Reprinted from: Barron’s
By, Randall W. Forsyth
While global markets rallied Monday on growing chances for a solution for America’s fiscal dilemma, the sad reality about Europe’s even more intractable crisis intruded after Wall Street closed when Moody’s Investors Service stripped France of its triple-A rating.
M oreover, observes BCA’s Global Investment Strategy, Ireland has begun to recover without resorting to the usual expedient, a devaluation of its currency. As a member of the euro zone, Ireland could not alter its exchange rate to boost exports. Instead, Eire had to effect an internal devaluation — a lowering of prices and wages in order to make its economy more competitive in the global sphere.
As BCA points out, in the early years of the single currency last decade, Southern European nations and Ireland saw their labor costs rise sharply while the European Central Bank followed an easy policy while Germany, the largest EU economy, struggled. The result was a boom in money flows to the periphery, especially Ireland, sparking a wild real-estate boom, and an inevitable bust.
Subsequently, labor costs were brought down in Ireland in a massive deflation that resulted in a 20% plunge in nominal gross domestic product between 2008 and 2011. Unit labor costs fell a massive 10% — while they rose 5.5% in Italy and 3% in Greece. Bottom line: Ireland slashed wages and prices to become competitive. Now, as a result, Ireland is recovering while the rest of Europe is mired in depression and massive unemployment.
This contrast hasn’t gone unnoticed in financial markets. Dan Fuss, the vice chairman and portfolio manager of Loomis Sayles, one of the canniest fixed-income managers around and a speaker at Barron’s Art of Successful Investing conference last month, was an early bull on Ireland’s turnaround and loaded up on Irish bonds. Similarly, Franklin Templeton’s Michael Hasenstab, who recently was a subject of a Barron’s magazine interview (“Vindication for a Contrary Vision,” Oct. 22), was reported by the Financial Times to have an €8.4 billion ($10.75 billion) in Irish debt, which has yielded huge gains as the benchmark Irish bond due 2020 has seen its yield plunge this year to 4.80% from 8.40%.
The difference between Ireland and the other so-called PIIGS is a much more flexible labor force and significantly lower tax rates than the rest of Europe, according to BCA. “The Irish experience suggests that while fiscal austerity is important , euro zone troubled economies may be well served to focus their policies on labor market flexibility and the corporate tax system,” the advisory writes.