Ireland is definitely facing a liquidity crisis, and that liquidity crisis could evolve rightly or wrongly into a solvency crisis. It needs help.
Like any such problem, that help involves emergency short term measures (basically cash funding) and long term advice and financing to solve its structural long term problems. In the next few weeks the short term problem is not the Irish state but the Irish banks. They need funding on a huge scale as their short term funding requirements are enormous, whilst confidence falters and money is withdrawn from the system by nervous counterparts. This difficulty will become a real burden on the Irish state next year as they have previously stated that they will be guaranteeing nearly all the liabilities of the Irish banking system. The ECB, European union members, and the IMF are fortunately all prepared to help. However, negotiating how much burden the Irish people should suffer in this emergency phase is going to be difficult. What can go wrong ?
Lenders tend to impose conditions when disbursing funds; enforced austerity and foregoing some sovereignty are painful for any nation, though more so in this case given the history of the Irish nation’s fight for self rule. Whilst Ireland can possibly claim it does not need help if it reduces or walks away from guaranteeing its banking system, simply copying the Icelandic approach to banking system failure might potentially cause more losses and chaos abroad than at home. Presumably a successful negotiation will result in an element of burden sharing.
The main problem over negotiations is probably going to centre on Ireland’s attractively low tax profile that encourages significant inward investment. This is a critical advantage for Ireland, which is seen as unfair in the European single market by its fellow members. From a European perspective these allowances take jobs and tax revenue away from them, whether it be multinationals or pop stars. However, this is a crucial advantage for Ireland – by giving up this competitive advantage Ireland would effectively accept short term relief whilst losing the long term advantage.
What about the long term ? I have argued here previously (see blog) that the long term problem (which is the root of this short term problem) is the inflexibility imposed on labour and capital markets by the single currency regime. In the short term hopefully the politicians and the financiers can get together to solve the immediate liquidity problem. But I still struggle to see how in the long run all Irish banking debt can be honoured and how being a member of the single currency regime is optimal for the Irish economy.