Portugal

In all the bruhaha about Greece's approaching credit event, people have taken their eyes of Portugal. The country is going down the Greek path with high speed - austerity, a shrinking economy, more austerity, and political and social instability around the corner. Matt Lynn over at WSJ Marketplace has a lot of clever things to say why Portugal actually has LESS of a chance to pull out of the death spiral than Greece... higher private debts, for example. The one difference I see is that Portugal is not a complete banana republic -- the government actually tries to implement reforms, and get some things done. Meanwhile, the Greek clown show continues; yesterday, the Greek parliament even failed to liberalize the opening hours of pharmacies... 

The bright side of the Irish crisis

These days, it is easy to remember why economics used to be known as the "dismal science". The EU finance ministers are meeting today, to put the fine print for the Irish rescue package together. One European bailout is following another; growth is mostly poor, and even where it isn't, output is not returning back to trend; and unemployment is stubbornly high. News that the last big private Irish bank was being nationalized last week seems like a small wrinkle. And yet, one can think of this detail as possibly a first ray of sunlight.

Whenever the future of the Euro is discussed, the practical difficulties of leaving are pointed out. In particular, as soon as there is a good chance that a country might leave, its banks will face a massive run on deposits; converting assets and liabilities into the new national currency will be tricky, as any mismatch will zap bank capital. But how do these problems look in a country whose banks have blown up already? Where the capital injections for the banks are so gigantic that they more or less double the national debt? And where banks mostly live on liquidity support from the rest of Europe? That place is Ireland, and somewhere, someone is hopefully thinking what I am thinking -- this is the time to get out.

The euro was a gigantic mistake in the first place, a vainglorious triumph of politics over sound economics. When the financial crisis broke out, the Queen famously asked during a visit to the LSE - why didn't anybody notice in advance? On this one, for once, many economists were actually acutely aware just how bad an idea the euro was. Barry Eichengreen wrote many articles and a book warning about foisting a new gold standard on advanced economies with massive nominal rigidities. Nobody listened.

Ireland will have to suffer massively in years to come as it is for the folly of its bankers and the stupidity of its housing bubble. It will have to live with IMF-EU imposed austerity. Why not try to get something in exchange for all that pain? A new Irish pound, introduced overnight, would quickly devalue and restore Irish competitiveness. An independent central bank could set appropriate interest rates while anchoring inflationary expectations. The banks would still have to struggle with potential asset-liability mismatches, but the problem cannot be large compared with the capital injections necessary already. And depositors have been taking their money out already. Once the new currency is in circulation, they can put it back in, as there is no uncertainty about the Irish future of the euro left.

What would this do to the rest of Europe? An Irish exit from the nightmare that the euro has become would surely see Greece, Spain, and Portugal leave, too. Depositors there would run on their banks to get euros out while they still can. Banks in some of these countries are healthier than in Ireland; an Irish exit would impose some real costs on the Club Med. And yet, much of the "health" of Spanish banks is illusory anyway, as it depends on fantasy valuations of all the brick and mortar on their balance sheets (something that the Bank of Spain is increasingly concerned and unforgiving about). A quick exit may still be better than a decade of slow, grinding deflation combined with Zombie banks and Zombie household balance sheets being kept on artificial life support before the inevitable rise in interest rates at some point pulls the plug.

When Britain left the gold standard in 1931, the governor of the Bank of England famously declared (having been aboard a ship and out of contact when the decision was made): "I didn't know we could do that." Leaving the euro may seem similarly unimaginable to many, but it may be just as feasible. In the 1930s, cutting the link quickly led to a recovery of demand, by reducing deflationary pressures. Far from the shattering blow to confidence feared by many, exiting the gold standard was actually great for business. Leaving the euro may be every bit as good.