Ireland Loses Its Fiscal Sovereignty

Over the weekend it became clear that Ireland is waving its fiscal sovereignty good-bye, by accepting a € 90 billion (this is an estimate as at the time of writing the details of the deal weren't yet finalized) bailout under the IMF/EU bailout umbrella.


What looks like a step to stop the rot on the surface is in reality yet another step down the road to perdition. Yes, markets will probably 'calm down' in the wake of this bailout, just as they did after the bailout of Greece, but what then?

Before we discuss this point, allow us to point out an important reason why the bailout of Ireland and its insolvent banking system is an especially bleak day for those of us believing in free market capitalism.

One of the features of the bailout as mentioned above is that Ireland loses its sovereignty in terms of fiscal policy. Not only is this one step closer to the European 'Super-State', a centralized Leviathan with a gigantic, faceless bureaucracy deciding the fate of hundreds of millions of people, it also means that the high tax, low growth socialistic welfare states in the European Union finally get to eliminate a tax competitor.

Before Ireland's economic miracle turned into an unsustainable boom on account of the ECB's ultra-low interest rate policy in the wake of the dot-com bust, the country experienced a well-balanced period of economic growth, largely owed to its decision to lower taxes so as to attract business investment. Thus Ireland sports one of the lowest corporate tax rates at a mere 12.5%. This strategy worked – by offering a degree of economic freedom (of which tax rates are an extremely important component) not available elsewhere in the EU, in addition to an English-speaking, well educated work force. Ireland was set for success.

This success was not exactly joyfully received by the sclerotic over-bureaucratized socialists in the rest of the EU. 'Tax Harmonization' became the battle cry of the legalized highway robbers. Luckily, fiscal sovereignty ensured that they got 'tax competition' instead – which is exactly as it should be.

Giving people the liberty to vote with their feet and their wallets ensured that the high-tax nations had to hold back with inventing new and higher taxes at every opportunity. Instead they were forced to seriously consider something that was entirely new for their model of constant expansion of the State – simplifying tax codes and lowering taxes.

It is of course not so that they succeeded. In a famous experiment, a German TV station sent a citizen with his annual tax declaration into a branch office of the German tax authority, where he proceeded to ask the various bureaucrats and tax specialists passing him by to assist him with a few problems he had encountered in filling out his return. The result: the people who should know the tax code best were not able to give him coherent answers to his questions. Instead, a hefty debate broke loose, without a definitive result.

What this example illuminates is that we have arrived a juncture where the law has ceased to serve the citizenry. Instead it has become an impenetrable jungle of purposeful obfuscation, so that everyone runs the risk of becoming a criminal by mistake. This is not freedom – it is tyranny.

As a consequence, tax competition can be seen as an important factor holding back or at least slowing down the steady encroachment of tyrannical law on the citizens of the over-bureaucratized welfare/warfare states of the EU.

In this sense we should mourn Ireland's decision to bow to the demand that it accept a bailout not only because it allows bondholders to once again get away scot-free without having to take the losses that are rightfully theirs, but also because a champion of low taxes and a simplified tax regime has been emasculated.


The Parasites Are Killing the Host – Another Blow to Free Market Capitalism

As to the particulars of the bail-out, apparently the UK is going to stump up the biggest share of it, at ₤ 7 billion. This is on account of the fact that British banks are the banks most exposed to Ireland's debt and so the UK is between a rock and a hard place with regards to Ireland. It is either 'bail out Ireland' or 'bail out our own banks all over again'. The same motivation of course drives the other countries contributing to the bailout as well, in addition to attempting to keep the failed Euro experiment alive at all costs.

As we learn from the Irish press:


“The EU and IMF will make enough funds available so Ireland does not have to borrow from the financial markets for the next three years, under a programme likely to be announced this week.

The agreement may be framed to allow the government to borrow from the markets if conditions allow, but will make clear that otherwise money will be available from the EU/IMF fund. Brian Cowen’s official spokesman said that ‘‘Ireland was not in the bond markets at present because the cost of borrowing was prohibitively high at around 8 per cent.

The negotiations were focusing on trying to secure access to funds for Ireland at a more realistic rate."

The plan will also include an immediate injection of capital into a number of Ireland’s banks, including AIB and Bank of Ireland. As well as this capital injection, which could be in the region of €10 billion, a further contingency fund will make additional capital available if necessary over the next three years and will also stand ready to provide funds to the exchequer.


(our emphasis)

Readers may remember that we predicted here that eventually a number of the PIIGS would opt for getting financing from the EU's bailout fund in addition to Greece simply because it is from their point of view a sensible commercial decision on account of the lower interest rate they will have to pay.

Note here that the above quote from Brian Cowen's 'official spokesman' is unintentionally funny. The new interest rate represents a 'more realistic' rate? The exact opposite is true – the market rate IS the 'most realistic' rate.

The rate that is not realistic is the one Ireland will have to pay under the bail-out conditions. It will no longer reflect the market's assessment of the risk that Ireland will default. In other words, the EU is becoming more akin to a command economy by the day.

The winners on this day are the bondholders who have now received notice that their investment activities are henceforth completely risk-free. The biggest losers are all the rest of us.

The bureaucratic and political classes of the European Union are busy digging the grave for free market capitalism. The economic system that has in the course of many centuries been responsible for creating all the wealth that we enjoy in modern times is slowly but surely dismembered by a bunch of nincompoops who have never created an iota of wealth themselves. The parasites have decided to kill the host.


What Happens Next?

We strongly doubt that from the point of view of officialdom anything has been achieved beyond buying a little bit more time.

The markets are highly likely to simply shift their focus, as has happened after the bailout of Greece (which in turn seems to be in danger of falling apart already).

For a while we are sure the 'risk-on'/'risk-off', 'paid to play' crowd (thanks to Mr. Skin who posts at Bill Fleckenstein's site for the terminology) will rush out to party now that Ireland is off the table, but neither has the main fundamental problem disappeared (namely the fact that if we were to employ GAAP in the context of national budgets, everybody would be bankrupt already), nor has anything changed with regards to the more immediate problem that several of the PIIGS , namely the remainder that we could subsume under the new acronym 'PIS', are also still circling the drain.

We doubt the markets won't come around to attacking them. They surely will, just as in the sub-prime crisis of 2007-2008, the markets picked off the insolvent firms one by one, starting with the weakest and smallest, and then training their sights on the biggest, until Paulson's infamous 'bazooka' had to be fired – along with the lobbing of the fiscal/monetary equivalent of a few tactical nukes.

So enjoy the party while it lasts, but be aware that this is precisely what it won't do – last, that is.

We reiterate that the biggest upheaval is not behind, but likely still ahead of us. Neither do we believe that nations like Greece will find it politically feasible to go through years of grinding deflationary depression in order to retain the euro as their currency, nor do we believe that the markets will just leave the 'PIS' alone.

Most likely Portugal is next in their sights, with Spain following closely behind. At that point the danger of a wider blow-up will be great, as Spain is a sizable lump that won't be easy to digest (even though it would still be possible by the arithmetic of the bailout umbrella fund).

Sharecast has a few interesting quotes from British conservative MP's that highlight the change in social mood that will see to it that it will become more and more difficult to justify more bailouts as time goes on:


“Conservative MP John Redwood said the European Central Bank should be responsible for keeping Ireland afloat and that as a non-euro member Britain should not be involved.

‘I don’t think this is Britain’s problem; I think it’s a euro area problem,’ he said. Fellow Conservative MP Douglas Carswell said:

‘If we are going to pay to solve this crisis we should pay Ireland to quit the euro.’

Sam Bowman, head of research at the think tank the Adam Smith Institute said Britain’s involvement in the bail-out:

‘Puts the interests of the European Union and the eurozone before the interests of Ireland and the British Government should have no part in paying for it.’


With this the gentlemen quoted above are merely articulating what the citizens of the countries paying for the bailouts generally think. This illustrates the growing difficulties the EU's bureaucracy is facing in its self-imposed task of rescuing the euro in its current incarnation no matter what the cost. Those who are required to pay for all of this are balking ever more frequently and forcefully.

Below we present the charts as of Friday's close, i.e. prior to the bailout announcement (note that the markets were already well aware that such an announcement was in the works).


1. CDS – all prices in basis points, color-coded

5 year CDS spreads on the sovereign debt of Ireland, the senior debt of Bank of Ireland, Allied Irish Bank and below on Japanese JGB's. Notre the huge blow-out in Anglo-Irish, which appears to be the one Irish bank that now finds itself on the sacrificial altar. This is to say, the debt of Anglo Irish is going to be restructured, i.e. the 'credit event' that will force sellers of the CDS to pay up is on its way.



5 year CDS spreads on the remaining PIGS (Portugal, Italy, Greece and Spain). Note how 'already rescued' Greece has begun to become the subject of renewed market jitters in the wake of Austria's decision to withhold its tranche of funds for December until Greece coughs up some 'credible data'. The others are ticking up again too – click for higher resolution.



5 year CDS spreads on the sovereign debt of Romania, Hungary, Belgium and Austria – these spreads are coming in in the wake of Ireland's bailout – click for higher resolution.



The Markit SovX index of CDS on 19 Western European sovereigns – so far this looks like a fairly typical 'retest of the breakout'. It's still a bullish chart – click for higher resolution.



2. Euro Basis Swaps

As measure of dollar funding pressure in the euro area banking system one would have expected these to improve on bailout speculation. Alas, it hasn't happened so far.



3 month euro basis swap – moving deeper into negative territory. Not good – click for higher resolution.



1 year euro basis swap – a tiny bounce in this one. From a technical perspective, this doesn't look too bad yet, as the previous rebound high serves as support thus far – click for higher resolution.



5 year euro basis swap – similar to the 1 year looks technically still healthy – click for higher resolution.



3. Other Charts


5 year CDS on Australia's 'Big Four' banks – these seem to profit from the bailout of Ireland, in short term positive contagion effect – click for higher resolution.



The SPX indicators combo – as a reminder, this shows the SPX, the gold-silver ratio, the gold-commodities ratio and a proprietary SPX/VIX indicator developed by our good friend T.R. at Citi. Notable: the divergence between SPX price and the volatility measure, we would caution however that this is probably influenced by options expiration in this case – click for higher resolution.



DXY – hugging the cloud. The US dollar index running into Ichimoku cloud resistance. Should DXY weaken from here, risk assets will get a boost – click for higher resolution.


Charts by: Bloomberg




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2 Responses to “Ireland Bailed Out – What Comes Next?”

  • “he people who should know the tax code best were not able to give him coherent answers”

    Tangentially relevant but, Italy has a march on anyone in the EU with regards to byzantine fiscality.

    In Italy we have a peculiar variety of professionals known as “commercialisti” whose sole job is to fill-out your tax returns. That’s because the tax form is usually a book rather than a form and it requires an amount of legal and fiscal knowledge to fill-out that it is a full time job. But, there is a catch. Although a common mortal cannot hope to be able to file his/her own tax returns in Italy, the commercialista is not responsible for any omissions or mistakes that can and do result in prosecution for presumed fraud.

    In one particular case towards the latter half of the 90s, I remember the tax return being all of 90 pages; ninety pages!! On that occasion, the tax form had been distributed late and not even the commercialisti had had time to be trained on it.

    Italy is a few steps ahead of anyone else in the EU.

    • Guidoamm,

      yes, Italy’s tax code is byzantine, and probably even more so than that of other European nation (however, don’t think for a moment that ANYONE truly understands the German tax code for instance). Also, Italy has a unique situation in that it has very high private sector savings, but a hopelessly indebted and disorganized pulic sector. Italy remains the lynchpin of the euro area’s crisis in fact. It is imaginable that the EU/IMF tag team can bail out Portugal, Belgium and even Spain, if push comes to shove. Spain may be difficult, but not impossible. Alas, it is truly game over if Italy should get problems rolling over its debt. That would be one step too far.

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