December 3, 2000

This borrowing binge is blowing our bubble

Posted in Celtic Tiger ·
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News footage from Britain in 1987 shows champagne-swilling Hooray Henrys corking Bolly in celebration of Nigel Lawson’s tax-cutting budget. For many, this landmark budget was the culmination of Mrs Thatcher’s revolution and the high point of Lawson’s career.

The “wonderful chancellor”, as Thatcher called him, became the embodiment of the decade — successful, arrogant, smart and immensely overweight. Following the budget came an orgy of consumption fuelled by excessive borrowing and huge wage increases, leading ultimately to a bubble, a subsequent collapse in confidence and a sharp slump.

By 1990, it was apparent Britain was in a serious recession and commentators began to look for scapegoats. The first reputation to go was Lawson’s. The formerly wonderful chancellor was vilified in the press for his economic myopia, his 1987 budget was slammed and his erstwhile colleagues discarded him as an electoral liability. His job at Number 11 was filled by John Major and the rest is history.

Lawson’s so-called miracle budget became synonymous with a short-lived boom in classic cars, one-bedroom basement flats in Wandsworth and pokey, dark second houses in Provence.

However, serious analysis undertaken by the Institute for Fiscal Studies in Britain tells a different story.

Although Lawson’s 1987 budget may not have been entirely prudent and his subsequent rubbishing of dissent might be described as hubristic naivete, in 1991 the Institute calculated that the impact of the budget itself was modest. In fact, the real culprit behind Britain’s boom/bust cycle was the earlier liberalisation of financial markets, which made credit more easily available to punters than it had ever been. Essex man was actually “largin’ it up” on borrowed cash which had little or nothing to do with Lawson and his tax cuts. In total, Lawson’s tax bonanza injected a trifling �14 billion into the economy; the liberalisation of financial markets injected a whopping �40 billion.

With woods and trees in mind, let’s focus on Ireland 2000 and the budget debate. Much has been made of the appropriateness and timing of tax breaks and increasing spending. Many argue that we’re at the top of the cycle and Charlie McCreevy should not be fuelling the inflationary fire with more money (incidentally, McCreevy sticks to the view that all inflation is externally generated, which raises the question why there is a budget surplus at all).

On Wednesday, if McCreevy injects over �1 billion into the economy in tax cuts etc, there will be hoots of derision from all sides about irresponsibility and the like.

But it seems to me that focusing on the budget misses the point. It is an annual ritual a bit like the summer solstice — important in its day but rather meaningless now. The real story in Ireland appears to be just like that in Britain in the 1980s: a wall of money is crashing down on the economy in the form of apparently unlimited borrowing.

If we look at the figures, we get an idea of just how modest an impact the budget is likely to have compared to the monumental disaster brewing as a result of the ongoing borrowing binge.

According to the central bank’s latest bulletin, private sector borrowing rose by 24 per cent to June. The percentage figure is large enough, but the actual figure in pounds is more alarming. Irish people borrowed just over �21 billion in the 12 months to June of this year. Given that GDP is likely to be �81 billion this year, the figure implies that private sector borrowing is running marginally under 25 per cent of GDP per year. This is a phenomenal amount. Repeat it to yourself: borrowing is 25 per cent of GDP.

Is it any surprise that the economy is overheating?

People are borrowing because there is no incentive to save. With inflation running towards 7 per cent and deposit interest rates at best 3.5-4 per cent, savers are losing at least 3 per cent per year on deposits. What is the point in saving, as long as Germany remains in the doldrums? Growth figures (growth slowing down to 2.3 per cent from 4.6 per cent) from the former wirtschaftwunder this week suggest that could be the case for some time.

Irish people and Irish companies would be mad to save. So we will spend and hope the Germans don’t wake up.

By spending we will drive both inflation and, ultimately, wages upwards. The whole partnership process will embed these wage increases into future agreements across the board. The more wages, the more borrowing, the more borrowing the more inflation and back we go to wages again.

This process will only lead to more, not less, industrial unrest as employers and workers slog it out for their slice of the pie. As long as the euro remains weak, Ireland Inc can beat itself up without looking uncompetitive to the outside world. The CNN reports of Celtic industrial anarchy will be massaged away by massaged Irish profit figures, boosting bonuses in corporate America — to an extent.

In essence, our gig depends not on ourselves but on the path of the dollar. If the dollar remains strong, our weakness is obscured and McCreevy can do whatever he wants and maybe we can all borrow a little more.

But how low can the Nasdaq go before the dollar begins to feel the strain? 2000? 1750? 1500? With the US high-tech sector down 50 per cent in six months, who is to say that the dollar couldn’t fall that far, particularly if Germany and France recovered?

Is our economic success predicated on the dollar defying gravity in tandem with German economic failure? If so, here’s to neighbourly relations and European solidarity ahead of the Nice summit.

Like all bubble economies, it is credit — not tax cuts — which drives spending on cars, lavish Christmas bashes, second homes in Marbella, two golfing trips per year and the Man United away strip from D’Olier Street. Private sector borrowing is probably going to be 10 to 15 times more expansionary than any consequences arising from what Charlie McCreevy announces this week.

Given the storm clouds building in the global stock markets, financial distress on a major scale here in Ireland can’t be far away. Is it any wonder that this week Sean FitzPatrick, one of the savviest operators in town, announced Anglo Irish Bank’s purchase of a Swiss bank? The flight to quality begins.