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Joint Committee on Finance, Public Expenditure and Reform díospóireacht -
Wednesday, 15 Jul 2015

Latest Eurozone Developments and Future Implications for Euro Currency: Discussion

We will now move on to the latest eurozone developments and future implications for the euro currency. I welcome Mr. Colm McCarthy, economist, and Professor Frank Barry, economist at Trinity College, Dublin. The format of the meeting is that our witnesses will make their opening remarks in the order in which they were introduced and that will be followed by a questions and answers session.

I wish to advise the witnesses that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. However, if they are directed by the committee to cease giving evidence on a particular matter and they continue to so do, they are entitled thereafter only to a qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given. They are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person, persons or entity by name or in such a way as to make him, her or it identifiable.

Members are reminded of the long-standing ruling of the Chair to the effect that they should not comment on, criticise or make charges against a person outside the House or an official either by name or in such a way as to make him or her identifiable.

I call Mr. McCarthy to make his opening remarks.

Mr. Colm McCarthy

I thank the Chairman. I want to speak briefly about what has happened since last Sunday or early Monday morning. I will place it in the context of successive so-called rescues of Greece and draw a few conclusions about what this may mean for the eurozone going forward. First, we need to be clear that what emerged at the weekend has not moved Greece any closer to an exit from reliance on official lenders. The economic situation remains very grim. The Greek economy looked briefly last summer as if it was beginning to recover. There was then a political crisis towards the end of the year and things began to turn downwards. We do not have very recent data but with the banking system closed down, as a result of actions by the ECB, in the middle of tourism season, it is reasonable to guess that economic activity in Greece is declining.

A number of forecasts are quoted this morning in the Financial Times from people who think that output will be down again this year. The events of the weekend have also reminded people that there are fundamental design flaws in the eurozone and that these have yet to be properly addressed.

I want to say a few things about this third Greek rescue. Of course, it has not been negotiated yet. All that happened at the weekend was that a process was initiated and there will now be discussions and negotiations that may eventually lead to a third so-called rescue programme for Greece.

I will give a little bit of background. When states lose access to the private sovereign debt markets they can no longer run budget deficits, nor can they replace historic borrowings as they fall due. Unless they can get some form of non-market finance, they will be forced immediately into possibly highly destructive fiscal corrections. There are international mechanisms to avoid that. The most important one is the IMF, which is a kind of credit union for governments. Governments can go there if they can no longer finance themselves on the private debt markets.

In Europe we now have a common currency and arrangements have emerged in crisis circumstances in Europe. As members of the joint committee know, the IMF has been corralled into these. The objective of official lending programmes as traditionally provided by the IMF has been simple - it is to return the distressed country as quickly as possible to credit worthiness and hence to market access, without unnecessarily severe contractions in economic activity. That is the objective of these programmes. Sometimes they work and sometimes they do not, but mostly they have worked around the world.

We had a second programme for Greece in 2012. This is the third one. A second programmes means that the first programme failed and a third programme means that the second programme also failed. The third Greek programme remains to be negotiated. It will have to be implemented against the background of an economy which seems to be contracting again. The banks are closed for business and will probably require yet another recapitalisation. Greek government debt is already approaching 180% of GDP. Some people feel that it will now rise to 200% if the rumoured terms of the third programme are enacted.

Of course, Greece has already been in default twice to the IMF. The summit communiqué released on Monday morning indicates that the third programme will have the following features; no early recapitalisation of the banking system that is not provided for in the communiqué. The communiqué is only a draft. It was done in a hurry and is also very badly written. The detailed programme may fill in some of the gaps. As of now, however, there is no provision for the early recapitalisation of the banks, or even for the early re-opening of the banking system; a renewed and front-loaded fiscal contraction - this, it should be borne in mind, in an economy that is almost certainly contracting again; and third, no write-down of state debt.

Commentators have already warned that a programme along these lines will likely see GDP in Greece not just fail to stabilise but also possibly to contract further. I have cited two references to short pieces that were published yesterday and which are worth looking at. There has been a score of other pieces by economic and financial commentators around the world, which are along the same lines. They identify a high degree of risk that the third programme for Greece will also fail.

I would remind members of the committee that there is a third programme because the second one failed and there was a second one because the first one failed. These people are predicting that there will be a fourth.

The communiqué lists a series of reform measures, some of which could assist economic recovery in the longer term. None of them is likely to have sufficient effect inside the programme horizon to offset the negative impact of new expenditure cuts and new tax increases.

I want to go back briefly to the first Greek rescue in 2010.

The financial crisis erupted around the world in 2008. The European sovereign debt crisis started in Greece in 2010. There had been weakness in various peripheral sovereign bond markets through 2009 and spreads widened and so on. The first crisis of a country that looked as if it could not borrow at all happened in Greece. The troika did not exist until the Greek rescue was put together in 2010, which was important and has cast a long shadow. The background is that the government changed at the end of 2009. There had been a New Democracy government under a man called Karamanlis, which had fiddled the figures. The public finance numbers were not correct. Public debt was much higher than it appeared to be and the budget deficit was much bigger. The new PASOK government under George Papandreou progressively discovered the scale of the holes in the public finances, Greek prices fell and eventually Greece was forced out of the bond market and had to be rescued.

At this stage virtually all of the Greek state debt was debt to private investors in Greek sovereign bonds. Greece did not have any official debt or none worth talking about. Briefly, the state debt in the early months of 2010 turned out to be 115% or 120% of GDP. People had thought it was much lower but the figures were not correct. The budget deficit was into double digits and the economy was contracting. In those circumstances, it is unrealistic to argue debt sustainability. There were economists in the International Monetary Fund, IMF, at that time who argued that the Greek debt was not sustainable and there should be a haircut of sovereign bond holders. That was not done. It was overruled by the political leadership of the IMF and pressure from the big European states. The first so-called rescue of Greece was a rescue of its creditors. That will be familiar to people who followed what happened here with the creditors of the bust Irish banks. Many of the problems we are dealing with date back to the failure to handle the first Greek rescue properly.

One of the things that disturbed me and many other observers about events last Sunday was the explicit threat to expel Greece from the eurozone. The manner in which it was delivered was laughable. Wolfgang Schäuble, the German finance Minister, referred to a five-year time out from membership of the currency union. That is utterly impractical and could not be done. The fact that the threat was made was extraordinary. This is meant to be a currency union, its members have abolished their own currencies. They do not have any currencies. People talk about bringing back the drachma as if it was still alive somewhere in a cave on Mount Athos and could be revivified. It does not exist. Greece does not have a currency any more than Wexford has a currency. To threaten a state which has abolished its own currency with expulsion from the common currency is an extraordinary event and it was a first.

This in turn means that the risk of an ultimate Greek ejection from the common currency has not gone away. As for the programme, if a third programme for Greece was being designed by economists rather than politicians who are trying to allocate blame, it would have several features. It would have to show a clear path back to market entry, that is what financial rescue programmes do. When the IMF takes the plane south, to Latin America, as it has often done, to Brazil and Mexico and places like that, its modus operandi is to find out how bad is it; say the debt is too big; find out who was foolish enough to lend the money, whether the government or the banks; break the bad news; give it a haircut; lend the government enough to get through a few years in which it will have to cut the budget deficit anyway, because it is a structural deficit, and hopefully get the country back into a position where it can borrow money again; and try to do that without deflating the economy too much. That is what these financial adjustment programmes are supposed to do. That is what it says in the text book. That was not done in the first or second Greek rescues. It looks like it is not being done in the third. That means that the decisions at the weekend do not address the problems in the Greek economy but they also do not remove the risk of Grexit. Some of the newspapers on Monday reported this as great news and it means the risk of a country being flung out of the euro has been removed. I do not think that is the correct interpretation. That risk has not been removed.

As for the programme itself, there have been new reports this morning that the IMF may not participate in the next programme. The German Government tried to make IMF involvement a condition of there being a third programme. There has been a lot of angst in the IMF about its involvement in 2010. The IMF was split. Many people in the IMF did not want to go along with the first Greek programme because they thought it was not properly designed and that it did not pass a test which has been in the IMF rule book for ten or 15 years, since the Argentinian crisis. The rule is not to lend IMF money to a country unless the programme is going to make its debt sustainable and will get the country back into the sovereign debt market under its own steam within a few years. That is my paraphrase of the rule. The rule is known colloquially as the “no more Argentinas rule”. The IMF had to ignore that rule, which it did not because the economists wanted to but because the executive board, which is political, and the then managing director, Dominique Strauss-Kahn, wanted to participate in the Greek rescue as a junior partner with the European institutions. The clock has turned, however, and it looks as if the executive board of the IMF may forbid the board to lend any more money to Greece because the deal does not respect the rule that it shows a plausible way to debt sustainability for Greece.

There is a long report in the Financial Times this morning, which I find credible but who knows? The IMF has non-European members. They are called China, India, Brazil, Australia and all sorts of other people. It is their money as well. Greece is in default to the fund and they are all conscious that what they agreed to do in 2010 was a mistake and it is possible that the IMF executive board will decline to participate in the third programme as envisaged. The Germans have said they will participate only if the IMF does because there is some convoluted argument that they trust the IMF and they do not trust the European Commission or something. I do not know what it really is about. I would not assume the IMF is going to participate.

If any of the committee members have free time during the summer and want to understand the international politics of what is going on, they should read a paper by Paul Blustein about the first Greek deal. It is a fantastic paper. I noted it at the bottom of the document I circulated.

This guy used to work for the IMF and he has spoken to all the principal actors. I regard the May 2010 Greek deal as the original sin in the mismanagement of the eurozone crisis and this guy has nailed it. If one reads nothing else about the first Greek bailout, this is the thing to read. He has spoken to all sorts of people. People retire all the time from the IMF. Once they retire, they are free to tell the truth, which they are not allowed to do when they are in office.

Similar to other institutions.

Mr. Colm McCarthy

It is a phenomenon with which we will all be professionally familiar. I will finish with a few comments on the implications of all this. A blame game has been going on for the past six months: the Greeks screwed up; the Greek Government did not do its negotiations properly; the finance Minister wore a leather jacket; his wife forgot to wear a helmet on her motorbike or whatever. Similarly, there have been allegations that the Europeans were engaged in blackguardism and blackmailed the Greek Government and all of that. That is just a blame game. What is interesting is whether the third programme passes the simple tests for a feasible and plausible rescue effort for a country that is in a mess. To claim to be involved in the financial rescue business and then for it to say it is really upset because the country it has been sent to is in a mess is kind of weird. Of course it is in a mess. That is why the country called it. Those in the ambulance business tend to find people who are injured when they are called out and they do not expect the callers to be able to drive the ambulance.

The explicit and unveiled threat last weekend of expulsion of a member of the eurozone was a pretty extraordinary event. I can quite understand why the Greek Government felt it had to capitulate. However, it creates a situation in which this common currency area is no longer seen as irrevocable by its leading member. I think that will create conditions of instability very quickly the next time some country gets into trouble. If that country is a big country such as Italy or France, the systems are retrievable but if it is a small country such as Portugal, Slovenia or Ireland, we now know that the small countries are expendable. It is a fact that every finance Ministry in Europe has prepared contingency plans for what they will do if this thing blows up. They will all deny it, for good reasons, but they all have them. If I were involved with one of these smaller countries, I would be dusting off those plans now. There is an increased risk the currency union will unscramble at some stage. It is now clear that the smaller countries will be deemed expendable in those circumstances. It has been a very bad week for Greece but it has been a bad week for the eurozone.

Professor Frank Barry

The single currency was a political project. It was not an economic project. It was not designed by economists and most economists were probably quite antagonistic to it. I am, therefore, going to be forced to say something about politics and to step outside my own area. I agree with Mr. Colm McCarthy that no side has come out well over the current impasse. Syriza had a very weak hand to begin with and played it very badly. My graduate students were asking me over recent months whether it had not got any diplomatic advice. Germany has reversed 50 years of hard work developing goodwill on the part of the other peoples of Europe.

Ireland has not played its hand well over this impasse either. I remind the committee of a comment the historian Joe Lee made 30 years ago. “[While] the ‘political’ skills of Irish representatives in negotiating situations are widely acknowledged ... there seems to be no comparable criterion for assessing the calibre of conceptualisation of the Irish case.” He is suggesting that we have a very good diplomatic service, which I think has stood us in very good stead. However, the comments my graduate students made about Syriza can also be levelled at the Irish Government. Traditionally, the Government's comparative advantage has been as arbitrators and facilitators in negotiations. It did not make any attempt whatsoever to play that role this time round. We seem to have forgotten a point Garret FitzGerald stressed repeatedly. Every time he spoke about the European Union, he noted the important role the European Commission played as a defender of the interests of smaller states. The European Commission has really been sidelined completely over the course of this impasse. It has been sidelined over the course of the crisis going on years. It is in our interests and the interests of other small and weaker states to try to resurrect the power and the influence of the Commission. Instead what we have had over recent weeks is a naked battle of interests. In these kind of battles, the interests of the strong will always dominate the interests of the weak. This is something we really need to bear in mind.

Let us think back to the logic behind the single currency. Flexible exchange rate systems lead to dramatic fluctuations in international competitiveness which can lead to conflict between states. They are, therefore, regarded as undesirable. The system of fixed exchange rates which we had over several decades or so in the run up to the introduction of the single currency was also regarded as undesirable because it did not prevent speculative attacks against currencies in the fixed exchange rate systems. I am sure the committee will remember sterling crashed out of the fixed exchange rate very dramatically in 1992. Then the speculative pressure came on Ireland and we crashed out shortly thereafter. The single currency was seen as a way to avoid the undesirability of both flexible and fixed exchange rates. Now, as Mr. Colm McCarthy said, rather than having an irrevocably fixed single currency that prevents speculative attacks, we have returned, under this notion of a Greek timeout from the euro, to that era of fixed exchange rates which are not irrevocably fixed. We are now back into one of those worlds, which was deemed undesirable to begin with and one of the benefits of introducing a single currency.

Economists always view the introduction of a single currency essentially as a European federalist project. It was known that there were design flaws in the system, but the assumption would be that when cracks appeared, that would lead to closer integration, essentially a united states of Europe. It is clear there is no appetite for this now. The people who constructed the euro to begin with were of that kind of federalist disposition and assumed that ultimately we would move in that direction and have something like a big Washington budget that cushions states of the US when they are hit by a shock. We have no equivalent in Europe. That is what I mean by euro federalism. There is clearly no appetite for that now so we are stuck in limbo, or in a worse place.

The rigid fiscal rules that have been imposed and strengthened over time in the eurozone were really designed to obviate the need for that sort of Washington-style budget. The notion was if countries adhered rigidly to these fiscal rules, they would not get into the sort of crisis where a Washington-type budget might be required. Those fiscal rules were policed by the no bailout clause. The no bailout clause said, "If you make mistakes, you suffer." It was designed to ensure mistakes were not made. The no bailout clause imposes costs on lenders as well as borrowers. If a company goes bankrupt, lenders suffer as well as the company. The no bailout clause rule was overturned in the Greek case in 2010 by the troika. As Mr. Colm McCarthy said, the IMF tore up its own rule book in tearing up the no bailout clause. If the no bailout clause had been rigidly imposed in 2010, the IMF would have said essentially that Greece was bankrupt and that people who lent money to Greece would have to take a haircut or write off their debts. That was overturned. It was very strange that the IMF did it but the IMF, as Mr. Colm McCarthy said, is politicised.

Since then the successive Greek deals have said, in essence, and I will try to put it as pithily as possible: "We will lend you more money, which you will never be able to pay back, in order to help you pay off your creditors". That is what these Greek deals say. When I say it in that way, it is clear that it cannot work. These debts will be written off sooner or later. Ten years hence, when we are out of this crisis, these debts will be written off.

Essentially, all this talk about reprofiling is a pretence or mirage. If Colm McCarthy owes me €1,000 and he is supposed to pay it back to me tomorrow, which is like money in my pocket, reprofiling means that I tell him not to mind paying it off tomorrow but I will take it from him 50 years hence. That is what reprofiling is. It is really the same as writing off the debts. It is pushing them out so far into the future that, essentially, it is meaningless. Governments do this for political reasons, not for economic reasons. It is essentially the same as a write-off except it does not allow Greece to return to private markets. Greece is still sitting with this high nominal debt-to-GDP ratio, so it cannot borrow in private markets. It is the same as a write-off except it does not achieve the same purpose as a write-off would, which is to allow Greece return to private markets and borrow to get its economy under control.

For Greece, the situation with the current deal is that reforms are mandatory. Nobody disagrees with reforms. In the Irish case, to be honest, when the troika came here most economists more or less breathed a sigh of relief thinking that this would enable some reforms to be introduced in Ireland that the politicians could not get through because of the power of vested interests. The question is whether that has actually succeeded, whether we have seen the legal profession opened up or not and so forth, and whether those reforms have really been achieved. Reforms are a good thing, but reforms will yield economic benefits only in the long run. There is no way that a reform will appear in the form of increased GDP over the next year or two. It is a long run process.

The second element of the Greek deal is more austerity. Austerity is detrimental in the short run. It is a great deal more detrimental to Greece. An equivalent amount of austerity in Greece is much more detrimental to the economy because the Greek economy is so much more closed. With austerity in Ireland much of the hit is taken by imports. We are three times more open to imports than Greece is, just as we are far more export oriented. Being an open economy means that part of austerity is cushioned as the blow is taken by imports. More austerity for Greece has a more dramatic impact on Greek GDP.

The final point I wish to make concerns the role of the European Central Bank, ECB. Again, politics comes into play here. For the last few years Mario Draghi has been the hero of the weaker, peripheral nations in Europe. When he announced quantitative easing and said the ECB would do whatever it takes, that was to the benefit of the debtor countries. The creditor countries, such as Germany, did not like it. In the long term it is like inflating away one's debt. Mr. Draghi was a godsend to the European periphery. Politically, he and his cadre have seen that they have moved too far in terms of being in the corner of the weaker, peripheral states and over the current crisis they have reversed position and taken a course of action that has been detrimental to the peripheral states, particularly to Greece. As Colm McCarthy has been writing, the Greek banks were solvent the last time it was checked, therefore the role of the ECB is to carry out its main function, which is to provide liquidity to banks that are solvent but illiquid. It has failed in its duty to do that, for political reasons.

We are in a mess and, as yet, no exit strategy has been mapped out from the mess.

This has been very interesting. In fact, it is a breath of fresh air to hear the two analyses, especially from the point of view of Leinster House. I gather the witnesses are saying that the Irish Government's position on debt write-down in the Greek case does not have a logical economic basis.

Mr. Colm McCarthy

Economists tend to think about these financial crises in a forward looking way. They tend to think: "It is a flipping mess. What will we do to fix it?" We are driving an ambulance and the patient is lying on the side of the road spewing blood. The trick is to see if there is some way to fix it. One does not interrogate the patient and ask if they were driving too quickly and the like. One gets him on a stretcher and into casualty as quickly as possible. Politicians tend to play a different game. It is like 12 year old children playing football when some fellow gets a kick in the head and they say: "It was not me, ref, it was him or him". That is really what has been happening for the last six months. Various governments have unwisely got into stuff relating to what was the source of all the problems in Greece. Everybody acknowledges that Greece has had poor macroeconomic management for 30 years or longer, since the 1970s, and everybody acknowledges that the Greeks did not come up with a terrific medium-term plan and so forth.

Is there any economic school that believes this is fixable without debt write-down?

Mr. Colm McCarthy

I do not believe so. Debt write-down is a necessary condition. It is not sufficient. I will put it this way. Consider April and May in 2010, a time when the Greeks owed approximately 120% of GDP. It turned out to be a little more when the final figures were compiled, but everybody thought at the time that it was 115% to 120%. The Deputy will recall that it was the Papandreou government. The deficit was thought to be 10% of GDP that year, although it turned out to be a little higher as well if memory serves. In addition, and very importantly, the economy was in a nose dive. If one has a high debt and is running a high deficit, which means the debt is increasing, and the economy is sinking, that is debt unsustainability on any reasonable metric. That is why the first Greek deal was such a mistake.

Currently, there are people who are saying that the Greeks owe 180% of GDP, but the repayment terms have been stretched out, some of the loans are now 30 year loans and so forth. Some of the loans have the feature that the coupons do not have to be paid for the first five or six years, although some of the IMF loans are more up-front. Some people have been saying that Greek debt is not as bad as it looks because of favourable reprofiling and the other matters Professor Barry mentioned. That is fine. However, look at the Financial Times supplement today and the page which shows what government debt is trading at in the secondary market. One should do that from time to time because everything else in the Financial Times is some guy's opinion. The figures show what that debt traded at yesterday, which was an interest rate of 12.26%. That means Greece has unsustainable debts. There is not a large amount of Greek Government debt out there at present, but what is out there is trading at an interest rate which is way off the chart of anything that is conceivable. That is the bond market to which Greece is allegedly going to return.

I cannot repeat this often enough - the purpose of these financial rescues is to get the distressed country back to an ability to borrow at affordable rates of interest within two or three years. That is what those programmes are always designed to do.

The interest holiday is meant to be part of this. Did Ireland ever achieve an interest holiday in its negotiations?

Mr. Colm McCarthy

The history of what happened is as follows. In November 2010, we were the second country to get into trouble and the troika was more organised by then. The troika was a shotgun marriage that arose early in 2010 in quite disorganised circumstances. We were the first outing it had as a threesome, as it were. The deal that was done here featured an adequate amount of financial support, in my opinion.

Some of it involved us selling off financial assets owned by the Irish Government. That is another day's work. One of the weaknesses or unsatisfactory features in the financing of the Irish programme was the application of very high interest rates. I am sure members will recall that this was resisted by the IMF at the time. The IMF guys in Dublin were very unhappy with the terms of the November 2010 deal, but they were overruled. If I recall correctly, the initial rate on the European money was 5.8%. I think the rates on some of the other stuff were even higher. Subsequently, the Irish Government succeeded, including through the promissory note deal but separately as well with the European financial stability facility money, as it was called, in getting a lengthening of maturities and a reduction in interest rates. The initial interest rates were ridiculous. They were absolutely unpayable.

The euro has been a disaster for half the length of its existence. One of the great political taboos is to question the euro in any way. Obviously, we have lost exchange rate and interest rate tools. As Professor Barry has mentioned, we have probably returned to a fixed exchange rate system that could come under speculative pressures. Is there a body of economists who are looking at a structured route out of the euro in this scenario that would be as safe as possible? It is the view of many economists that if Greece does not get a write-down, it will not be able to function within the euro. If that is the choice Greece is facing, it must be the case that a level of work is being done. What would be the best way? What would that path look like? What supports could the EU put in place at a humanitarian level to ensure that path is not as disastrous as it would otherwise be?

Professor Frank Barry

I presume work is being done in the background on how to alleviate a necessary exit, but I do not know that this is the case. The assumption is that a disorderly unwinding of the euro would be catastrophic. Greece would not necessarily pull out by choice. If the ECB was not providing it with the necessary liquidity, presumably the Greek Government would start to issue IOUs which would become the new drachma and would ultimately produce a currency to pay off those IOUs. The general presumption is that this would be catastrophic for Greece because it would lead to hyperinflation. The new currency would not hold its value. It would depreciate rapidly and cause hyperinflation. Nevertheless, it might be beneficial for Greece in the long run, depending on whether it denominated its debts in this new currency or whatever.

The exchange rate has been extremely beneficial for Ireland's recovery over recent years. I checked the data before I came to this meeting. In terms of the US dollar, €100 would have translated to $160 in 2008, but now it is closer to $100. In terms of sterling, €100 would have bought £90 in 2010, but now it buys £70. The exchange rate has been very important for us. The weakness of the euro has been a major component of Ireland's recovery. That is why I lauded Mario Draghi earlier. It has been hugely beneficial to Ireland. As Greece is essentially a closed economy, it does not benefit nearly as much from this as Ireland does. In a way, this has been an unanticipated benefit to Ireland of having the euro. Of course, there is no way of predicting whether the euro will be weak or strong. It is a sort of random factor that has worked in our favour.

Perhaps Mr. McCarthy might give his view on whether this could be done in a structured manner.

Mr. Colm McCarthy

I would like to begin by reflecting on what it means for a country to join a currency union and to abolish its own currency. It means the country has no exchange rate policy any more. That is for sure. Professor Barry has explained that. He is quite right when he says that the weakening of the euro over the past while has been particularly beneficial for Ireland. We are much more likely than the continental European countries to trade in sterling and dollars. They tend to trade more with one another. If a country scraps its own currency, it has deeper consequences beyond exchange rate policy. It means that for all practical purposes, it is using a foreign currency, the creation and destruction of which it has no control over. If its banks get into trouble, it cannot provide them with liquidity other than with the permission of what is for all purposes a foreign central bank.

Down through the years, some countries around the world have chosen not to have a currency. Montenegro is an example. When Montenegro was established as an independent state, the Montenegrin authorities decided not to bother having a currency. The deutsche mark, which became the euro, had been the popular currency in the Balkans. As a result, Montenegro does not have a currency; it just uses the euro. A few other European states, including the Vatican and Kosovo, use the euro without being members of the eurozone or the EU. It would be fun if the Vatican got slung out. I thought the Vatican banks had problems a while ago, but the ECB did not seem too bothered about it.

I would like to answer the important question that has been asked by Deputy Tóibín. A country in the position that Greece is in now might not benefit hugely if it had an independent exchange rate. As Professor Barry has pointed out, Greece does not have a broadly based export sector like we have. It is a quasi-closed economy. However, if Greece had an independent currency, it would certainly be able to provide liquidity to its banking system. In such circumstances, it would not have had to take the sucker punch that has been the closure of its financial system in recent weeks.

I was also asked about the practicalities that would arise if countries had to deal with some kind of chaotic break-up of the common currency area. It could be incredibly messy. It has happened in the past. Two currency unions in Europe - the rouble zone and the Yugoslav dinar zone - broke up in the 1990s. In the case of the rouble zone, each of the 15 constituent states in the Soviet Union retained a local central bank. The central bank of the Soviet Union was the Bank of Russia in Moscow, but there was a central bank quasi-branch office in Kiev, in Almaty in Kazakhstan, in Belarus and in all the other places. When Russia resigned from the Soviet Union, the local central banks in places like Kiev decided to start dishing out liquidity to all the new banks that were created there by politicians' chums. There was a massive creation of reserve money by these new central banks in places like Ukraine.

It was still the rouble.

Mr. Colm McCarthy

Yes, the stuff was still regarded as roubles and was used to purchase real goods and services in Russia in exchange for these claims against the central bank money that had been created in Kiev and Belarus, etc. Needless to say, the Russians got tired of this after a while and said "that's all over". Of course, people got very fond of creating money, as they do. The region in question ended up with huge hyperinflation. Brand new currencies had to be established, and were established, in Ukraine, Belarus, Kazakhstan and so on. The whole thing was chaotic. It was a very costly way to break up a currency union.

The circumstances were worse in Yugoslavia because there was a war, which is a really bad way to break up a currency union. Somewhere I have a 5 billion dinar note that was presented to me with great ceremony by fellows in the central bank in Zagreb. I might have lost it. It is worth about sixpence. There was phenomenal hyperinflation in the region. There are currency unions that have broken up. If there is some kind of cataclysmic event that breaks up the eurozone - it would really have to involve Italy or France going bust, rather than expendable places like Portugal - I hope and presume it will be managed. I think the reason Mr. Tsipras ultimately threw in his hand relates to a problem encountered by individual member states in the system.

I am sure he was advised he did not have any cards. It is very difficult to create a new currency in competition with an old one that is already in circulation and very credible. If Texas decided to go independent, it would be up against it in trying to introduce a new currency in competition with the dollar. It would be a different story if one were to try to introduce a new currency in Croatia in competition with a currency that has 5 billion printed on a note which is the price of a newspaper. The authorities in Greece would probably not have succeeded in getting their people to hold a new currency. In all the states around the Balkans that have currencies, the balance sheets of the banking systems are mostly in euros. That is true is Croatia and in Serbia. Serbia has a currency called the dinar and Croatia has a currency called the kuna. Croatians use the kuna for buying newspapers and cigarettes but the currency that is held in banking matters is the euro. It is similar to a common feature in Latin American, which is called dollarisation where transactions in the economy are largely dealt with in a foreign currency.

What can countries do that are worried that something like this might happen? A country can either try and introduce a currency of its own in adverse circumstances, which would be incredibly difficult for a country like Greece - it could use it as IOUs for paying wages but that would be about it - or a country could see if there is an alternative foreign currency it might use, at least temporarily, whose central bank might be more accommodating than the one in Frankfurt. This country has options in that regard that Greece does not have.

Mr. Colm McCarthy and Professor Frank Barry are welcome to the committee and I thank them for coming in. I listened with interest to the witnesses discuss the reasons bailouts should work, which is to return distressed countries to creditworthiness in order that they can enter private markets, and I agree with them on that. It is a simple analysis. Professor Frank Barry said that economists are a forward-looking people, and I agree with him on that, but so are business people. I come from the world of business, and I am viewing this in a simplistic way as he has profiled it. I disagree with his analysis of reprofiling debt and pushing it out over many years into the future. The debt is still there as a percentage of GDP and people lending money are not silly. They carry out due diligence and realise what is at play. If one pushes debt out a long period into the future, it means one has not crystallised the loss. One may crystallise it when it can be afforded but it has not been crystallised immediately. In essence, that allows a country or business that is in debt to have a cashflow, which is what keeps everything afloat. Reference is often made as to who the wealthiest person in Dublin is today, and it is the person who has the handle on the most liquid cash. It is not the person who has the most assets because a person may not be able to dispose of them.

What do the witnesses consider is the value of honest engagement? People in business trade a great deal with people they trust. So much can be put down on paper but from the financial meltdown we have had, and we have had more experience of it than most, I have noted that it is the people one trusted and worked with who are the ones that have brought us through it. Any new customers we were getting in during that distressed period were coming from a distressed situation and one was very cautious to move in because one could be exposing oneself when one did not need more exposure. With Greece, it comes down to what is its honest engagement here and what is the general compliance. We are all meant to be a European community working together. We cannot say it is terrible and this is a case of the large countries versus the smaller countries when we expect everyone to engage honestly.

I read Mr. Colm McCarthy's article in the Irish Farmers' Journal last week in which he said something which he mentioned briefly in his presentation, and he can correct me if I am wrong, that the money that has already been lent is lost. If we were to agree with him that this money is gone, would we not be not daft if we did not ensure the taxpayers' money that is going to this new €80 billion plus bailout is secure? I cannot stand over money going into a black pit again. The mistakes of the past have been made but we cannot endorse new mistakes. There is a simple concept in business: one borrows money, one makes decisions and if one makes bad decisions, one suffers. However, the minute one runs out of cashflow or out money that has been agreed with one's lending institutions, one has lost control of one's business. Until one figures out a way to get that cashflow back, one has lost control. Essentially, Greece has done that; it has lost control. It finds itself in a desperate position and it needs to work extra hard to ensure it gets itself quickly back to a position where it can borrow again.

As Professor Frank Barry said, the euro was a political venture. Europeans have embraced the euro. He and I will have met many people who would say it is great that we can buy items in other countries where we know the cost and the exchange rate. I have bought many machines and other items I needed for business in the eurozone and the transactions were transparent in terms of currency. I remember when two of us travelled to France in the early 1990s and when we exchanged £50 or £60 in traveller's cheques, we got different amounts in the local currency. It was a joke and we were being ripped off left, right and centre. We should not forget the bad days. The reason politicians sought to introduce a common currency was that there was a demand for it, and I believe it is worth fighting for despite all its frailties.

There were many reasons for the foundation of the European Union but there were two main ones, one of which was security in Europe because there had been two major wars within a number of years and Europe was decimated. Thankfully, we have had reasonable security even though it could be argued that there are many threats on the outskirts. The second main reason for its foundation was food security. The Union has delivered on that, much to the detriment of many farmers. I am a member of the Joint Committee on Agriculture, Food and the Marine. I am also engaged in farming and we have seen that the prices paid to farmers for products is the same as the prices they were paid 20 years ago. However, the EU has kept the food in the consumer's shopping trolley at an affordable price and it has also ensured the food is traceable, which is important. The European Union has introduced many positive measures. It guaranteed equal pay for women and it introduced many other good measures that would not be in place without it. I dislike the spinning of this discussion into one of larger states versus smaller states. That angle should be kept out of this discussion. It is not fair. This is about taxpayers' money and Mr. Colm McCarthy might address that point.

Mr. Colm McCarthy

If the Deputy was upset about what I wrote in the Irish Farmers' Journal last week----

I am not but I just want to avoid that happening.

Mr. Colm McCarthy

-----he will have great fun tomorrow morning. The Deputy was right to raise the question about trust between member states. It is a type of confederal arrangement of 28 states, 19 of which are in the eurozone. Clearly, the sight of people on the Greek side running around accusing one another of blackmail and terrorism was not great. On the other hand, some senior European politicians, including Jean-Claude Juncker, announced a few weeks ago that all those guys who were complaining about the design flaws in the eurozone were an Anglo-Saxon conspiracy. There has been a great deal of loose talk on both sides.

To return to my earlier point, countries get into trouble because they are not being run very well. To go along to a financially distressed country and start complaining that it is not run as well as Denmark is silly. By definition, it is not very well run. Otherwise we would not be there. I have some familiarity with Greece. It does not have the breadth of a modern economy we have, nor does it have the public administration we have. The Greeks have intense problems with low level corruption, which is very common throughout the Balkans. It is the same in Romania, Bulgaria and Croatia, which are in the EU, and in several other countries such as Macedonia, Albania and so on. We get bothered because there are very occasional scandals here involving corruption in planning, fiddling around with zonings and all that. That is in the ha'penny place by comparison with what people take for granted in south-eastern Europe.

People do not have to pay speeding fines; they just slip $10 to the police officer. If one tried it here, one would be arrested. They do not pay taxes, but bribe tax officials. They do not pay customs duties, but do deals with the customs officers. One can buy examination results in universities and pay for better grades. One of the scandals in Greece is the waiting lists for the medical system. People can move up the waiting lists by bribing officials in the public hospitals. I am not denying that problems exist in Greece or that successive Greek Governments have been slow to address them. However, Greece is in a mess, and the purpose of a financial rescue programme, which should have been the case in 2010, is to fix it, not to kick it down the tracks.

In 2010, a large amount of money was loaned to Greece which it used to pay off the foolish lenders to previous Greek Governments who should have taken a hit upfront, not as a moral measure but as a practical one. This is how business people deal with financial no-hope cases. For example, if they are not getting their money back, they will take 50 cents in the dollar and move on. It is not business-like to pretend anything different. If one has loaned money to someone who is not going to repay it, one has lost the money. It is gone. One can put it into one's books today or in ten years' time. The act of putting it into the books is not the source of the loss. The source of the loss was the lending decision. Much of the extend-and-pretend that is happening is due to the fact that European governments do not want to tell their taxpayers they loaned their money to Greece, that it was a mistake and they should not have done it.

There is some spin going around that the Greeks have not bothered their barney over recent years making any effort to rectify their situation. It is not true. Speaking from memory, while the Greek budget deficit in 2010 was 15% of GDP, last year it was 3%. In circumstances in which the economy was collapsing, they knocked ten points off the deficit by increasing taxes and cutting public spending. The idea that the Greeks responded to the 2010 deal by lying on the beach drinking ouzo is incorrect. There have been shocking caricatures in the Greek newspapers of Germans as Nazis, and in the German newspapers of the Greeks as layabouts. I have no sympathy with either characterisation.

Professor Frank Barry

In some of Deputy Barry's remarks he seems to conflate the EU with the eurozone. I am very supportive of the advantages Ireland has derived from being part of the EU, which has been spectacularly crucial to our prosperity. However, the eurozone is a different matter. It is a component of the EU. The benefits to which Deputy Barry referred have derived from our membership of the EU. There is no element of euroscepticism in what I am saying, given that I have been referring specifically to the eurozone. However, Deputy Barry is correct to make the point that there have been benefits to our adoption of the euro as well as costs, for example, the transaction cost benefits. It is wonderful to fly abroad and use one's own currency. Against that, we must weigh the costs, which we are pointing to. In Deputy Barry's comments he appears to downplay one of the costs, namely, the political tensions raised, particularly during recent months, by the negotiations essentially between the Germans and the Greeks, although other countries have been involved.

Although I do not read the British newspapers very frequently, I have been devouring them during recent weeks to see how it is playing out there. The British newspapers from right to left have all been supportive of the Greeks and hostile to the German position, which is of interest because it may have an impact on the outcome of the forthcoming referendum in Britain. If Britain withdraws from the EU, it would be very detrimental to us. If the eurozone collapses and Greece is forced out of it, it may also force Greece out of the EU. Mr. McCarthy has spoken about the break-up of previous currency unions that have had a detrimental impact on trade. Countries exporting to Greece will not be happy to take these new IOUs or whatever new currency is developed there. When Argentina defaulted, Argentine ships were seized around the world.

The great benefit to Ireland of being in the EU, aside from the agriculture sector which I will not talk about, has been that it has allowed us to act as a magnet for foreign direct investment in a way that would not have been possible otherwise. If trade relations in Europe break down as an outcome of the messy disentangling of the eurozone, it would be catastrophic for us. I am not a eurosceptic in that regard. It is beneficial to keep those issues separate from each other.

I thank both contributors, who have described very accurately what we are facing and the folly of the line the Eurogroup has taken in dealing with the Greek crisis. Although Mr. McCarthy said we were different from the politicians, he suggested that for political reasons we must be careful about the use of strong language on either side and that loose language had been used. I suggest it is time for blunt language. Mr. Varoufakis said that when he made economic arguments, of the sort Mr. McCarthy has just put, in a measured way to the Eurogroup, he might as well have been singing the Swedish national anthem, and just got blank stares. They were not interested in the measured, objective economic arguments such as Mr. McCarthy has just reproduced, almost word for word, from the interview with Mr. Varoufakis published in the New Statesman. Almost any economist, left or right, looking at this is saying the same, that the judgments and policies made by the Eurogroup, headed by Mr. Schäuble, had nothing to do with sound economic management and was purely about politics. If it is not about sound economic judgment, we must ask what is it and what is motivating it. I would be interested in hearing Mr. McCarthy's opinion. We must be honest. If it is not about sound economic judgment, which it clearly is not, and it is about shoving something unsustainable from every point of view down the throats of the Greeks, we must speculate about the real motive. It is not about hyperbole. We must be honest. Greece was subjected to economic terrorism and political bullying for purely political reasons and our Government went along with it for purely political reasons. Mr. Varoufakis said the Irish, Spanish and Portuguese Governments were, to his surprise and disappointment, among the most energetic enemies of the Greeks during the negotiations because they were afraid of the political embarrassment that would result if they sided with the Greek Government in saying there had to be debt write-down and a lifting of the austerity. Was he not right?

Mr. Colm McCarthy

Yes. It is unhelpful in a political negotiation for the various people involved, including people in the Eurogroup and some of the Greek politicians, to have resorted so quickly to hyperbole, which does not move matters forward.

In 2010, when Mr. Varoufakis was teaching in the University of Athens, he wrote a piece stating he thought the 2010 deal was silly. He thought the debt was unsustainable then and that the deal simply relabelled some Greek sovereign debt, which was a dodgy asset in various French and German banks, as a liability of taxpayers. In other words, he objected to the 2010 deal along the lines outlined by me, Professor Barry and numerous other people, including those on all sides of the political spectrum. Whether the deal was more offensive to socialists or capitalists, it is hard to tell. Deputy Boyd Barrett referred to Mr. Varoufakis's interview in the New Statesman during the week, which was very interesting. It might have been a bit self-serving since he was the only witness. Some of the details are amazing, such as the fact no minutes were taken. He was quoted somewhere else as stating the fact he criticised the May 2010 deal upset many people, on the basis that in politics one will always be forgiven for being wrong but one will never be forgiven for being right. Many people did not-----

Mr. McCarthy might add that no one will ever admit one was right even when they adopt one's position.

Mr. Colm McCarthy

We now have deal No. 3. The fact there is a third rescue is an indictment of the second one and the fact there was a second is an indictment of the first, particularly if one does not accept the narrative that the Greeks spent the past five years on the beach. I do not accept this narrative. I fully concede the Greek Government should have done more on tax reform. It is still arguing about the independence of the central statistics office. One of the senior officials there was blackguarded by successive Greek Governments. It is still going on and it should not have happened. However, it is not true that the Greeks made no effort at adjustment. They did so in very adverse circumstances. It is difficult to have much sympathy for either set of protagonists.

My criticism of Mr. Varoufakis and Mr. Tsipras is they have capitulated to the blackmail of the European Union.

Mr. Colm McCarthy

Deputy Boyd Barrett would have gone ahead into a chaotic expulsion from the eurozone.

I would have prepared plan B for an exit because one could not go into a negotiation with these guys unless one had plan B. This plan B had to involve being willing to go out of the eurozone if they were not willing to be reasonable.

Mr. Colm McCarthy

Many people have looked in detail, in secret sometimes, at the nuts and bolts and how one introduces a new currency which will be deemed from day one to be an inferior currency to the one already in wide circulation which constitutes 100% of the asset and liability sides of the financial-----

Time is short. I accept Mr. McCarthy's point.

Mr. Colm McCarthy

Hold on.

I accept the point that it is difficult.

Mr. Colm McCarthy

How does one do this? All of the people who have looked at it have concluded the grim situation in Greece would be substantially worsened very quickly if one did this. I am sure this is what the Greek Government knew last weekend.

In the interview with New Statesman Mr. Varoufakis stated he told Mr. Tsipras he advocated stating if they did not give Greece a reasonable deal they would impose a haircut on the ECB, take over the Greek Central Bank and issue their own currency. He had a plan B.

Mr. Colm McCarthy

No, he conceded five people were party to this and that they would need 500 to implement it but that once the 500 were informed, it would come apart in their hands. He conceded this in the same interview.

I very much accept what Mr. McCarthy states as it absolutely accords with my view. It is not only Mr. McCarthy, Mr. Varoufakis and the left, as Mr. Krugman and anybody looking at this, including the IMF, who state the thing is unsustainable and we will be back in crisis mode in a few months time. The crisis could escalate again this week. A few minutes ago I received a text stating many of the ministers in the Syriza Government have resigned and there is a general strike on the streets against the deal. We do not know what will happen. Mr. McCarthy has stated what the Greeks are being asked to accept is unsustainable and will not resolve the crisis, and we will be back here again. Therefore, do we not have an obligation at this stage to look at plan B? Otherwise, we are simply looking at a dire situation waiting to see what will happen.

Mr. Colm McCarthy

This partly comes back to a question Deputy Barry raised. One either believes that careless lenders should take haircuts up-front in the cause of financial health, or one does not. If one does one must state the European institutions and the IMF, who signed up as lenders for this poor deal in 2010, and for an inadequate second deal, made silly loans and in the interests of restoring financial health they should now take haircuts. We are great in this country for saying the clowns who lent money to Anglo Irish Bank should have got haircuts. We all agree with this. Fair enough, I think the clowns who lent money to the Greek Government in 2010 should get haircuts, including European Governments and the IMF.

Professor Frank Barry

I wish to address one of the points raised. The process of dealing with the Greek crisis has been incredibly politicised. I suspect Mr. McCarthy might agree that in many ways it would have been better if the European institutions were not involved with this and if it was actually just determined by the IMF. The IMF is well used to making these decisions. It advocated in 2010 that a Greek haircut should be imposed. We know what the IMF advocated here at the time of our bailout. The whole process and the participation of the European institutions has made the whole thing messier. The IMF might well be able to go in now and state it will impose a haircut on Greece's creditors but this would not necessarily be extended to Ireland. This is how the IMF might well resolve the political difficulties faced by the Irish Government and other governments in feeling unable to adhere to this type of outcome. We all understand the constellation of political factors in Ireland which caused the Irish Government to take the decisions it has. Perhaps the way out is for the IMF to deal with these issues, if it were prepared to do so.

Mr. Colm McCarthy

This is a reasonable view. Another view states the IMF should have kept out of it altogether and let the Europeans sort out their own mess. This is an increasingly popular view, needless to say, in China, India, Brazil and other countries which are now exposed. The critical point is that the no-bailout clause means haircuts. The logical corollary of stating there will be no-bailouts is that France or Germany will not pay for Belgium or Greece if it goes bust. We do not have a united states of Europe. This is not Texas and we do not willingly transfer tax revenues across international boundaries except in a very small way. The no-bailout clause in the original design of the eurozone made sense. There was no banking union, which did not make sense, but the no-bailout clause did make sense provided everybody understood what it implied. What is implied was that if one lent money to the Greek Government, the Greek banks or anybody else, one would get a haircut the minute they got into trouble. The abandonment of the no-bailout clause in May 2010 has fathered all of the antagonism ever since. If this had not happened Bild would have had nothing to write about Greece. The consequence of this would have been that various financial institutions in France, Germany, Britain and elsewhere would have had problems in 2010, but they would have had to have been dealt with by their own governments. Instead, the debt problems were laundered through the Greek treasury.

That is the source of all of these. There was nothing really wrong with the no-bailout clause. What was wrong was that they abandoned it.

I thank the witnesses for attending. We have had a very long term and the buckets and spades are in the back of the car. We did not need to be sent away in the mood they have induced. They have given a very baleful assessment - although being baleful is not a reason not to analyse it. However, the commentary amounts to an indictment of how the Union does its business today and secondarily an indictment of the creation of the euro project within that Union. How do we deal with this situation? It can be dealt with along the lines suggested by Deputy Boyd Barrett and one is likely to end up like St. Ruth at the Battle of Aughrim when he put up his head and got it shot off. So I do not think that is a solution.

That is what is happening now.

Maybe, but I do not think that is a solution.

Since the "Mercozy" creation, the Union has not been run in the way it used to be in the time of Jacques Delors and Roy Jenkins. The arrival of the French President Mr. Hollande has not changed that very much. That raises many questions and many people are concerned about whether the Union is becoming one for corporates rather than for people. None of that undermines anything that Deputy Barry has said about how Ireland was transformed by membership of the Union. However, that is an enormous question confronting us now.

On the flaws in the euro, we did not have bank resolution and we did not have supervision of the banks in the way we should have. We now have this. What other flaws do the witnesses see that can be rectified? Deputy Boyd Barrett asked a fair question: name any school of economics that believes that debt sustainability is the outcome in Greece. It is difficult to find any school of economics or credible economist who thinks that. The reason behind what Mr. Varoufakis alleges in his piece with regard to Spain, Portugal, Ireland, etc., is that those countries made a pragmatic assessment of what was feasible and cut their cloth to measure. The write-down was not going to happen in these discussions at the weekend. If that meant "Grexit", that meant "Grexit" as far as the German mindset was concerned.

Here we have this noble project that has achieved so much, but the practical politics of it at the moment is that, whether it is in the Bundestag or in the ECB, the German mindset is dominant. We politicians can rail against it all we like and economists can point out what the witnesses have pointed out here today, but what was likely to come out of last weekend's summit that would have addressed this situation in a way that was likely to lead Greece back to market access?

Professor Frank Barry

I have nothing to say on that, because that really is a question for the politicians. I am sure Mr. McCarthy will have more to say on that.

Mr. Colm McCarthy

Professor Barry would not accuse me of that.

Deputy Rabbitte raised a few issues about the original design of the eurozone. Banking union is critical. The critical flaw in the original design of the eurozone was the absence of banking union and that remains. Some people are writing about banking union in the past tense as if it was done and dusted. Until there is a Europe-wide system of bank resolution, probably some system of insurance for bank liabilities and a non-discretionary universally available lender of last resort function for the central bank, then we do not have a meaningful banking union and we do not have those things.

It is extraordinary that people can talk about banking union in the past tense as if it had already been achieved. We witnessed in recent weeks that the gunboat that was sent down the Aegean was not one that floats. It was the closure of the banks by the European Central Bank which decided not to act as a lender of last resort to the Greek banking system. That was the design flaw that really mattered.

A definition of a monetary union should be one in which the address of the headquarters of the bank does not matter and has no consequences for the solvency of that bank. I will give an example. In the United States, Delaware specialises in company secretarial business. Many people there do company registrations and all that. People think there are tax deals in Delaware that are better. That is not really true. However, many US corporations are headquartered in Delaware, including many banks. I believe that Lehman Brothers was headquartered in Delaware. Somebody noted that if Delaware had been a member of the eurozone rather than of the United States of America, when all these banks went bust the Governor of Delaware would have been asked to bail them out using the tax revenue of Delaware to do so. However, he was not asked to do so because the United States is a monetary union, there is no question about it.

The United States also has a no-bailout clause, which has applied to several cities in the US. Detroit went bust recently. The people who bought Detroit bonds are getting 50 cents on the dollar. That is after the substantial fiscal transfers built into the US system, so the US has a banking union and Europe still does not. That remains the big design flaw. It is the resolution of bust banks that is critical in all this.

Banks go bust in the United States every week. Every Friday officials from the Federal Reserve arrive to a bank and fire all the management, and the bank opens on Monday with the Federal Deposit Insurance Corporation taking care of the depositors. That is not how it worked in Greece because we do not really have a monetary union, just a common currency area.

The Deputy also asked the important question of what might have been done last weekend. What might have been done last weekend could have been done in 2010, namely to show the Greek political system some, even distant, sight of the winning post. One has to show the horse that there are just two furlongs to go and one might get there. That is why debt has to be written down. It is also why we need to avoid frontloading the austerity too much. It is not possible to wave a magic wand and say that there is no need to balance the budget ever. That is silly. However, one must be very careful about the phasing and timing of the fiscal consolidation measures, something that the IMF, in fairness to it, was always careful about in the programme here, as I am sure the Deputy is aware. However, sadly those things were not done and I am fearful that we will end up with another botched deal for Greece.

Professor Frank Barry

The reason I kicked this question to touch, as Mr. McCarthy has in essence done too, is that the Deputy would no doubt say that was politically not a feasible solution to expect out of the weekend.

That is the €64 billion question, a figure with which we are familiar in Ireland.

Professor Frank Barry

Is that all? A mere €64 billion?

I thank both Professor Barry and Mr. McCarthy for their interesting presentations on this matter, of which we will not see the end any time soon.

Mr. McCarthy said countries get into trouble because they are not run very well. The corollary of that is countries get out of trouble because they are run very well. I am sorry Deputy Richard Boyd Barrett is not present to hear that comment. From a politically partisan perspective, much has to be said about the way this country has been run since we entered into a bailout programme and managed to exit it successfully.

The point was made that Ireland was the second bailout experiment, the first being Greece. The difference was that when it came to our turn, we had an adequate amount of financial support. The IMF had similar concerns and was not happy with the percentage point on our debt but we managed to use the European financial stability facility, EFSF, money to lower the interest rate, did a deal on the promissory notes and so on. In effect, we reprofiled our debt. Ordinary people recognise that when one takes out a mortgage on a house, one is reprofiling one’s debt, banking on the mortgage going down over time as one’s income improves, a reasonable level of inflation which will improve the value of one’s income over the long term and the value of that asset increasing over time. I do not see anything particularly wrong with the idea of reprofiling debt, assuming - I do not want to sound like Margaret Thatcher - a country behaves a bit like a household. In other words, it manages itself properly as a successful economic entity.

At the time of the first Greek bailout, its debt-to-GDP ratio was 120%. How much less was Ireland’s?

Mr. Colm McCarthy

From memory, it was still below 100%. Of the €64 billion that went into the banks, some of that only emerged in 2011. At the end of 2010, Ireland’s debt ratio was well under 100%.

At the worst point, it was 119%.

Mr. Colm McCarthy

That was a year later.

Apart from Mr. McCarthy’s view that Greece did not get the haircut it should have got in the first bailout programme, it is still not clear to me how the situation in Greece failed to resolve itself more successfully. My understanding is that before the Syriza Government came to power, Greece had returned to positive growth but is now back in negative growth. There was light at the end of the tunnel.

There has been a lot of talk about Germany’s role in this. At a conference I attended recently in Europe, I noted it was other small European countries which were unhappy about bailing out the Greeks, like the Baltic states. A commentator from Latvia said the per capita income there was half that of Greece. The owners of Greek debt now are other European countries. Some of them are not particularly happy to be taking any further hits when their people earn half as much as Greek citizens. It is unfortunate this debate focuses entirely on Germany and not the other European countries which stand to take the hit.

I am not surprised at the stand the UK’s media is taking on this. One of the issues around Brexit and euroscepticism is the fact that Europe has become too obsessed with the euro project. That is one of Britain’s dissatisfactions with its engagement in Europe. The idea the euro experiment is falling into some kind of disrepute is happy days for some of the UK media.

There is dissatisfaction with Germany. Is there an honest broker who could do a better deal like, for the sake of argument, Matteo Renzi, and might be able to pull some of the more disparate voices together around a table? There have been two failed bailouts in Greece.

It looked as if Greece was coming out of the tunnel before the election of Syriza. Europe has come some way in protecting the euro and eurozone member states from the circling sharks waiting to see the next blood in the water. We have had the stress tests and have put money in place to protect against the next run on the euro. Mr. McCarthy made the point in an interview on why the ECB pulled liquidity out of the Greek banks. My proposition is that €2 billion was taken out of Greek banks in a short period. This was a run on the euro without the Greek Central Bank imposing, or indicating it was even willing to impose any capital controls. That surely made sense.

Mr. Colm McCarthy

First, it calls itself a monetary union. One of its declared objectives is the end of financial fragmentation in Europe. That was one of the trumpeted purposes of the EMU, the Economic and Monetary Union. One would need to have an economist’s sense of humour for this but the idea that capital controls are an instrument of economic policy and monetary union is absurd. That is a Heath Robinson monetary union. It is a bizarre idea.

Senator Hayden is correct that the Greek economy did seem to be recovering last year. It looked as if the budget deficit, as conventionally measured, was down to about 3% of GDP. The non-interest deficit was heading down towards zero or even a small primary surplus this year. However, there was a lot of political uncertainty in the last months of the Antonis Samaras government last year. Syriza then won the election. The election of alternative political parties that might be inexperienced and radical is what economists call endogenous. If one squeezes a country for five years with no-hope programmes, then one cannot predict who will win an election. Experienced people, including those in the IMF, take those matters into account and try to avoid programmes that fail for such a long period, precisely because one will get political instability as a consequence.

On the point about the small European countries such as Slovakia and Latvia-----

Finland was not too keen to sign up either.

Mr. Colm McCarthy

The Senator referred to poorer European countries so I thought she was-----

I was just adding to the mix. Let us take the case of the three Baltic states.

Mr. Colm McCarthy

The two states that have been most voluble are Slovakia and Latvia, but no matter. The Senator referred to them taking further hits on the money they have lent to Greece. What I and, I believe, Professor Barry were trying to say, and this is what it says in the Ladybird guide to financial rescues, is that the losses have already occurred. This business of believing that the losses are caused by the decision to recognise them is the source of many of the current difficulties. People lent money to the Greek Government as part of the official lending programmes and much of this money was used to pay off other creditors, which is the way these things go. At the end of the process, there was a very sharp contraction in the Greek economy and it is probably contracting again. Greek debt is retailing at interest rates of nearly 12.5% on the secondary market and the country cannot repay the money, which means the debt is not sustainable, as the International Monetary Fund concluded. This means that when the Prime Minister of Slovakia states his country does not want to give any more money to Greece, he is misunderstanding the point. He or his predecessors decided some years ago in effect to buy Greek government bonds, although they were not in that form but that is what it amounts to. These have since reduced in price, which is tough but these things happen.

Professor Frank Barry

May I make a brief comment on the reason Ireland recovered and Greece did not recover? Needless to say, there are major structural differences between the two economies, the most crucial of which is the export orientation of the Irish economy. As Mr. McCarthy indicated, we are highly dependent on sterling and the dollar. The decline in the value of the euro has been very beneficial to us. We have also been incredibly lucky in terms of the export sectors in which the economy is concentrated. This is not a matter of pure luck, however, as it is also the result of government policy and the policies pursued by public agencies over decades. Our goods exports are concentrated in pharmaceuticals. Indigenous industry exports are concentrated in food and agriculture and services exports are concentrated in computer and information technology services. It has been very beneficial to have an economy that is concentrated in all of these sectors.

Let us take pharmaceuticals as an example. As a sector, pharmaceuticals have increased as a share of overall eurozone, British and US imports. It has been extremely beneficial to us to have been in these sectors. Greece has such a different structure from Ireland that imposing austerity in Ireland has been necessary, one would say, because if we run out of money we have no option but to impose austerity. This has not been sufficient to explain the recovery, however. One cannot say that imposing equivalent austerity in Greece will have the same result because Ireland and Greece have completely different types of economy.

I do not doubt that. For example, Ireland has, for want of a better word, a well-established bureaucracy and a robust tax collection system.

Professor Frank Barry

That is correct.

As Professor Barry pointed out, Greece has a closed economy whereas the Irish economy is an open one, with 40% of exports going to a country, the United Kingdom, which is doing especially well. We are in a different position entirely from Greece.

I ask the witnesses to respond to my question on the moves that have been made towards banking union. Last year, only seven - the figure may be even lower at this point - of 129 European banks failed stress tests and we established a bank resolution mechanism which will be backfilled with funds to protect the banking system. I am personally committed to Europe and ensuring Greece continues to be a full member of the European Union and euro. Do the witnesses not agree, however, that the markets have factored in a Greek exit from the eurozone? The markets fell by approximately 2% at the start of the first day of the recent crisis and finished the same day even less than 2% down. Have we simply moved on and have the markets factored in the difficulty of Greece? Is it not the case that a Greek exit from the euro would not be the catastrophe Mr. McCarthy believes it would be?

Mr. Colm McCarthy

It would be a catastrophe because it would turn what had been billed as a durable monetary union into some kind of an ad hoc, quasi-fixed exchange rate regime, from which countries could be kicked out. That would have a very bad effect.

On the Senator's question about the completion of banking union, there are three components of a proper banking union. The first is centralised supervision of the banks, the second is centralised ex ante rules for the resolution of failed banks and the third is liability insurance for banks, in particular, for small retail deposits. All that has been achieved in Europe is the first of these components, namely, centralised supervision of, I believe, 123 listed banks. The European Banking Authority, which is an offshoot of the European Central Bank, did an asset quality review of these banks last year and this review was followed by stress tests and so forth. The Senator is correct that nearly all the banks passed the stress tests, including the Greek banks. What we have seen in recent weeks in this so-called banking union is the ECB refusing to act as lender of last resort in the face of a deposit run, thereby closing down four banks that it supervised and to which it gave a clean bill of health last year. These banks recapitalised themselves to the tune of €8.5 billion last year.

While it is very hard to make me feel sympathy for banks, I have sympathy for the four Greek banks because the lender of last resort ran away when it saw a deposit run against them. Central banks were invented in numerous countries in the last century and even later in the United States - I mean the 19th century. I apologise for repeatedly referring to the 19th century as the last century despite having 15 years to get used to the change. The reason for the creation of central banks was largely to create a public good, namely, the ability to stop depositor runs against banks that were solvent. The actions of the European Central Bank in recent weeks will feature in the textbooks in the years ahead because the ECB helped to accelerate a run against banks which it had deemed to be solvent and had supervised. It did so by pulling its liquidity support on 28 June last in what was an extraordinary sequence of events.

As for bank resolution, one of the reasons the Greek banks were not deemed to have been insolvent was that to have deemed them insolvent would have triggered their recapitalisation by the European Stability Mechanism and no one wanted to do that. Members will recall the famous proposal for retrospective recapitalisation of the Irish banks which was declined and did not take place. Klaus Regling and others stated this could not be done because the European Stability Mechanism was to fund future bank insolvencies and would not be used for retrospective recapitalisation. If it is now believed that the Greek banks are bust, ESM recapitalisation, if it is effective, should be triggered because the present is what was then the future.

It is simply not the case that a banking union has been agreed to, the reason being that several member states do not want a banking union. What has been undertaken is centralised supervision. Supervision has never prevented bank busts, however. For example, there were big bank busts recently in the United Kingdom, which has had national bank supervision in place for a couple of hundred years and still does not seem to have got the hang of it. There will always be bank busts because banks are fragile institutions. Centralised supervision is an improvement, particularly in countries which are bad at doing supervision, as Ireland was, but it is nuts to believe that supervision will prevent future bank busts.

What would prevent them from creating mayhem is a properly funded bank resolution system and a properly funded deposit insurance system for retail customers of banks who have been queueing outside banks in Greece for the past six months. We do not have those things. They have not moved to a banking union; they have made some steps in that direction, but it is not complete.

Mr. McCarthy has made some interesting comments. Does he accept that the Irish bailout programme has worked for any number of reasons and not because of austerity?

I refer to Mr. McCarthy's interesting point about Greece. He has said that when people see no light at the end of the tunnel, they will eventually vote for a more radical solution. We are talking about the politics of the crisis. He makes the point that the Greek people had lost confidence in their own institutions as much as anything else and that Syriza was, in effect, the plan B about which Deputy Richard Boyd Barrett talked. They were looking for a more radical solution, which seems to have failed miserably, in so far as they are concerned.

Mr. McCarthy has referred to our interest payments and profiling the money we borrowed. We seem to fail to explain that most of the money we have borrowed - a 120% debt-to-GDP ratio - was borrowed to maintain public services; it was not borrowed to manage the banks and it was not a bank bailout. Profiling means repayments are pushed to be made in the future when it will almost not matter and the repayments are to cover the interest, which is the big one. For example, we are paying 3.1% of GDP in interest payments. If I remember correctly, at the beginning of the year Greece's repayments were something like 3.4% or 3.5% of GDP. The profile of repayments being made by Greece was not far off ours and many of the measures it has taken such as reducing budget deficits are similar to what we did, yet the level of expenditure on pensions in Greece is still at 17.5% of GDP versus 12% in our case. Considering the state of the Greek economy at the beginning of the year, it could have worked through it over a couple of years in the same way as we did, yet the Greek people chose a solution that has landed them in an incredible disaster zone. Does responsibility lie with the Greek institutions or the Greece people? There is an element of delinquency or a refusal to accept that they were living beyond their means. I am only saying this because much of the conversation this afternoon has focused on the criticisms of the institutions in Europe and individual countries. Like Senator Aideen Hayden, in travelling around Europe I have not noted huge sympathy for the Greeks because many countries have endured their own cutbacks and changes in how they manage their public services, just as we have. The picture Mr. McCarthy paints, in which the Greeks have made huge sacrifices, has not been painted very well outside Greece. The commentary on the situation in Greece is still very poor and even the Greeks did not help with some of the comments being made by Syriza since it was elected.

Mr. Colm McCarthy

The picture being painted of the situation in Greece is not entirely factual. On the pensions system, the Chairman is correct that the percentage of overall public spending on pensions is very high, but it has a very poor unemployment insurance system. For example, many public officials were let go. It is not true that the Greek Government did nothing post-2010. It had a very bloated public service-----

They have taken people back.

Mr. Colm McCarthy

Very few have been taken back since, but I agree that some have been taken back. However, instead of being put on the dole, many were included in the pensions system. Therefore, the Greek pensions system provides for a lot of the income distribution which in other European countries is provided for by routine social expenditure. These cross-national comparisons of public expenditure ratios are very treacherous, unless one knows the details of what each country does.

On the broader question, one must be clear on what was the objective in Ireland when the so-called bailout began at the end of 2010. The Government was two years into a fiscal consolidation programme at the time. That programme started in July 2008 before the bank bust. The then Government made a series of expenditure reductions in the middle of the year. There was an emergency budget in October 2008, another budget in the spring of 2009, followed by another in the autumn of that year. During all this time the Government was able to borrow. We were not driven out of the bond markets because our initial public debt was very low. We also had a bunch of international equities held in the National Pensions Reserve Fund which was not a pension fund but rather a kind of hedge fund. It included short bonds and long equities, which sounds like a hedge fund to me. When push came to shove, these assets could be flogged, which we did and the markets knew that we could flog them. The full extent of the losses in the banking system was not realised. It came to be realised a little more through 2010. Therefore, the objective position on the public finances was completely different.

The Greeks were bust in March or April 2010 the Greek public finances were shot, whereas ours were not. When we eventually had to have a programme, it was in the context of another run on the banks here. People will remember the famous radio interview given by the Governor of the Central Bank, which, it was believed, impelled the Government into a rescue package. He was conscious that there was a run on the banks and that it would accelerate and he believed there was nothing else he could have done. However, the circumstances were completely different. As Professor Barry outlined, the negative impact, the deflationary impact of the tax increases and expenditure cuts on aggregate demand here, was much less than in Greece because of the openness of the economy and the broader export base. We were also lucky that our big trading partners were Britain and the United States which were not doing great, but they were doing less badly than many continental European countries. Therefore, we had a little luck, which is not to say our programme had been perfectly designed or executed. The IMF will also stress that the Irish programme was owned by the Irish authorities, that the Irish authorities had embarked on a medium-term programme which involved austerity and cuts in spending and increases in taxes. However, they embarked on it and had authored it. The programme in Greece was imposed and there was little or no ownership of it there.

The IMF is very big on the question of ownership; if there has to be a difficult macroeconomic adjustment, one must show people the exit and persuade them that it will only last for a few years, that everything necessary will be done, including haircuts for creditors, that the people will have a reasonable chance of getting out inside three years and that those concerned can design the programme. Both rules were broken in Greece.

If the Greek interest payments were at the same percentage of GDP as ours-----

Mr. Colm McCarthy

Is the Chairman saying the Greek debt should, therefore, be sustainable?

At least it should be sustainable in the short term in order that they can work through-----

Mr. Colm McCarthy

If one believes that, one can buy Greek bonds at 50 cent to the dollar. Ten-year bonds yield a figure of 12.5% - roll up and buy.

When we started our programme, we had to negotiate and then renegotiate. Greece went to plan B.

Mr. Colm McCarthy

In a sense, I almost do not care too much about this issue, as one could argue forever about the Greek negotiating strategy. I refer not only to the current Greek Government but also to earlier ones. At a famous meeting with Ms Merkel and Mr. Sarkozy in Cannes, a former Greek Prime Minister, Mr. George Papandreou, suggested the holding of a referendum and was shuffled out of office. His government was replaced with a technocratic one. Although one could argue that the Greeks have not handled their negotiations and diplomacy with their European partners very well since the very beginning, the official lenders really ought to have a soul above this and say that since they are dealing with a small European country that does not have enormous policy-making resources, allowances have to be made instead of complaining about poor diplomacy.

The eurozone is built such that there are major productivity differences between countries at the periphery and the core. Money is obviously generated by those at the core. As those at the core need somewhere to deliver the money, credit is created to be accessed by those at the periphery. The inherent imbalance within the system will repeat itself because, as Mr. McCarthy stated, the eurozone does not have the transfer mechanism that is available in an actual currency union such as the United States.

Mr. Colm McCarthy

It is not impossible to design a monetary union that would be durable and include regions with very different levels of economic development. The Deputy did not say it, but he is hinting that a monetary union will work only if each component is comparable in terms of productivity, living standards, etc. That is not really true. The United States is an example. There are states in the union in which real incomes are half those in the better off states. Italy was a monetary union using the lira until 1999, but real living standards in Lombardy were two and half or three times what they were in the south. That is probably still true. That there are considerable differences in living standards is, therefore, not the point. Whether monetary union is a smart idea is a different issue. It will be durable, however, provided there is full banking union and a proper central bank that acts as a lender of last resort.

It could also be a question of the transfer mechanism whereby funds could be transferred to those regions over time. The United States has such a mechanism. Politically, that is not attractive to Germany.

Mr. Colm McCarthy

One should not forget a lot of public expenditure in the United States is through state and municipal budgets. The amount transferred through the federal budget in the United States is less than is typically transferred in this part of the world. If we had separate statistics for the various counties of Ireland, we would discover Dublin has a very large budget surplus and that most of the rural counties, especially in the west, have large deficits. Technically, it is feasible to have a durable monetary union including geographical regions with very different levels of economic development. Whether it is politically a good idea is another story. There are examples in history. The Soviet Union was an example, as was the rouble zone. They can have high or low levels of transfers. The technical problem with the design of the eurozone is that it is not a banking union.

Let me give the Deputy another graphic example. The state of California nearly went bust three or four years ago. It ended up paying people with bits of paper, IOUs, because the budget deficit of the state was enormous. However, nobody started withdrawing bank deposits from bank branches in California because there was no link between the solvency of banks in the state and the public finances of the state. In other words, the United States is a monetary union with full banking union. What we have seen in Greece, again in the past few weeks, has illuminated some of the original design flaws in the eurozone. People started hefting money out of Greek banks for fear of redenomination risk and what had happened in Cyprus where bank accounts had been frozen. What is now happening in Greece is extraordinary. People cannot pay bills to Greek people across the road. It is not that they cannot transfer the money out of the country into dollars or to Switzerland, for example. A businessman in Athens who owes money to a firm in Thessaloníki cannot pay that firm even if he has the cash. All of the newspapers have been on about pensioners trying to withdraw €50 per day from the ATM. The SME sector is typically cash positive in the banking system, contrary to what one would expect based on reading the newspapers. The transactions balances are immobilised. That does not suggest a monetary union. It cannot happen in the United States; there would be no chance of it happening.

On behalf of the committee, I thank Mr. McCarthy and Professor Barry for participating. The meeting went on for a little longer than I had expected, but it was very interesting.

The joint committee adjourned sine die.
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