrupt guarantor.

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I'm afraid I'm still not following this Ireland Inc. bankruptcy argument.
The time for letting the banks go is long gone, with money poured down their respective drains which we will now never see again.
As noted elsewhere, as far as I'm concerned the Banks are probably gone anyway due to their Derivatives Portfolios.

4) What happens all our deposits in Irish banks which are currently denominated in euro?
I presume that they become punts on a one for one basis. So they effectively lose 40% of their value.

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Surely deposits [or loans in accounts] would become converted at the stated exchange rate.
This gives an artificial boost to each depositor and a kick in the teeth to every borrower.
Given the assumption that more people owe than have money, the act of devaluation will cripple us unless its done the way you suggest.

5) What happens to mortgage holders?
I presume that interest rates will rise to around 10%. They are being kept low by the ECB at the moment. Depositors will want some compensation for keeping their savings in a mickey mouse currency.

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I foresee a return to the 22% Commercial rates in 1992.
We have a poor record of managing our own financies prior to joining the EU.
Foreign investment banks will lend to our banks and we will have to self-fund all our own loans.

To summarise:

In my layman's opinion, David Mc Williams is findamentally wrong is he is seriously suggesting that devaluation and leaving Europe will benefit us.

Devaluation in an of itself won't deal with this issue.
Our loans are in Euros, our guarantees are in Euros, there is little to be gained monetarily.
Devaluation will momentarily make our goods more competitive in relation to competition from other EU economies.
But this isn't the seventies - its not even the nineties- and the EU is moving towards more globalization and less trade restrictions so we are exposed to less costly comparison goods and services than ever before.

Deflation, the 20th Century Nation-State fallback, simply will not work in the 21st Globalized Century world we now live in.
It may be an effect of McWilliams time spent in Nation-State teaching economic courses and economies that he doesn't see this.
This is not a slap for McWilliams, it is a fact and it is important that we understand the depths of his short signtedness.
McWilliams spends his time sauntering around Chinese airports made easily accessible through the benefits of price reduction through Globalization.
Yet he fails to see how Globalization, being brought into direct competition with China and India, will prevent his Nation State devaluation from working.

Our goods and services are overpriced in relation to places like China and India.
We won't become competitive enough to win huge market share from them through devaluation.
We don't even compete in some of he markets they excel in.

Devaluation only worked when our main trading neighbours like America, Europe and Britain stayed high and we went low.
Our two other trading partners are already devaluing ahead of us - so our advantage will be nil - and we're still tied to Europe
Leaving Europe is a non-starter, because the points raised above and my responses only touch on the real problem, implied by Brendan.

Our credibility would be so shot that all our loans would be called in at once - we would be bankrupted.
No form of rescue investment would be available to keep us going to avail of any meagre benefits of such a move.
Perhaps this was what Brendan meant when he referred to Bankruptcy - sorry, I'm only seeing this now as I work through this stuff.
Of course there might be the typical "rescue" investment from certain quarters buying Ireland Inc for a snip which might not be to our benefit.

This is my shortlist of proposals, and none involve Ireland individually devaluing and leaving Europe.

1. We need to focus on value-added excellence in all things we do.
2. We need to focus on investment in infrastructure to free up finances and get some money moving in the economy again.
3. We need to invest in education and promote inventiveness, with returns to the state in terms of work done here pre-or post graduation.
4. We need think tanks to focus our indigenous industry on emerging lucrative markets which wave we can profitably surf until China and India figure out a way to give 80% of the quality for 40% of the price.
5. We need a new commercial bank to service this new economic activity, not an old bank burdened down with debt.
6. We need Irish people and companies to pay their debts to other Irish people and companies, even if its only staged payment of historical debts so we can get this economy mving again.
7. We need to use our connections to Europe to maintain our credibility, support our indebtedness and leverage our influence where we can to develop new ideas and markets we can benefit from.

There may be an argument for the Euro devaluing in relation to the American, British, Chinese and Indian currencies, but that's for another thread.
Consideration of such a move will involve the double-edged sword of Oil bcoming priced in Euros, driving up demand for the currency.
The real question for economists is how to deal with the growing Pacific Rim economies and the potential collapse of America.

FWIW

ONQ.