Ireland's Troubles Spell Impending Doom for the Euro

The Irish government has given the world a peek into the country’s real bailout costs. And it isn’t pretty. All of a sudden, the Emerald Isle is on track to be the first eurozone nation to go into default. Even if it doesn’t happen, just the possibility could erase all of the euro’s gains since June.

What makes the situation even more troubling is the fact that Ireland was once the shining star of the European Union. Its growth was truly impressive, and every statistic seemed to be hitting the right benchmarks. Ireland’s debt-to-GDP ratios – common benchmarks of leverage used by central banks – were widely considered positive by EU officials. And the country’s industrial production hummed at a constant rate while domestic consumption was also ratcheting higher.

Then, the financial crisis hit.

Ireland was completely turned upside down as the country’s real estate sector went belly up. The decline decimated the nation’s bank balance sheets. As property valuations dropped, loan values held by these banks also declined. In particular, Anglo Irish Bank, one of the country’s main lenders, suffered massive losses – forcing the Irish government to bail out the financial institution.

The Irish government has used up approximately 23 billion euros to shore up Anglo Irish Bank’s balance sheet and operations. And it hasn’t been enough. On September 30, Ireland’s finance minister, Brian Lenihan, said the bank would require another 6.4 billion euros. He also said the total bailout bill for Ireland’s troubled banks could come out to 45 billion euros – or almost 17% of the country’s GDP.

Despite all the government spending, the Irish economy continues to be in the dumps. The country recently reported negative growth in the first three months of the year – a drop of 1.2% according to Ireland’s Central Statistics Office. Not surprisingly, the contraction has been accompanied by nationwide unemployment. It’s just a half point or so shy of 15% – one of the highest in the European Union. (In another example of how quickly things have turned sour in Ireland, the unemployment rates was less than 5% just three years ago.) The exponentially higher jobless rate has taken a big bite out of the Irish government’s revenue.

Tax receipts in Ireland have decreased 24% since the financial crisis began.. The figure takes into account a 70% decline in capital gains tax receipts as well as a 7% decline in income tax receipts.

So to keep their economy churning, Irish officials have turned to the global bond market. But the price the government continues to pay remains much too high. Recently, Ireland’s government auctioned 1.5 billion in short-term securities to the market. On average, Ireland’s benchmark securities cost the government over 4 percentage points more than German equivalents (or almost 3 times as much). The higher costs place more pressure on its overstressed economy.

Right now investors’ biggest fear seems to be that Ireland’s credit rating could be downgraded. The euro has already been dinged by other country’s rating downgrades, most recently with Spain’s. If Ireland’s rate drops one or two notches, it will place even more significant downward pressure on the euro.

But Ireland might be lucky if it just suffers a downgrade – because it could very easily become Europe’s first nation to default. If that happens, inventors may believe it’s the beginning of the end for the European Union.

While those fears would obviously have a negative effect on the euro, I don’t see a precipitous sell-off similar to the one witnessed in the beginning of the year. Still, the euro is not a place you want to put your money right now. The future for Ireland looks bleak, and that vision can easily spread to the other EU economies.

Richard Lee
for The Daily Reckoning

The Daily Reckoning