EDNA O'Brien was right: August is indeed a wicked month. Humid air saps the energy. Everywhere is shut. Our leaders are on holidays. And that is when financial markets can do their greatest damage.
Markets never sleep and just as they did in August 2008, last Thursday they smelt blood and pounced: as US politicians were infighting and euro area leaders were firefighting, worries about the ability of politicians on both sides of the Atlantic to control spiralling public spending drove Italian and Spanish interest rates to over six per cent.
At those levels governments and banks find it almost impossible to fund themselves and a vicious circle dynamic kicks in. By Thursday afternoon that dynamic caused stock markets to experience falls the kind of which we hoped we'd seen the back of. Billions have been wiped off pension funds and bank capital. More seriously, the stability of the global economy is in doubt.
Like all hunters, financial markets like their prey to be big and juicy and weak. With a debt ratio of 116 per cent of GDP, Italy fits the bill perfectly. Though not as healthy as Ireland's, Italy's economy is sound enough but its debt is so high that its public sector will require a bailout if interest rates stay above 6 per cent for too long. Emergency spending cuts and tax hikes of €48 billion had passed through the Italian parliament three weeks ago and, together with the 'enhanced' European Financial Stability Fund agreed a few days later, the euro's problems seemed solved.
Unfortunately, governments forgot to actually implement the agreed measures and with one eye on this complacency and another on the Washington Muppet show, financial markets began doubting that the debt crisis was going to be solved.
But whereas the US can print money, the ECB cannot and the €440 billion ESFS fund is not large enough to bail Italy out should it need it. It may not. But wanting to prepare for the worst, financial markets assume the worst will happen and, in doing so, they make their own fears come true: by driving Italy's cost of borrowing above 6 per cent, its debt servicing becomes more onerous, making default -- and a possible collapse of the euro -- more possible.
Although our debt interest rates were falling and despite ECB President Trichet's praise for our adjustment efforts to date, Thursday's exchequer figures show that -- one-off revenues and a temporary boost from tax hikes aside -- our fiscal position is heading in a very Italian direction.
In one way, Silvio Berlusconi was right to claim this week that Italy's economy was sound. Sadly, a government that cannot rein in excessive spending and debt -- and which raises taxes instead -- can destroy even the strongest of economies. That is what is happening in Ireland right now.
The tax take in the year to July looks good, but flatters to deceive. On a no policy change basis -- that is, stripping out the Universal Social Charge and lowering of tax thresholds -- taxes performed poorly. VAT revenues fell and corporation taxes were stagnant. More ominously, the vicious feedback of income tax rises in the real economy is now very evident from Thursday's Live Register showing the third successive monthly rise in the dole count. With the Croke Park deal set in concrete and current spending still rising (up €800 million in the year to July compared with the same period of 2010), taxpayers know their incomes are going to fall through stealth taxation. This in turn is killing the spending and jobs needed to generate tax revenues and the growth needed to bring down our debt/GDP ratio.
It could be so different: a drastic rate cut in stamp duty has actually increased, not decreased, revenues. Between 1987 and 1990, this strategy boosted growth and revenues. It also worked in the December 2009 Budget when Brian Lenihan targeted wasteful spending and overpay, while keeping taxes unchanged.
Since Croke Park however, we have gone back to the strategy of 1982 to 1987 -- preserving excessive pay and spending waste -- while raising taxes. Copperfastened by the troika agreement that 'requires' the Government to introduce a property tax, this takes the pressure off pay cuts. In truth, the IMF and ECB would rather see us cut local authority waste and overpay. But just as bondholders got their wishes, so have vested interests. That we retain the highest pay and pensions of any local government system in Europe (except perhaps Denmark) not to mention 112 local authorities for only 4.5 million people, beggars belief. That is why taxes will rise. To fund needless duplication -- 33 separate motor tax offices, 33 separate arts officers, 112 local government chief accountants and so on -- the poorest citizen will pay a household charge.
As well as being illogical, this strategy is the most economically damaging one possible: it will do far more damage to demand, job creation and growth than would a policy of cutting overpay and waste. That in turn makes bringing down our debt/GDP ratio more difficult.
It is not too late for Ireland to turn back. Whether the same can be said of Italy is another story. If it cannot stave off default there will be other serious implications for Ireland. As EU Commission President Barrosso admitted, preserving the euro may require extending the bailout fund to the point where we create, de facto, a United States of Europe with a common fiscal policy. If this needs to be done to save the euro, so be it. But it goes against everything we were promised when we voted for the Lisbon treaty. Together with the inequity of the Croke Park deal, don't be surprised if this issue features in the Presidential election
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