There is reason to be concerned about Ireland and it's all due to the health of their banking system. One cannot overemphasize the importance of a sound financial system and the overall health of an economy. The banking system is like an engine in a car. If it breaks down, the car will go nowhere. Even though these developments are occurring across the ocean, they can certainly be a rippling effect to the U.S. due to their direct and indirect financial interests. As for the latest development in the potential Irish banking crisis, November 17th, 2010 Economist article highlights those concerns.
As background, it should be noted that most of Europe uses the Euro as their main currency, which is both advantageous and disadvantageous. The Euro is a single currency that comprises of many European nations. Usually, countries individually run their money supply, but this is not the case in Europe. While the benefits of a single currency faciliates more monetary stability and freer trade, its main downside is that it provide less flexibility to poorer countries. Usually, countries can adjust their monetary policy by devaluing their currency to deal with rising deficits and counterbalancing large trade deficits. However, struggling European countries like Ireland, Portugal, and Greece are not able to do that because their money supply is tied to the Euro. As of right now, European Central Bank is opting to not lower the value of the Euro which is compounding the problem.
The main concern is how Ireland's banking system will impact the Euro. All indications point to Europe stepping in to save the Irish banking system from collapsing. If the Irish banking system collapses, then the financial interests of other European countries will be negatively impacted. Then there's the concern if this will have a ripple effect on other low performing countries, such as Portugal and Greece. Foreign investors will be spooked by this development and would probably resort to taking their funds out of Europe and investing them elsewhere.
Many Irish and European officials are correct to say that there are differences between the problems experienced by Ireland compared to situations in Portugal and Greece. First, Ireland has shown more political will in addressing their budget deficit than either of the Southern European countries. As for their competitiveness, you can see that the Irish's economic fundamentals are superior to both Portugal and Greece. While Ireland's current economic growth is lower than both, it should be noted that their living standards as measured by per capita growth and unemployment rates are much better. This can be attributed to their superior economic freedom scores that measure a country's productivity, fiscal management systems, and business-friendly environment.
Overall, it will be politically difficult for Europe to bailout Ireland. There is already uneasiness and frustration from mainly Northern European counterparts that are resentful of having to use taxpayer dollars to rescue countries that have not adequately managed their fiscal and banking risks. When talking about a potential bailout of $68 billion to $117 billion, that will mean that more austerity practices will have to take place throughout Europe or risk facing higher deficits. Either scenario can dampen economic prospects in the future.
As Americans, we should closely monitor developments in Europe. Obama has stated that he is committed to increasing U.S. exports, which create jobs. However, that goal will be compromised if European economic prospects continue to diminish. Lower wealth from Europe will mean less money to spend on U.S. goods. One should not be surprised if the U.S. plays a large role through the International Monetary System in helping stabilize Europe because our economic fortunes are tied to their success.
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