Rating agency Fitch tonight warned it may
downgrade Ireland and five other euro zone countries in the absence of a
comprehensive solution to the region's debt crisis which it concluded may now
be "technically and politically beyond reach."
Furthermore,
the agency placed the ratings of Belgium, Spain, Slovenia, Italy, Ireland and
Cyprus in credit watch "negative," which means a downgrade is probably within
three months.
This move
comes on the back of unexpectedly poor economic data for Ireland, which showed that
its economy weakened considerably in the third quarter, shrinking at the
fastest rate in more than two years.
GNP is a
better measure than GDP in this case because GNP removes repatriated corporate
profits that have left the shores. Many
companies use Ireland as a tax haven, so the monies that cycle briefly into and
then right back out of the Irish system really should not be counted towards
their economic progress. With economic
contraction, the Irish fiscal deficits will once again breach agreed-upon
levels, and repaying debts also becomes that much harder. It is a negative spiral that can be quite
destructive and difficult to stop.
The bottom
line here, which should surprise no one, is that austerity shrinks an economy
and that economic shrinkage and crushing debt loads are incompatible.
Ireland's
debt yields (i.e. the interest rates that its bonds pay) are instructive. While it is true that Ireland's debt yields
are down quite a lot from their maximum levels (which were over 23% for 2-year bonds
and 15.5% for their 9-year bonds), the
current yields of 7.9% and 8.6%, respectively, are utterly unsustainable for an economy that is shrinking! Therefore
it is only a matter of time before those high rates crush the finances of the
Irish government.
Do you know
why the generally agreed-upon limit for persistent government deficits is 3%? It's
because that's the basic rate of GDP growth that history has shown to be
sustainable. As long as deficits are
growing at the same rate as the economy, then the debt-to-GDP ratio stays
constant and everybody is happy. If (or when, I should say) the economy grows more slowly than the rate of interest that is
demanded from a government, it is a mathematical certainty that either the
deficits will swell or austerity
and/or tax hikes must be imposed. There
is no other way to balance the books.
On this
basis, Ireland has major financial problems problem and its economic outlook is
grim.
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