Sheer determination is neither sufficient nor necessary to make a great nation

(This is a post that I wrote about a month ago but did not have to post.  I have added a news article that confirms my predictions.)

Many great nations of the world today and in the past (not necessarily big nations) seem to share a common characteristic: sheer determinations (for example, the determination to succeed against all odds and the determination to endure in the face of great sacrifice).  Many aspiring nations thus try to instill this seemingly intuitive concept in their population.  However, I want to argue that sheer determinations in fact are neither sufficient nor necessary for a great nation.  On contrary, when combined with wrong policies, they could lead to a tragic end.  For example, the great experiment of communism failed not due to a lack of sheer determinations.  It was executed and implemented with sheer determination paralleled only by religious zeal.  However, this utopia was unable to produce workable policies, which lead to not only its own failure, but also extreme human catastrophes and sufferings. 

Today I fear that nations such as Ireland or Spain are making the same mistake.  Their mistakes are so similar that understanding the correct solutions to their problems would have profound implications to large, and particularly small nations in the Western world. 

Take Ireland as the example.  With the determination to succeed, the Celtic tiger achieved tremendous growth in the last couple of decades.  However, this growth also induces a huge property bubble.  With the bubble collapsing through the Great Financial Crisis in 2008, Ireland made two mistakes that are being repeated by almost every developed nation, large or small, in the world. 

First, Ireland bailed out the stakeholders in Irish banks and put all the liabilities on the public balance sheet.  Since Irish bank's liabilities are very large in comparison to Irish government balance sheet, this approach puts tremendous burden on the Irish people.  This burden is the root cause of the extreme austerity practiced by Irish government today.  At the same time, since this approach does not completely unclog the financial system, the wobbly Irish financial institutions are still reluctant to provide sufficient funding to the Irish economy.  This movie is being played in most Western nations today. 

Second, as if Irish people have not suffered enough in the last few centuries, the Irish people not only needs to repay the debt that went sour but also suffer severe cuts in their welfare.  The Irish government, and many wrong-headed policy advisors, have so far cast a cursing spell on the Irish people by successfully arguing that the sheer determination to endure in the face of great suffering is sufficient and necessary to solve the problems and that growth can result from severe cuts of government budget in the face of a quasi depression.

Both approaches are completely mistakes.  In the first situation, the correct approach should have been wiping out the shareholders, forcing bondholders to take a big haircut and to convert their remaining stakes into equities, and inject government funds as debt (and equities if necessary) in the failed financial institutions.  The reformed financial institutions could easily raise further equity and debt financing on the public markets given their clean balance sheets.  These institutions would also be willing to lend for the same reason.  I have suggested this approach since the fall of 2008. 

After Ireland committed missteps in the first situation, the correct approach for a small nation like Ireland would be to replace Euro with Irish pounds and devalue its currency substantially in the process.  Ireland suffers from a loss of competitiveness problem from the collapsing property bubble.  Its problem could be solved through either internal deflation or currency devaluation.  Since it shares Euro, currency devaluation is currently not available.  Internal deflation is much more painful and does not guarantee success.  In the recent years, as Ireland cuts benefits and services, the magnitude of GDP shrinks, due to the cuts directly and the increased saving by the population as a response to the cuts.  The double-digit fall in GDP actually leads to an increase in total debt to GDP ratio (due to the sharp fall in GDP) and the credit spread between Irish government bonds and German Bunds (the benchmark risk free securities in Europe).  See this new article here:

http://online.wsj.com/article/SB10001424052748704029304575526190591102772.html?mod=WSJ_hps_MIDDLEThirdNews

The sheer determination to endure in the face of great suffering is not sufficient to solve the problem of a small nation like Ireland.  In fact, it is not sufficient for big nations like the U.S. for the same reason. 

Since Ireland is a small nation (its GDP is less than 5% of the European GDP), the sheer determination to endure in the face of great suffering is not even necessary to solve Ireland's problem.  Instead, if Ireland replaces Euro with Irish pound, and devalues its currency substantially in this process, the export-driven growth would be able to pull Ireland out of the current slump, just as in any similar crisis in the past, especially for emerging markets.  The smaller Western nations in deep slumps should understand that the sheer determination to endure in the face of great suffering is neither necessary nor sufficient to solve their current problem.  Adopting the current approach would help solve their problem sooner.  (Unfortunately, the second solution will not apply to large nations).