November 2011        

Should Ireland remain in the euro?

Membership of the euro zone means that this state’s rate of interest and cost of credit is decided for the benefit of the euro zone as a whole, not by the needs of our economy. Also, the rate of exchange of the euro vis-à-vis other currencies is decided likewise, with the overall euro-zone interest being the dominant concern. And thirdly, as long as Northern Ireland remains with sterling, our continuing membership of the euro zone, especially if it were to move towards a fiscal as well as a monetary union, would add a profoundly new dimension to partition.
     The euro zone is a flawed and reactionary system, for at least three main reasons. It was set up as a political device to reconcile France to German reunification after 1989, using political means—an EU monetary union—that have proved to be inherently unsuitable for such a purpose. Most economists regard the 17-member euro zone as being in no sense an optimal currency area, able to sustain its own currency indefinitely. Such an area has shown itself incapable of withstanding the strains of trying to maintain one currency, interest rate policy and exchange rate policy for economies that have different levels of productivity and implicit economic competitiveness, different resource endowments, and different degrees of exposure to economic shocks of one kind or another. It has prevented euro-zone deficit countries from protecting themselves against exports from the stronger euro-zone economies by robbing them of the ability to devalue their currencies.
     Finally, it put Ireland under the rule of the European Central Bank, whose policy it is to prevent insolvent private banks going bust anywhere in the euro zone and which insisted in September 2008 that the Government keep Anglo-Irish Bank afloat, at horrendous cost to the people of this state.
     Joining the euro in 1999 was undoubtedly the biggest mistake ever made by the Irish state. It made us adopt the currency of an area with which we do no more than roughly a third of our trade, that is, exports and imports combined.
     It made us adopt unsuitably low interest rates at the peak of the “Celtic Tiger” boom of the late 1990s, because it suited Germany and France at that time, thereby creating the Irish property bubble.
     And it put us under the control of the European Central Bank, which, after making us take on the bad debts of our insolvent banks, is now imposing austerity on us and the other so-called PIIGS countries, even though we all need economic growth and not deflation.
     Euro-zone interest rates were then low to suit Germany and France, which were in recession in the early 2000s. But Ireland was experiencing a boom and needed higher interest rates to prevent price bubbles. Instead, Ireland effectually halved its nominal interest rate in joining European monetary union. This gave huge impetus to the borrowing binge that followed between 2001 and 2007, and especially after 2004. This was concentrated on the property market and expanding domestic demand. The growth rate then slowed, as expansion of output shifted from exports to the domestic sector in response to the euro zone’s low-interest regime and the housing boom of the early 2000s.
     As late as the end of 1997 almost 90 per cent of all Irish bank lending was financed by Irish bank deposits, while property-based lending made up less than a third of the combined loan books of the Irish banks.
     Irish bank customers could borrow in foreign currency; but as the borrower carried the exchange rate risk, such loans were very expensive and rare.
     Our membership of the euro removed this de facto cap on Irish bank lending. Irish banks could borrow money from other euro-zone banks without any exchange-rate risk. The cost of borrowing halved as Irish interest rates converged on German rates during 1998. This combination of a massive increase in the availability of credit and a halving of interest rates was the harbinger of economic disaster.
     By the end of 2007, Irish bank lending was almost seven times greater than it had been a decade earlier, while over the same period Irish bank deposits had “only” tripled. This meant that the proportion of Irish bank lending financed by Irish bank deposits fell to less than 45 per cent.
     The value of having one’s own currency, and with it the ability to follow an independent exchange-rate policy, was shown decisively for Ireland in the period 1993–99, when the currency markets forced the Irish elite to abandon the fixed exchange rate that was part of the EU’s exchange rate mechanism.
     From the 1920s to 1979 the Irish pound had been pegged at par with the English pound, reflecting the conservative economic outlook of the state. This gave Ireland an implicitly overvalued currency, which reduced competitiveness and inhibited economic growth and employment in those decades.
     In 1979 Ireland broke the link with sterling but tied its currency to the Deutschmark instead in the European monetary system in preparation for European monetary union. It was given EU subsidies to encourage it.
     Britain joined the EMS in 1990, but the markets forced it to leave it and devalue sterling only two years later, in September 1992. When this happened, Ireland decided to stick with the Deutschmark, so that by January 1993 the Irish pound was worth 110 pence sterling. Ireland’s overvalued currency was ruining its foreign trade, which was mostly with Britain and the United States and was not sustainable.
     This forced the Government to devalue the Irish pound by 10 per cent in January 1993. It floated downwards for the rest of the 1990s. It was a nominal 90 pence sterling when Ireland adopted the euro in 1999.
     Ireland’s annual economic growth rate, which had averaged 3 to 4 per cent a year from the 1960s to the early 1990s, rose to 6 per cent in 1993, the year of the devaluation. It averaged 8 to 9 per cent a year, well over double its earlier level, from then until 1999, when Ireland joined the euro zone. The 1993 devaluation gave Ireland a highly competitive exchange rate, encouraging foreign and domestic investment.
     This seven-year period was the only time in the history of the Irish state when in effect it floated its currency, giving the Irish economy a highly competitive exchange rate. This boosted exports, inhibited competing imports, and launched the country on the “Celtic Tiger” years of exceptional economic growth.
     If we had opted to stay out of the euro in 1999 it is likely that the Irish pound, like sterling and the dollar, would have initially risen against the euro, while our interest rates would also have stayed higher than those in the euro zone.

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