Betting On the Emerald Isle

 | Oct 24, 2011 | 12:00 PM EDT
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The next time you want to win a bet with your favorite investment guru, ask which two economies are the fastest growing economies in Europe. The answer will likely surprise you.

One of them is Ireland, which is an original member of Europe's PIIGS: Portugal, Italy, Ireland, Greece and Spain. The other is tiny Estonia. Both countries offer textbook cases of austerity, and why short-term pain just may be worth the long-term gain.

The medicine Ireland has taken is bitter. Its government's austerity plans are a combination of tax increases and spending cuts worth 30 billion euros ($41 billion) -- or 20% of a single year's GDP, imposed between now and 2014. That's the equivalent of about $3 trillion in cuts in the U.S. over the next three years.

But after standing on the precipice of economic collapse, the Irish economy has now increased for two consecutive quarters, which makes it the second fastest growing economy in the European Union (EU). Labor costs have plummeted and its current account swung back into surplus last year. It's true that the government's budget deficit will hit 10% this year. But that's a big drop from last year's 32%.

Savvy investors have taken note. Even as global financial markets endured stomach churning falls in August and September, yields on Irish debt plummeted from 14.2% at the end of July to just 7.5% by the beginning of October. That made Irish debt one of the best performing assets on the planet over the last six months.

With the Irish stubbornly sticking to their 12.5% corporate tax rates, the key to Ireland's rebound has been the return of foreign investment. Back in the glory days, the "Celtic Tiger" attracted massive amounts of foreign investment, as it was the EU's beachhead for high tech companies ranging from Apple (AAPL) to Dell (DELL). Dell moved on to Poland, but Twitter has come to replace it.

What's less known is that the Irish have emulated the route taken by the even tinier Baltic states -- Estonia, Latvia and Lithuania. By linking their currencies to the euro (Estonia joined the euro just this past year), the Baltics were in the same situation as the PIIGS are in now. They had to restore their competitiveness by reducing wages and prices. Austerity bit hard. Public-sector wages were cut by an average of 28%. Estonia's economy contracted by 13.9% and Latvia's by even more painful 17.9% in 2009.

Today, the region is booming again, with Estonia celebrating second-quarter GDP growth of 8%. As Estonian President Toomas Ilves puts it: "After [Stalin's] mass deportations, [austerity] didn't seem that bad. I guess it's harder if you've been living the good life of [Italian Prime Minister Berlusconi's] bunga bunga parties."

Now, all of this doesn't make Ireland an easy place to make to money. I joined contrarian investor Wilbur Ross, Canada's Fairfax Financial Holdings and Fidelity Investments took by investing in the Bank of Ireland (IRE) in July, both personally and for my clients. Thus far, it's been a rough ride. In fact, IRE dropped more than 30% just last week.

But I'm holding on, and betting that the Ireland will be among the first of the PIIGS out of the sty.

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