Your Word Is Your Bond… Right?
Well, the phrase works the other way around, too. Your Treasury bond is your word.
To break this word makes you a liar.
This is the context behind the talk of haircuts relating to the government debt in countries like Ireland.
When Germany began raising a lot of noise over the issue of giving haircuts to bond investors of EU government debts, albeit starting in 2013, the bond market had a simple reaction: call Germany’s bluff by jacking up the rates at which Ireland, Portugal and Spain etc. would have to borrow at to get any money from the markets at all. Ireland stopped buying bonds and received the avalanche of pressure described in my previous post here to accept a bailout it did not want, and did not yet need, for the benefit of Germany and France’s ambitions for greater central control of the finances of “weak” governments that had not properly controlled their banking industries.
More than other governments, Ireland made austerity cuts before it had to, made an aggressive rather than conservative estimate of what it was on the hook for when it backed all the deposits and debts of the banks (a point of contention), and made cuts that were very deep indeed. However, there is one thing that it did not touch.
Ireland did not raise corporate tax rates.
For this, it is the vile and despicable enemy of all good Europeans.
Unfortunately, that is not really much of an exaggeration.
…in at a NATO meeting in Lisbon, President Nicolas Sarkozy of France said he could not imagine that Ireland wouldn’t choose to raise its corporate tax rate.
Hint. Very subtle hint.
Mr Strauss-Kahn’s call to centralise power in Europe is significant because the IMF will contribute a large portion of the Irish rescue. In a speech in Frankfurt, he said: “The wheels of co-operation move too slowly. The centre must seize the initiative in all areas key to reaching the common destiny of the union, especially in financial, economic and social policy. Countries must be willing to cede more authority to the centre.
Very subtle indeed.
Incidentally, the center would be France and Germany.
I think a few Irish were concerned about this potentiality when they opposed approval of the Lisbon treaty for a tighter European Union. Well, this just goes to show that little things like democracy won’t be permitted to stop progress.
Breaking Your Bonds
So, in this context, many Irish opposition party members and members of the public at large are saying that the government should simply uphold deposits while renouncing all debts and bonds and inflicting haircuts – loss of principal owed on bonds – upon international investors.
Bonds are upheld by the full faith and credit of the treasury that issues them. When you break them, this happens:
- No more faith
- No more credit
This is precisely what would await Ireland. No one would want to lend it money for any purpose, for years, if it breaks its word and its bond and renounces debt like this.
A further consequence – the one that the European Union is seeking to avoid – is spreading contagion to banks in the U.K., Germany, and other parts of the European Union, to say nothing of panic in the bond markets once it becomes clear that Greece, Portugal, Spain, and possibly Italy, may move towards similar measures. As banks themselves own a lot of the bonds in question, once having viewed selling debt to needy/ greedy government treasury departments as a profitable business, the write-downs would inflict severe damage on these banks and bring a banking system meltdown – or a massive German bailout that would dwarf the size of the money being talked about for Ireland – closer to reality.
A Crisis That Didn’t Have To Be (Now)
Ultimately, it’s Germany’s government that provoked the timing of this crisis by talking about haircuts. Irish opposition seeking to make political hay of this and try to take political office on a platform of flattening international investors – and banks – are on the bandwagon too. But, without the talk about haircuts by Germany’s sitting government, the bond markets would not have moved like this.
Apparently, this is a good time for a crisis and someone wanted to make sure that the markets got shaken up now rather than later.
Thanks to this crisis, Ireland can be shoehorned into a tighter union against its will, with incredible pressure placed upon it to make the one concession it is fighting tooth and nail against.
A Strange Kind Of Tax Raid
That is, to raise its corporate tax rates.
Now, I can see why politicians from France and Germany are gleeful at the prospect of beating Ireland with a stick until it raises those rates. Those rates are the primary, and perhaps sole, reason why American companies are in Ireland rather than in other parts of Europe or other parts of the world. Indeed, the extremely intense pressure is already sparking warnings by major American firms that they will not willingly bear the brunt of such tax hikes.
Now, the Irish are on board, but the EU, the IMF, and the individual holders of the bailout purse strings, are not on board with this at all. Many people would like nothing more than to inflict this ultimate punishment and humiliation on Ireland for presuming to dare to be a tax haven within the Eurozone, seeing Ireland’s overheated real estate bubble and its subsequent bust as just desserts, well and fully deserved. Thus, every effort must be made to make a public example of Ireland.
However, there is a deeper consequence to this whole effort, and not just as far as American corporations are concerned. It’s something deeper, something less tangible, but something far more important in the end.
Your Word Is Your Reputation
Ultimately, it comes down to trust.
If you are not worthy of trust, then the only financial relationships you can enter in are with thieves and gamblers, people betting that you won’t collapse before they can squeeze the last possible dime out of you and fleeing before you inflict your damage on others by collapsing.
In tangible terms, this means being locked out of the bond markets for years.
Generally, a bailout sets up some kind of contingency fund to guarantee that a country can go completely without market borrowing for some time, intending to calm the markets so that the contingency fund never needs to be tapped, but the numbers have to be quite extreme to convince markets that er, you don’t need them anymore. And if you don’t need them anymore, why are you bothering with them to begin with?
But a haircut is on a different level altogether. A haircut makes a liar out of your government, your flag, your people. A haircut means you are literally cheating investors out of what you owe them in a legally binding contract. A haircut means you have chosen your convenience over your reputation, preferring to go without credit, and without respect, for the sake of avoiding new unpleasant choices.
That doesn’t mean that there aren’t situations where it has to be done, or simply ought to be done.
In general, though, and I think in this specific situation as well, there is a simple rule that can be followed that puts things in the proper perspective.
Last resorts should come last.
But this is simply my opinion.