November 28, 2005
When you touch down in Dublin after your winter break in the sun, the purchasing power of your euro drops considerably. What happens to debase the currency once you pass passport controls at Dublin, Cork or Shannon?
Why does the price of a cup of coffee surge 180 per cent – from ï¿½1 in Barcelona to ï¿½2.80 in Dublin?
The reason is simple: old-fashioned inflation. Although the official figures do not capture this, Ireland has been in the grip of an inflationary spiral for the past few years.
The easiest way to see this is in the progressive fall in the value of your money in this country and the corresponding increase in the value of the same money when you leave the place.
When the value of our take-home pay begins to shrink, we get worried and look for someone to blame, which explains the success of the excellent Rip Off Republic TV programme.
However, the real enemy of the TV smash hit is general inflation. Of course, the title Inflation Republic wouldn’t have caught the imagination in the same way, but it should.
So why have we been suffering price rises across the board? The main reason is the old-fashioned monetarist adage ï¿½too much money chasing too few goods’.
EU monetary union has allowed a deluge of credit to wash over us. We are borrowing money from wherever we can get it, four times faster than even the profligate Americans.
As this credit streams into the economy, it pushes up the price of everything from houses, creches and coffee to Christmas cards, wedding dresses and CDs. The new money has to go somewhere, and it finds its way into every nook and cranny eventually.
The new cash also pushes up the price of labour – which explains why our wages have gone up rapidly.
Interestingly, people do not see the latter occurring, which explains why people feel that they are just getting by despite wage increases. This is called a classic wage/price spiral.
If wages and prices are rising so quickly, why has something not snapped?
Why has there been no implosion, no meltdown, no competitive disaster?
There are two possible explanations.
The first is that EMU obscures the strains that a country or region experiences. When you eliminate exchange rates, interest rates and the balance of payments, you do away with the central disciplining mechanisms of macro-economics.
Before EMU, if we had borrowed so much credit, financial markets would have reacted to the growing inflation by speculating that our currency would have to devalue at some stage in the future to offset the fall in competitiveness.
Investors in Ireland would have concluded that in order to sell their stuff, the Irish would need to make it cheaper for international markets by responding to any increase in Irish costs with devaluation. This very rumour would have caused capital flight, and interest rates would have moved up.
All these factors, once triggered, have a self-disciplining effect.
In contrast, once you are part of a larger currency union, like EMU, none of these signals are picked up because you have no currency, no domestic interest rates and no real balance of payments to worry about.
This is why New York City was declared bankrupt in 1975, simply because no one appreciated its level of delinquency until it was too late. Like Ireland today, there were no typical warning signs.
A second reason why the creeping inflation has not led to any blow-out is that inflation is being superseded by greater forces.
The blow-out approach to economics is based on the idea that eventually stuff runs out. It can be summed up by the ï¿½you can’t fool all of the people all the time’ assertion.
But maybe sometimes you can. While there is no doubt that inflation is now in the system, its deleterious impact is being offset because we are also importing money and people at a faster rate than anywhere else in the world.
We are importing credit faster than any other country on earth, but we are also taking in more immigrants than most other countries.
For example, Ireland is absorbing seven times more immigrants per head than France or the Netherlands.
This is causing our national economic capacity to expand. In the construction and services sector, for example, the new immigrants are keeping wages lower than they would be if there were no immigrants.
Cheap credit is financing developments that would not make any economic sense had there been difficulty getting our hands on borrowing.
So we are prolonging the party by importing new money and new people.
In the longer term, economic history tells us that there are two problems with this. The first dilemma is that although we are prolonging the party, the nature of the party is changing. In recent years, inflation and generally higher costs have been causing our manufacturing industry to shrink, relative to everything else.
This development is dismissed by those neo-liberal or free market economists who believe that manufacturing is not important.
These blokes argue that, for example, America’s huge trade deficit is not important. Similarly, they say that it does not matter if Ireland becomes a service economy. Well, it does.
The same argument pertained in colonial Spain when the plundered gold of the Latin Americas flooded Spain. To cope with the demand for finery, Spanish merchants turned to foreign suppliers.
All the gold flooded back out of Spain to Britain and Holland.
In fact, its newly acquired riches went through Spain like a dose of salts. As it became progressively more uncompetitive, Spain experienced three national bankruptcies between 1557 and 1597 – less than 100 years after Columbus had claimed the New World for the Castillian crown.
The message is simple: hard work is better and longer-lasting than easily acquired wealth.
More recently, Germany tried to use immigrants to escape the inevitability of capacity constraints. In its postwar period, known as the wirtschaftwunder, from 1947 to 1967, Germany experienced phenomenal growth. By the early 1970s the Germans were running out of people.
To prevent wages from going through the roof, they imported Turks to do the jobs that newly-rich Germans would no longer do. In so doing, they prolonged the boom for a few years, but when it eventually ran out of steam, they were left with a second-generation immigrant population accused of stealing (now scarce) German jobs.
So next time you arrive home and feel the purchasing power of the euro in your pocket diminish, think about inflation.
Until recently, we reacted to inflation with outrage, as seen in the Rip Off Republic programme. But in reality we are all part of the rip-off. We are demanding higher wages to offset higher costs, while at the same time whingeing for 21st-century wages and 20th-century prices. It doesn’t work like that.
All prices are rising. Cheap credit and immigrants are masking the problem now, and this false sense of security might continue for awhile yet.
But history backs up Abraham Lincoln’s observation: ï¿½You can’t fool all of the people all of the time.ï¿½