The Irish Financial Crisis Becomes a Political Crisis

http://www.nytimes.com/2010/11/23/world/europe/23ireland.html?_r=1

This has been an ongoing concern of mine for most of the European debt crisis. First, universal austerity simply does not work as a strategy for dealing with massive debt levels as its deflationary influence essentially digs the hole deeper as you are trying to get out. Secondly, it's politically damaging considering that it will coincide with a severe economic crisis. Ireland is in the midst of what can only be described as a depression and that will not correct anytime soon. In fact, it will get much much worse considering the magnitude of their fiscal contraction. The incumbent government will lose the next national election considering that the prime minister has a whopping 11% approval rating from the last poll I saw. Frankly, they should lose given that they have been in power for the boom and now the collapse.

This really is an issue where many Irish sense that their nationally sovereignty is at risk in these bailout agreements. At the same time, they really don't have a choice, but then again neither does Europe. The EU cannot allow Ireland and its banks to fail due to the collateral damage. It will be interesting if Ireland decides to take the approach that they will limit what austerity measures they put in place because they realize their importance to European financial stability. In the long run, Ireland's economic situation will get so bad that it risks severe political instability of the sort that we haven't seen in a while in most developed countries. They already have a 14.1% unemployment rate and that will not get better with the austerity measures being proposed.

As far as the EU's approach on all of this, I am doubtful of its long term viability. Basically, Germany and France are on the verge of backstopping Greece, Ireland, and then Portugal and Spain. If and when Spain becomes part of the mix, I really don't know that they are good for the money. At the same time, they are pursuing deeply deflationary policies which pose a particular problem in the context of a deflating asset bubble. The deflating real estate prices in Ireland, the UK and Spain are one of the major causes of the ongoing banking problems and austerity will only contribute to further deflation of those prices. As this pain continues, it will be difficult for governments to maintain policies of retrenchment.

Frankly, there is a serious risk that Europe is entering a deflationary spiral of a fairly severe magnitude, which will invariably lead to continued political instability.