GLOBAL ECONOMY I: by Peter WestmoreNews Weekly
Ireland's woes show depth of financial crisis
, November 27, 2010
Four years after the collapse of the US housing bubble precipitated the global financial crisis, the fallout continues with Ireland and Portugal now in danger of joining Greece as recipients of a European Central Bank bailout.
The extent of the problem can be seen from the figures. Last May, the European Union put together a €750 billion ($A1,100 billion) emergency fund to prop up national economies which faced financial collapse.
The threat of financial collapse arises where a nation's government or national debt reaches a level where international financial institutions will no longer lend to them, because they have concluded that the government or the nation simply cannot pay off its debt when it falls due.
The Eurozone countries and the International Monetary Fund agreed on a €110 billion bailout for Greece, to be accompanied by the implementation of harsh austerity measures by the Socialist Government of Greece.
When the Eurozone was established, it was believed that the economic strength of nations such as France and Germany would enable them to support their weaker neighbours.
In fact, what happened is that the people in countries with strong economies resent having to use taxpayers' money to bail out their spendthrift neighbours.
But without such a bailout, there is a risk that the collapse of the weaker economies will bring about the collapse of banks in the stronger nations. It is estimated that the combined debts of Portugal, Spain, Ireland and Greece total €2,000 billion (about AUD$3,000 billion).
In turn, this could cause a chain reaction of a type which nearly brought the global economy to a stand-still in 2008.
The problem in Ireland stems from the collapse of the property bubble which left many investors and the country's leading banks, which had lent money to the investors, insolvent. A savage economic shake-out has destroyed the savings of many, but the cost of rescuing the banks has pushed out the Irish government deficit to the point where lenders are unwilling to put up more money.
Last September, the Irish Government announced that it would inject up to €34 billion ($50 billion) into the Anglo Irish Bank, a bank it took over at the height of the financial crisis in 2008, taking the budget deficit to around 32 per cent of GDP. (In Australia, the federal budget deficit is around 4 per cent of GDP.)
The Irish Finance Minister, Brian Lenihan, said that if the Government failed to inject more capital into Anglo Irish, it could bring down the entire Irish economy. "Any Anglo [Irish Bank] failure would bring down the sovereign. It is systematically important because of its size relative to the national balance sheet," he told London's Financial Times
. "No country could contemplate the failure of such an institution."
A further €6 billion ($10 billion) has been injected into the troubled Allied Irish Bank and the Irish Nationwide Building Society, in which the Government took a controlling stake in 2008.
At the EU summit late in October, German Chancellor Angela Merkel and French President Nikolas Sarkozy told leaders that taxpayers should not be the only ones to cover the cost of bailing out the banks. They suggested that the lenders should carry a share of the burden. Mrs Merkel repeated her comments at the recent G20 Summit in Soeul, capital of South Korea.
While these comments seem reasonable, they have spooked Europe's financial markets, to the point where lenders are refusing to lend money to either the Irish Government or the country's embattled banks. As a result, interest rates in Ireland have risen dramatically.
The international lenders' nervousness is compounded by the fact that, since the Greek bailout was organised last May, things in Greece have worsened. Not only have there been riots in the streets, but Greece's financial position has deteriorated further.
Despite the rescue package early this year, Greece's debt position has gone from 115 per cent of GDP in 2009 to 127 per cent this year, and is predicted to jump to 144 per cent of GDP next year, while its government deficit has worsened to 15.4 per cent, according to London's Daily Telegraph
The problems have also spread to the Iberian Peninsula. Interest rates have risen in Portugal, to the point where Finance Minister Fernando Teixeira dos Santos has said that Portugal is now at the mercy of global financial forces, and might be forced into a rescue package.
"The risk is high because we are not only facing a national or country problem," he said. "It is the problems of Greece, Portugal and Ireland. Markets look at these economies because we are all in this together in the Eurozone."
A simultaneous bail-out of both Ireland and Portugal could cost €200 billion ($300 billion). This would largely deplete the EU's rescue fund.
The concern now is that the crisis will spread to Spain, which has a larger economy than Greece, Ireland and Portugal combined. Foreign banks' exposure to Spanish debt amounts to €850 billion ($1,300 billion).
Despite signs of strong economic recovery in Germany, the global financial crisis is far from over.