June 8, 2003

Standing up in the Olympia

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The Red Army was perplexed. Why did the Germans risk everything when they had so much?In the spring of 1945 as the Red Army swept west through the orderly villages of East Prussia, the average Russian soldier could not figure out why such a rich country (Germany) would invade such a poor country (Russia).

“The Germans are not fools,” wrote one Red Army captain to his wife, “what could they possibly have needed in Russia”. Nothing more encapsulates the ludicrous nature of the German invasion of Russia in 1941 than the lackof any real economic reason to take up arms.

For many Germans in 1945, East Prussia was the real soul of the country. Situated in what is now Lithuania, Russia, Belarus and parts of Eastern Poland, were Germans who had lived there for centuries. Konigsberg, its capital, was home to the great German philosopher Immanuel Kant.

Financially, like Ireland today, East Prussia had historically benefited from the monetary union with the rest of Germany.The huge capital base in Germany proper facilitated the ability of East Prussians to borrow at low interest rates. The sophisticated capital markets of Berlin were tapped to invest in agriculture around Konigsberg and the heavy industries further west in Silesia.

Unfortunately, Ireland today is tapping the sophisticated capital market of Frankfurt not for investment, but for jollification.

EMU facilitates a process where Paddy can borrow from Gunther to buy cars that Gunther has made for export. A conspiracy theorist would have a field day here as Gunther wins both ways!

Paddy gets to sit in traffic in his new e50,000 car, up to his eyes in debt and thinking he is loaded. There are now more Mercs per head in Dublin than in Frankfurt how’s that for zeitgeist?

The point is that the recent interest rate cut by the ECB should not be welcomed here. In fact, it is probably the worst thing we need at this stage in our economic cycle.

To understand this crucial point we must go back to first principles and consider how the economy works in Ireland.

Old-fashioned economics tells us that when the price of something goes up, the demand falls. Well this is not always the case here. In fact, cheap credit and a certain psychological disposition that has gripped the country, has led to a situation where in Ireland, when the price of something goes up, the demand does too.

Years ago when I was working at the Central Bank, a wise old economist told a confused delegation from the World Bank that was trying to figure out some esoteric detail of the workings of this place that “the laws of economics stopped at Holyhead”. Little did I realise at the time how correct he was.

Let’s call this new theory of economics in which the demand goes up as the price goes up  the “Midnight at the Olympia theory of Economics”.

It refers to the fact that the keeping up with the Jones’s spending, which is causing many to aspire to buy Mercs, is perverting the economy. Conspicuous spending is like a virus in a creche once one person gets it, everyone does.

Because people define themselves by possessions, what we buy throws down the gauntlet for others to do the same.When I buy a snazzy watch,you have to do the same. Likewise, if I buy a Merc, you do likewise, not because you need the car,but you need the parity of status.

Eventually, this carry-on has the same effect on a society as people standing up at gig when they could all happily sit down instead and this is where the Olympia comes in. Back in the dull days of the late 1980s when Dublin pubs closed early and nowhere served a drink except the long-gone Blazes restaurant, Midnight at the Olympia was a godsend. You could pay a tenner and get two extra hours drinking and all you had to do was stomach listening to the likes of Smokey.

So there you are,pint in hand sitting down happily with a mate. Just then the bloke in front of you stands up. You have to stand up. The bloke in front of you puts his girlfriend on his shoulders and you now have a 14-foot Triffid waving wildly in front of you. A girl beside you asks if she can get on your shoulders. You now have a complete stranger sitting on you, your pint is spilling all over the place, you can’t see the accursed stage and all you came for was a quiet drink.

I could go on, but you get the picture. The minute the bloke in front of you stood up, you were doomed.

Spending acts in the same way, as people try to keep up with each other in a rather futile exercise that fails to satisfy anyone. More cars, more goodies, more useless stuff that simply costs money and causes all of us to work harder and borrow more to waste on useless possessions.

Economics should come in at this stage to put the dampeners on all this malarkey. But our dear friends the Germans, through no fault of their own, ensure that we continue to cod ourselves.

Because the Germans are already rich and old, they have huge amounts of savings.These savings are useless to them unless someone borrows the cash giving them interest in return. Luckily, EMU allows the Irish to borrow all the German cash they want and in the process, give the Germans some income.

But there are not enough of us and with the French and Italians not spending either, there is not enough demand around Europe to keep interest rates up. So interest rates fall as they did again this week.

Yet because the Germans are old and have all the possessions they need, falling interest rates eat into their saved wealth making them less likely to spend. So the rate cutting exercise becomes a bit like pushing on a string and the EU economy does not recover and could conceivably shrink more.

And over in free spending,youthful Ireland, the low interest rates exacerbate the spending binge. So we borrow even more cash.

But what about wages, they too should have a role in putting the brakes on things and surely they can’t rise indefinitely? Well, yes and no. Again, the presence of the old Germans causes us a problem. Despite, its recent strength, the euro is made weaker overall by the high saving Deutschers.

If Germany is not spending, it must get someone else to buy its goods and, despite our best efforts, we cannot purchase all the Mercs going.

So, over time, the euro falls as it has done since its inception (until very recently). This fall in the euro gave Ireland a false sense of competitiveness that had more to do with the age profile of the average German civil servant than Irish productivity. So we pay ourselves over the odds. Both Irish wages and Irish borrowing rise exponentially to finance conspicuous spending and the German economy remains rooted to the floor.

Although the euro has rebounded of late, this will not last because history shows us older populations have weaker currencies.

Where does it all end? If Germany remains in recession permanently, we might just escape, but then Europe will have bigger problems. Germany in a recession means German unemployment at or above four million. What happens if it goes to five or even six million?

When does a Jean Marie Le Pen emerge in Germany, railing against foreigners, Slavs and greedy Paddies? When will the Germans say they’ve had enough? Unemployment in Eastern Germany is now 19 per cent.This cannot last without some significant impact on domestic politics.

Nobody is talking Deutschland Uber Alles again, but seeing people like Giscard d’Estaing and his mates talking about a European Constitution when the biggest economy is in recession, makes one wonder what planet these guys are on. Every time interest rates are cut, it means more Germans are on the dole and this is bad news for Europe.

We might “benefit” in the short term if a land price bubble and a borrowing binge can be looked on as benefits but the future of Europe depends on a stable Germany and that looks further away today than at any time since unification.