Brian Gaynor 's Opinion

Investment columnist for the NZ Herald

Brian Gaynor: EU's complexity is big cause of its problems


Austerity, referendums, elections, bank bailouts and German domination are the main topics of discussion in Europe at present.

This column will be looking at these issues in relation to the PIIGS (Portugal, Italy, Ireland, Greece and Spain) over the next two weeks with a particular emphasis on Ireland and Greece.

The first point to note is that the European political and economic structure is incredibly complex.

This is one of the main reasons why the continent is in strife at present.

As the accompanying table shows there are 27 members of the European Union but only 17 have adopted the euro.

Ten of the EU members continue to use their own currencies, including the United Kingdom, Sweden, Poland and Denmark.

In addition six non-EU countries also use the euro. These are Andorra, Kosovo, Montenegro, Monaco, San Marino and the Vatican City.

Although Greece may abandon the euro there are a number of countries lining up to join the EU.

Croatia will become the 28th member next year - but will keep its own currency in the short-term - while Turkey, Serbia, Iceland, Macedonia and Montenegro have applied to join.

Most of the problems are in the 17-country euro area, which is dominated by Germany, France, Italy and Spain in terms of GDP.

The problem with these euro countries is that their monetary policies and interest rates are controlled by the European Central Bank (ECB) whereas the non-euro countries have their own, independent, central banks and monetary policies.

The ECB's low interest rate strategies contributed to massive property bubbles in Spain and Ireland and the near collapse of their banking sectors.

Spain's housing bubble was fuelled by cheap airfares and the desire by Northern European residents, particularly from the United Kingdom, to purchase holiday homes on the Mediterranean.

As house prices soared more and more Spaniards jumped on the bandwagon and many of the country's MPs bought a large number of rental properties.

The Irish housing bubble was caused by the strong underlying economy, aggressive bank lending and a huge increase in inward migration, particularly from Poland and other Eastern European countries.

New housing construction surged from just 21,400 in 1993 to 81,000 in 2005 and 93,400 the following year.

New Zealand, which has a similar population to Ireland, had a peak of 26,000 new houses in the mid-2000s.

The Irish construction industry has disintegrated, with only 9600 new houses completed over the past 12 months and residential property prices have fallen 50 per cent since mid-2007.

House prices in some of the more fashionable areas of Dublin have plunged by more than 70 per cent.

Anglo-Irish Bank has failed, Allied Irish Bank is now controlled by the Government and the share price of the Bank of Ireland, the only major bank remaining listed on the Irish Stock Exchange, has nose-dived from more than €18 to just €9c in the past five years.

This has led to massive wealth destruction as bank shares were widely held, particularly by elderly investors, because of their blue-chip status and high dividend yields.

Irish and Spanish banks adopted the same aggressive property lending strategies as New Zealand finance companies.

However, there is major discontent in Ireland because none of its senior bank executives have been held accountable through the courts even though many lending policies, and related party transactions, were even more dubious than those prevailing in the New Zealand finance company sector.

There is a great deal of economic and social frustration in Ireland although the country has adopted a fatalistic approach towards its problems. The huge increase in public debt is the result, not the cause, of the economic meltdown.

When the Irish banks went bust the ECB insisted that the Irish Government guaranteed their bond holders.

The Irish Government borrowed to repay the bank bondholders and this has created an enormous burden on the state. The economy is caught in a downward slide with mortgage debt fixed and house prices continuing to fall.

The response to last week's referendum reflected the political divide that is developing in Ireland and across Europe.

The Irish were asked to approve the "Fiscal Stability Treaty" which was signed by 25 of the 27 EU member states three months ago.

The treaty requires countries to keep their annual government deficits below 3 per cent of GDP and overall government debt below 60 per cent of GDP.

In return signatories will be able to obtain funding from the EU's new €500 billion ($820 billion) permanent bailout fund, the European Stability Mechanism.

The Irish countryside and cities were covered with posters encouraging people to vote Yes or No.

The Yes supporters argued that Ireland would be denied access to EU bailout funds if the treaty was rejected, whereas the No supporters said that the treaty would deliver even more austerity. The referendum was carried with 60.3 per cent voting Yes and 39.7 per cent voting No.

However, a stronger No vote in poor constituencies reflects the view that the austerity policies are having a much bigger impact on low-income families.

There is a widely held view that posterity has been privatised, with most of the benefits going to a small elite, whereas austerity has been socialised, with the poor suffering the most.

This view was also reflected in the recent election results in France and Greece.

There was also a huge amount of confusion over the referendum, with one 20-year-old telling the Irish Times as she was leaving a polling station: "It's all over Facebook, saying vote No, so that's all I really know about it. Just to vote No because in the end the Government doesn't give us what we want."

The Yes majority has solved nothing as far as Ireland is concerned as the country is dotted with half-finished building sites, a huge amount of vacant retail space and deserted hotels.

There continues to be a high rate of economic immigration to the Middle East and other countries.

Ireland's unemployment rate is 14.3 per cent or 436,700 on a seasonally adjusted basis. By comparison New Zealand's unemployment rate is 6.7 per cent or 160,000 individuals.

The Irish realise that their residential property bubble was a huge mistake and they are determined to see their austerity measures through, although opposition is growing, particularly from the political left.

But the European crisis continues to deepen with the recent bailout of Bankia, Spain's third-largest bank.

The Spanish crisis is a concern because it is the fourth largest euro economy.

However its banking problems are not as big as Ireland's as economists estimate that Spanish banks require an absolute maximum of €100 billion, or 9 per cent of Spain's GDP, whereas €64 billion was pumped into the Irish banks, representing 40 per cent of country's GDP.

Portuguese banks will require an estimated €12 billion or 7 per cent of GDP.

The European crisis is evolving quickly but there is one obvious solution. That is the centralisation of fiscal or government policies in the euro countries in the same way that monetary policy has been centralised under the ECB.

This would also involve the centralisation of member country debt, including the issue of eurobonds to cover all euro countries, and a more co-ordinated regulation of banks throughout the euro area.

In other words the euro area needs a form of federalism with countries surrendering some powers, particularly over fiscal issues, to Brussels.

This will be hard to achieve but next weekend's Greek general election will give us some indication whether distressed European countries are willing to support a closer European union or would prefer to leave the euro and abandon the united Europe dream.

The first lesson for New Zealand from Europe is that any monetary union with Australia is unlikely to be a success unless the two economies are almost totally integrated. The other lesson is that residential property bubbles can have a devastating impact on a country's economy.

Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Investment columnist for the NZ Herald


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