Euro Debt Roils Global Bond Markets, Domestic Politics

9 November 2010. An Irish bond market already in free fall plunged further after Ireland announced on Thursday

that it planned to nearly double its package of spending cuts and tax increases to try to rein in its huge deficit.

Investors took it not as a sign of resolve but rather of Ireland’s desperation and uncertainty about the true extent of its problems.

The yield on Ireland’s 10-year bond climbed to 7.6 percent on Friday,

9 November 2010. An Irish bond market already in free fall plunged further after Ireland announced on Thursday

that it planned to nearly double its package of spending cuts and tax increases to try to rein in its huge deficit.

Investors took it not as a sign of resolve but rather of Ireland’s desperation and uncertainty about the true extent of its problems.

The yield on Ireland’s 10-year bond climbed to 7.6 percent on Friday,

expanding the gap with the 2.5 percent interest rate on comparable bonds issued by Germany,

which is emerging most strongly from the European debt crisis.

Borrowing costs in Spain, Portugal and Greece also spiked upward again,

as “investor” concern re-emerged that those countries would be hard-pressed

to bring their deficits under control and avoid defaulting on their bonds.

Those bond market jitters were a forceful reminder of the difficulties that remain after Europe’s debt crisis last spring,

despite the commitment of a combined 750 billion euros ($1.05 trillion) in bailout funds by the European Union and the International Monetary Fund.        

“The scale of the deficits are just so big,”

said Philip R. Lane, a professor of international economics at Trinity College in Dublin.

“The issues are political as much as they are economic.”

Prime Minister Brian Cowen’s increasingly shaky political standing in Ireland

may be threatened by the new deficit reduction measures,

which will cut to the heart of the Irish welfare system, including health care.

In Greece, regional elections on Sunday were viewed as a test for the Socialist Party led by Prime Minister George Papandreou,

whose government’s austerity measures have been wildly unpopular.

In a televised address, Mr. Papandreou claimed victory in the elections and viewed the results as support of his economic policies.

But the more immediate concerns involve Ireland.

Unlike Greece earlier this year, Ireland has enough cash on hand

to allow it to finance government operations through June 2011.

And it has, at least temporarily, withdrawn from the bond market

instead of paying the new, higher interest rates,

which Irish officials say do not adequately reflect the country’s true economic condition.

This is a smart move on Ireland’s part.

The ever widening gap between the interest rates Germany pays on its debt

and those of Ireland and other vulnerable euro zone economies

is partly a reflection of technical factors, like the tiny number of bonds actually being traded.

Low trading volumes mean that every time even a single spooked investor decides to sell an Irish or Greek bond,

it can be a market-moving event, causing the price to plummet and the yield to rise.

Still, the recent run-up in interest rates highlights a real concern throughout Europe:

that the first round of spending cuts and economic changes put forward by countries including France and Britain

may not be enough to bring deficits down to the target levels of 3 percent of gross domestic product by 2014.

In this respect, Ireland, where the deficit is currently 32 percent of its G.D.P., is exhibit A.        

A year ago, as cascading mortgage defaults brought down the biggest Irish banks,

Ireland became the first major developed nation to impose an austerity program.

The country was hailed worldwide as an exemplar of probity and national consensus.

But as the full extent of the banking and real estate bust became evident,

it was clear that the government of Prime Minister Cowen,

which has been in power since the onset of the crisis more than two years ago,

had underestimated the cost of fiscal recovery.

Now the possibility that he will be forced from office

or compelled to call a new election grows by the day.

Last week, the Irish government conceded that it had previously miscalculated the scale of its debt challenge.

It announced that the task would require an additional 15 billion euros in savings over four years,

bringing the total sum of tax increases and spending cuts to about 30 percent of Ireland’s total economic output.

Ireland’s need for cuts and taxes is hardly unique.

Whether in Spain, France or Italy, European nations have heavy welfare obligations —

ones likely to be curtailed to meet ambitious deficit targets,

even as tax revenue is constrained by low economic growth.

And political pressures are building in Britain,

where the government at least has a thin electoral mandate to cut the deficit,

and where politically sensitive components of the welfare state, like health care and pensions,

so far have largely been spared.

Last week, subway workers, firefighters and BBC journalists went on strike over proposed public sector cutbacks.        

The British chancellor, George Osborne,

considered the most militant deficit “hawk” among policy makers in the developed nations,

was taken to task last week by lawmakers.

They accused him of exaggerating the extent of the country’s fiscal problems

to justify broad cuts in middle-class benefits like universal payments to parents with children.

“How many children will be forced to leave their homes?”

demanded one furious member of Parliament.

“Will the numbers of homeless increase or decrease under your government?

Will there be a reduction in special needs education for children in our schools?”

In a report last week, the International Monetary Fund highlighted the extent to which

the debt ratios of all developed nations had exploded since the onset of the financial crisis.

The leader is Ireland, whose debt level has almost doubled, to nearly 100 percent of G.D.P.        

The monetary fund noted, too, how quickly markets could lose their confidence, according to this article in the New York Times.

It recalled that a year ago the interest rate spread between Greek and German bonds was 1 percentage point.

It is now nearly nine times as large — 11.3 percent for Greek bonds, versus 2.5 percent for those of Germany.

Let’s hope things don’t go so poorly for Ireland,

given ITS current rate spread with Germany of more than 5 percentage points.

David Caploe PhD

Editor-in-Chief

EconomyWatch.com

President / acalaha.com