IRELAND WILL WIN THIS GAME OF BLUFF / THE WALL STREET JOURNAL ( VERY HIGHLY RECOMMENDED READING )

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NOVEMBER 17, 2010, 7:58 A.M. ET.

Ireland Will Win This Game of Bluff .

By SIMON NIXON

The Irish are a nation of gamblers. The country may be struggling with the burden of a huge government deficit, soaring borrowing costs and a deeply damaged banking system, but it would be dangerous to bet against Dublin winning its high-stakes game of poker with the European Union over a possible bailout.


Ireland's aim is to secure a deal on the most favorable terms, including crucially the retention of its ultralow corporate-tax rate, a potent symbol of economic sovereignty that the minority Fianna Fail government is determined to protect at all costs ahead of next year's likely elections.


Dublin still has the strongest hand. The first thing in its favor is that no one can force it to accept a bailout; Ireland has to ask the European Union for help. And given the Irish government is fully funded until the middle of next year, it can in theory drag this situation out for months. If it did that, of course, contagion would likely spread quickly across the euro zone, as Tuesday's stock and bond selloffs showed, threatening the survival of the common currency. In that sense, Ireland is armed with a nuclear weapon.


In response, the EU is armed only with bows and arrows. There is very little it can do to force Dublin to seek an early bailout. The one pressure point is Ireland's banks, now only able to survive thanks to European Central Bank funding. But so long as the banks are still able to post eligible collateral, the ECB has little option but to continue accepting it, even though its lending to Ireland now totals €130 billion, equivalent to 80% of Irish GDP, much of it in the form of Irish domestic mortgage-backed securities specifically created to meet the criteria for the ECB's lending facilities. If the ECB were to impose an arbitrary limit on Irish borrowing, it could spark panic across the euro zone.


This game is due to be played out over the rest of this week with European Union and International Monetary Fund officials descending on Dublin to thrash out a deal. Ireland has signaled it is willing to consider a deal to recapitalize its banks, allowing them to borrow again in private markets. Optically, that suits the Irish because it enables them to claim the sovereign itself remains solvent and so shouldn't be subject to any external fiscal oversight that might put its tax arrangements at risk. Legally and practically, this argument is nonsense since any bailout needs to be channeled via the sovereign, giving the lenders the right to impose any conditions they wish.


That may point to an extended standoff between Ireland and the rest of the EU. If so, this crisis would be simply following the path of every other period of stress over the past three years both in Europe and elsewhere. But eventually the market will succeed in pressuring policy makers into the response it is seeking.


In this case, the market wants Germany and the other leading European economies to agree a quick deal to assist Ireland and, if necessary, Portugal, and it wants reassurance of what will happen to the bonds of bailed-out countries after 2013. In this scenario, Ireland can afford simply to stand firm and wait for Germany inevitably to fold.


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