The deal signed last Friday is the beginning of the end of Europe as we know it. The shift is on from a family of nations, with checks and balances, to a German Europe where diktat triumphs over dialogue, and the interest of the strongest wipes the floor with the concerns of the weakest. Luckily for us, the deal looks unlikely to work because they haven’t been able to come up with enough money to prevent another bond crisis early next year, as more than €1 trillion of bonds in the eurozone come up for refinancing.

But we should take a long look at this deal to see whether this is a place we want to be. Make no mistake, the EU is now a very different beast and, when this deal fails, something more extreme will take its place. So what might the new Europe look like?

It looks like Germany.

This is a place where, if you don’t like something, you declare it illegal. Last Friday, Germany said it didn’t like the business cycle, which is as natural as night following day, so they made it illegal. I don’t like heart disease, but it won’t go away if I declare it illegal.

Similarly, you won’t get rid of the business cycle by saying it doesn’t exist. The world doesn’t work like that. Let’s have a look at the world as it is in Ireland, rather than how the people in Brussels might like it to be.

Ireland, unlike any other European country, is suffering from a severe balance sheet recession. This is not a normal recession. A balance sheet recession means that the nation’s balance sheet is broken because, on one side of the balance sheet, there are houses and land bought in the boom and these are falling in value. On the other side of the balance sheet is too much debt, which is rising in cost as interest-only loans ratchet up to full repayment. And the income or the take-home wage of people is falling as taxes rise and the cost of servicing the debt (in terms of how many hours you now have to work to service the debt you took out in the boom) is rising.

In a situation like this, people do not spend, they save initially and then they dip into their savings to survive as their income falls. We have seen this development in Ireland. From 2007 to 2010 the savings rate rose rapidly as a terrified population retrenched. Now we are seeing a modest fall in savings, yet we are not seeing an increase in retail sales, so what is happening? People are dipping into their savings to pay the gas bill.

If the people are saving and no one is spending, how do you maintain even modest activity in the economy? Someone has to spend. If the government doesn’t spend, who will? The huge current government deficit is a reflection of the government spending to replace the money that has been taken out of the economy, as people are saving because they are scared.

This is called “counter-cyclical fiscal policy” in economics and it is the basis of modern economics. It is just what happens when people stop spending – the state steps in. If the state steps out now, people don’t simply spend again to replace the state.

That is why contractionary fiscal policy is called contractionary, because the economy contracts when the state cuts spending and increases taxes. We all know that a state can’t keep spending indefinitely, but when no one else is, the economy would just collapse if the state didn’t take up the flak. That is why the deficit is high. It is an automatic reaction.

This is what Germany wants to make illegal. It wants to make illegal an economic phenomenon which we have seen in every country over decades. This is a German fiscal union. It penalises rather than helps countries in trouble when they most need help. Now contrast this with an American fiscal union.

Our cousins in Boston had a mad property boom in the late 1980s; then, like the Irish boom, it crashed. Automatically, the unemployed Bostonians paid less tax to the American government and received more federal transfers. That is how a fiscal union works. In good times, boom regions pay more and in bad times they receive more. This smoothes the business cycle, and the depressed region has a chance to recover.

If Boston and Massachusetts had been in a German-style fiscal union, it would have been punished, not helped, and its post-boom depression would have gone on for years, rather than the quick recovery, which it experienced because the rest of America helped it out.

Without this aid, how do we tide ourselves over periods when we are trying to rebuild our balance sheets, which can only be done through debt repudiation or economic growth? What we have signed up to says that there will be no debt forgiveness, so we can only rebuild balance sheets through rapid economic growth. But where will that growth come from?
The government and Germany say it will come from a positive balance of trade because we will export our way out of this. Ok, let’s see if this is feasible.

The balance of trade of an economy is nothing more than a reflection of the balance of savings in the economy. If the punters are saving, then the government will have to spend to offset this saving, otherwise the economy will contract.

The only other way to maintain demand is if we can persuade foreigners to buy stuff from Ireland in huge quantities. But why would they buy stuff in Ireland that they can get at home?

According to our financial plan, we are going to bring the government deficit down from 14 per cent of GDP to 3 per cent in three years. So where will that missing 11 per cent of GDP come from? If government spending isn’t replaced, the economy has to shrink by the same amount – unless, of course, the trade surplus can increase dramatically, which would mean that our savings and government savings were offset by the purchase of Irish goods by foreigners.

But the simple back-of-the-envelope calculations would mean that, for
the economy to stay stable, the trade surplus would have to increase by at least 11 per cent of GDP from here.

The trade surplus today is €2.8 billion. But, given that our GDP is about €170 billion, our trade surplus would have to move sharply from €2.8 billion to €21.5 billion in the next three years to keep the economy stable.

Our main export markets are the US and Britain, followed by the EU. Whatever happens in the US and Britain, we know that the Germans have the rest of Europe signed up to austerity and we know that austerity makes the economy contract. Europe is already in a recession now and austerity will make it worse, so who will buy the extra €20 billion of Irish goods?

This deal is bad for Ireland. It is also bad for Europe because it turns the EU from a family of nations into a German protectorate, I’m not too sure I’d vote for that. Would you? But then again, I mightn’t be asked.

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