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Is Ireland the next Iceland?

Just a few moments ago I caught a very interesting post on Alice Cook’s site UK Bubble. The gist of the post was that things are falling apart in Ireland very quickly. Given what we saw with Iceland, I have to ask: is Ireland next?

I wouldn’t suppose that things are this fragile but we cannot dismiss out of hand talk of Ireland going the way of Iceland. Here is what Alice posted:

Someone left this intriguing comment on one of my posts yesterday:

Alice can you shed any light on what is going on in the Irish Republic?

Last week beef prices collapsed. This week I am unable to sell finished beasts at all.

Last week a police strike in Donegal was narrowly averted when the local authority agreed to stump up accrued overtime.

Bank of Ireland shares are trading for under 90 cents from a one time high of 18 Euro. It looks like the Government’s bluff is about to be called…

Rumour has it that the cashpoint system will stop within 3 days

Can you shed any light?

Is there anyone out there who can help?

Now, Ireland happens to be one of the worst affected bubble economies in Europe. They have seen a massive house price bubble along with huge leverage as their economy leapt forward over the last decade. However, this has all gone pear-shaped in the last year or so and Ireland has a recessionary economy with rising unemployment, collapsing house prices and severe knock-on effects in terms of commercial property. Immigrants, who once flocked to Ireland are no longer coming.

Meanwhile, Ireland was the first country to offer a blanket guarantee to it’s banks’ depositors. I welcomed this move as a necessary step to restore confidence. However, there are two problems associated with it.

  1. As Willem Buiter has pointed out, this move was a "beggar thy neighbour" policy which initially sucked deposits out of British institutions. British savers flocked to government-protected Irish institutions in the UK which courted the British savers with higher interest rates — the government had effectively subsidized the banks. Eventually, Europe as a whole got onside, and sweeping deposit guarantees were offered all around.
  2. The government must be able to credibly back up its guarantee. And this where Ireland looks a lot like Iceland. The country has an outsized financial sector which could not possibly be guaranteed by the Irish government. Moreover, Ireland is a member of the Eurozone — meaning it can’t print its own money. The UK, which borrows in Sterling can at least print money to finance any guarantees. The Irish are constrained — and, therefore, vulnerable.

It remains to be seen whether there is a sub-current of panic about the fragile Irish banking system that could lead it to Iceland’s fate. In fact, commentators like Wolfgang Munchau have argued that the single currency is a boon to the likes of Ireland because it prevents currency attacks like the one Iceland suffered, leading to its downfall.

However, a run on Irish banks is what would ultimately bring the Irish down. After all, it is the Government bank guarantee which creates the vulnerability. The Irish Government needs to make some contingency planning because an Icelandic fate is not out of the question. It need not worry about a currency run, but a bank run is still possible.

There are two ways to skin a cat.

Sources

Ireland – what is going on? – UK Bubble

Why the British may decide to love the euro – Wolfgang Munchau, FT

The Irish solution: unlawful, beggar-thy-neighbour and short sighted, but apart from that OK – Willem Buiter, FT Mavercon

Iceland, Switzerland, Denmark, Sweden, Jordan and countries with banks that are too big to bail out – Bronte Capital

The first casualty of the crisis: Iceland – VoxEU

Stunned Icelanders Struggle After Economy’s Fall – NYTimes.com

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.