March 12, 2006

Ireland's kamikaze capitalism

Posted in Celtic Tiger · 24 comments ·

Picture the scene. You walk into the library two days before your finals. Everything is a blur and that horrible pre-exam fear dominates. What if the wrong questions come up? Where are the photocopied notes you snaffled yesterday?

You sit down for some desperate last minute cramming. The bloke next to you, who you vaguely recognise from your class, takes out a Japanese dictionary. He thumbs it confidently.

You feel sick. What�s with the effing Japanese dictionary, you over-achieving bollix?

These are economics finals. So you tentatively ask, ��Why the dictionary?�

With the superior air of a man who has already secured a ��milk round�� placement, he sniffs: ��If you don�t speak Japanese, you�ll never get a proper job! They are taking over the world, don�t you know?� This is all a bit much to take two days before your finals. He moves the dictionary aside to reveal two airport bestsellers: ��Japan as Number 1�� and ��Yen! Japan�s New Financial Empire and its Threat to America��.

The year is 1989. The New York Times warns of an economic Pearl Harbour and adds that ��forty years after the end of World War II, the Japanese are on the march again in one of history�s most brilliant commercial offensives, as they go about dismantling American industry��.

The land on which the Imperial Palace in central Tokyo sits is valued at more than the entire real estate of Canada – the world�s second largest country.

Japan was experiencing the most inflated property bubble of the 20th century.

With paper profits from property back home, Japanese investors were busy buying up trophy assets in the US � from the Rockefeller Tower in New York to Columbia Pictures in Hollywood. The best-selling book of the year was Michael Crichton�s Rising Sun, which he said he wrote to ��make America wake up��.

Corporate America was in the grip of a Japanese hysteria and both mainstream commentators and the political elites believed that the Japanese march to world commercial domination was unstoppable.

Ambitious Dublin students – in an era of 18 per cent unemployment – bought into this and were swotting accordingly.

Last Thursday, almost 20 years later, the Bank of Japan announced it may raise the benchmark interest rate from almost zero by the end of 2006 after ��ending a five-year deflation-fighting policy��. This deflation followed a ten year recession in the 1990s. Instead of taking over the world, powered by its roaring property market, Japan suddenly, and for most people shockingly, went into an economic crisis that lasted almost 20 years. How did everyone get it so wrong?

People say that pride usually comes before a fall and in the case of the Japanese economy, this was certainly true. The Japanese property bubble lasted almost a decade and was driven by cheap credit, massive financial deregulation and a fair amount of pop-psychology as the herd reacted to the property boom. JP Morgan, the American banker, once famously said that ��nothing so undermines your financial judgment as the sight of your neighbour getting rich��.

In the case of Japan, this was right on the mark. The boom led to almost panic buying, financed by a banking system that lent out money for just about anything. It changed the behavior of Japanese people dramatically. Traditionally, subdued, frugal and hierarchical, the Japanese became loud, flash and freewheeling. Japanese, who hardly travelled before, began buying second houses all over the world from Honolulu to Hounslow.

A great example of the frenzy that later became know as ��kamikaze capitalism�� was seen in golf courses. As the economy boomed, so too did golf. The game was a central feature of Japanese corporate life and a permanent fixture in the shain ryoko or company outing. Membership of a golf club club denoted a certain privilege and bestowed a clear hierarchical structure on what is a very position-conscious society.

As property prices boomed, banks fell over themselves to lend to golf course developers, seeing golf clubs as a property play.

In 1982, one of Japan�s leading newspapers, the Nihon Keizai Shimbun, launched the infamous Nikkei Golf Membership Index, which calculated the average price of membership in 500 clubs. The market in club membership was sustained by salesmen who earned commissions flogging membership certificates with the free-lending banks financing up to 90 per cent of the so-called ��collateral��. From its base of 100,the index rose steadily to 160 in 1985 and then took off in the ��bubble�� years of the late 1980s to peak at 1,000 in June 1990.

In January 1990 � six months before the Golf Index peaked – the Bank of Japan began raising interest rates. Everyone thought the market could sustain what were modest increases of 4 to 6 per cent.

Initially, investors suggested it was only the foreigners who were selling.

When those who had bought at the top of the market began to sell, this quickly led to a stampede. Prices fell precipitously. The formerly faithful banks panicked as bad debts mounted on their balance sheets.

Overnight, credit conditions in Japan went from a flood to a drought. The more the banks retrenched, the more bad loans mounted – which in turn led to more bad debts, which led to more loans being called in as the banks faced bankruptcy. The large Japanese banks which had dominated global banking in the late 1980s saw their share prices collapse.

The economy went into a tailspin. Last Thursday was the first time interest rate rises have been signalled in Japan since 1990.The problem in Japan in the past decade and a half has been what Keynes identified as a ��liquidity trap��. He described a situation that pertained in 1930s America but is equally applicable to Japan during the 1990s.

In a liquidity trap, no matter how low interest rates go, people who just lost everything will not borrow. This means that cutting interest rates, assuming that you have the competence to do so, does not work. This is the economic equivalent of MRSA where the patient does not respond to traditional antibiotics. It implies that the recovery period is much longer than it would otherwise be and than anyone expected at the time.

Now let�s get back to Ireland. Do you see the similarities? Is your financial judgment impaired by the sight of your neighbour getting rich? Like the Japanese overseas investor, are you RoboPaddy – that unique Irish investor who runs around the world trying to buy the place, purchasing off plans from Alicante to Budapest?

Do you see the share prices of our banks going through the roof in the past few years as their profits (almost exclusively derived from the property-inspired credit expansion) grow? Will they, like the Japanese banks fall to earth? And if they do will some have to be bailed out by the government -as happened in Japan?

Think about it. When we start – like the Japanese � to believe our own propaganda, anything can happen. There are two crucial differences of course. Firstly, Japanese manufacturing remained -even throughout the property boom – hypercompetitive, innovative, disciplined and flexible.

Even when the domestic credit economy collapsed, at least manufacturing – which was controlled by Japanese executives – continued to export. We don�t have a domestic manufacturing industry. The second crucial difference is that we do not have a real central bank. If things went pear-shaped here, it is highly likely that our interest rates would be rising not falling.

This is because Germany operates in a different economic cycle to us. No country in the world has ever experienced a property meltdown that was not cushioned by falling or possibly zero interest rates.

Who knows, we might yet be learning Japanese in the years ahead – not to get a job, but to learn some lessons about how things could pan out here.

  1. David

    I just dont understand people at all in Ireland. Much of
    the economic growth in Celtic tigerland for the last few
    years is based on debt. Dr Dan and all those impartial
    auctiooner economists saying that ireland inc will
    continue to borrow to buy overvalued properties all over
    the world and owe 4-500 billion euro in the next few
    years. HELLO!!

    & does anybody ever wonder why the Brits/Japs/Germans are
    so willing to sell their London trophy properties to
    the “sophisticated” Irish property investor.

  2. Kevin

    Another very interesting article on the possible Doomsday
    scenario facing Ireland.

    With regard to the government bailing the banks out if it
    all goes pear-shaped, I’d be doubtful. Even if it was within
    the governments means, granting state aid to private
    business would be subject to serious scrutiny by the EU. If
    any of the continental banks smelt a possible takeover
    opportunity then they wouldn’t take government interference
    in the market lying down.

    If there were no takeover bids forthcoming, then I’m not too
    sure what would happen… Would you care to speculate on
    those possibilities David?

  3. Dave

    So, my wife and I are due to move back to Ireland from
    Australia at the end of June, and our current plan is to get
    into the property market in some form as soon as we can.
    I’ve got to say, though, your articles are giving me cold
    feet. I’m starting to think we’d be better off investing
    over here than even trying to afford that bungalow in the
    Cork countryside we want so badly, especially when we change
    from Dinkie to Sitcom.

  4. Mike

    Quoting David:
    “This is because Germany operates in a different economic
    cycle to us. No country in the world has ever experienced a
    property meltdown that was not cushioned by falling or
    possibly zero interest rates.”

    I think the comments by the then Tanaiste (Mary Harney)
    “Geographically we are closer to Berlin than Boston.
    Spiritually we are probably a lot closer to Boston than
    Berlin” may still come back to haunt us.

  5. Pete


    You’ve been writing excellent, well-researched,
    intelligent articles predicting falling house prices for
    quite a few years now (I’ve been reading them for at least
    6). It hasn’t happened. There’s a saying in science: “If
    theory and reality disagree, theory is wrong”. Could you
    suggest a date in the future when, in the absense of
    falling house prices, we should should conclude that
    economic theory is just wrong?

  6. David Mc Williams

    Hi Pete, I understand your frustration. I have been
    looking around the world and trying to see whether there
    is an economic theory/case that points to endless boom.
    Thus far, I’m scuppered – each one has ended in tears. On
    that basis, either Ireland is a one in a million exception
    or the economic cycle will reassert itself. We have no
    tools to slow this thing down, so, as an economist, I
    can’t see how else it will end.

  7. Paul Rux, Ph.D.

    David, as you suggest in your article on Japan, to play a
    game is one thing. To believe in it as reality is tragedy
    or farce or both. French novelist Honore Balzac observed
    this. I give due credit.

  8. eoin

    Pete is an example of how bubbles create their own logic. He argues that
    analysts who suspect there is a bubble have being doing so for years, and he
    ( along with other people, some “sensible”) gives up on the contrarian theory
    and enters the market, maintaining the bubble. No rationality can work here
    because it seems – without recourse to history ( even recent history – which I
    lived through – like the Nasdaq bust) that the worriers are chicken littles,
    have been proved wrong, and have lost out.

    Let’s remember that the nasdaq bubble was called, by Greenspan ( the
    irrational exurberence speech) in 1996.

    It seems that the worm will turn in America this year the WSJ just reported
    that 25% of all loans outstaning are due for a readjuectment within two years
    with some of the increases being up to 50%. I think we will get the worst
    possible bust, the bust caused by America’s readjustment, rather than by a
    measured increase in interest rates.

    As for why David has been “wrong” for 6 years

    1) Nobody could have predicted that the ECB would keep Irish interest rates at
    a real negative rate for so long.
    2) Nobody guessed the immigration levels.

    Both policies were disasterous. Both will reverse sometime. Leaving a huge
    unsold stock of houses.

    According to the cost of buying rather than renting runs from a
    multiple of 2.5 to 3.2 across the city, and they fudge by normalising for
    “quality” ( when location is all that should matter).

    so, although rents have firmed ( for the first time in 5 years) the increases in
    house prices have been greater year on year ( 10% vs 5%) and the cost of
    money is only going up, increasing that multiple even further this year.

    If you assume the ratio should be about even, Irish property should fall by
    60-70% plus. Which means that David was not that wrong six years ago.

    ( And rents will decrease in a recession too, of course.).

  9. Pete


    I have not yet abandoned the lessons of history and
    economic theory, becuase I realise that 6 years is not
    really that long a timescale, but there must be a time
    limit to how long theory and reality can diverge before we
    accept that theory is either wrong, or is so inaccurate at
    predicting when events will happen that it is useless. An
    error margin of 6 years is not useful to most people.

    A whole generation of Irish people, who probably never had
    much faith or interest in economics anyway, have learned
    that mindlessly following the crowd works, while research,
    reason and rational thought are for losers. And the
    evidence shows that they’re right. David and the chicken
    littles HAVE been wrong, and HAVE lost out. Even if prices
    fall 70% from their current level, those who ignored the
    chicken littles and bought 6 years ago will still be ahead
    of those who didn’t.

  10. John

    Where do these figures of 70% and such like come from?
    If there is a house price crash then the banks will dictate
    the price of property just like they do now.Property is
    priced at what people can borrow.If the banks pull there
    horns in or get taken over you can expect loan multiples to
    drop back to historical levels of about 3 to 3.5 times
    salaries,the average industrial wage is about €30000 with
    increasing amounts of immigrants working for a lot less.
    Go do the maths.

  11. gearoid

    For the last few years banks all over the world (including
    Ireland) have been selling their debt in the form of bonds
    to private investors thus ridding themselves of some of the
    risk. This would seem to suggest that they would not be as
    overexposed to falling house prices as the Japanese banks
    were in the 1980s. It also helps explain why lending
    policies have been the way they are. Although the
    situation seems similar, there are important differences.

  12. Aidan

    I have to agree with some of the other posters to the
    extent that the ‘correction’ when it comes is very unlikely
    to cause prices to fall to the level of six or seven years
    ago. However, I think that a long period of stagnation in
    prices, perhaps accompanied with a considerable correction,
    must be likely.
    I go back to Ireland a few times a year from my home in
    Holland and so I have viewed the Irish boom from a
    distance. I am also married to a Pole so I also get insight
    through my wife’s friends on how the Polish experience in
    Ireland is going.
    Two things strike me. Firstly, to me it is obvious that
    Irish people are paying over the odds for houses compared
    to The Netherlands. Comparing salary levels I don’t think
    that Irish people earn more but they seem to be paying a
    much higher multiple of their salaries than Dutch people do
    and here mortgage interest if fully deductible. Secondly,
    the Polish people are far more likely to share a flat with
    six other people (like Irish people do/did in
    London/NY/Sydney) than to rent a flat alone. No Pole would
    buy a house in Dublin when he can buy an apartment in a
    city in Poland for cash after a couple of years saving.
    I don’t think immigrants to Ireland are going to keep the
    housing market going except to stimulate a portion of the
    rental sector.
    As I have lived away from Ireland since 1998 I have missed
    the house price boom. It is probably too late for me to
    think of going back because I could not afford to live in a
    suburb close to a city centre as it is now. Given that I
    would be able to get a high paying professional job there I
    can’t see how people there can keep paying the prices in

  13. CiaranMcG

    Interesting article as usual. David, it’s true that we have
    surrendered an important control to the ECB. In effect we’ve
    lost the brake as we approach a bend up ahead. There are
    other actions, however, that can be taken that would make
    the impact of a crash less painful. One smart thing would be
    to take our foot off the gas. In effect, has the gov. not
    done the wrong thing in the design of the SSIAs, and in
    reckless spending sprees before elections (another about to
    begin)? Our central b. tells us that despite the risks, all
    indicators show our banking system is in good shape. Is
    there really a parallel with Japan in 89? Moreover, if the
    Central bank is charged with presiding over financial
    stability, why have they not other tools to do this job. For
    example, the ability to set and police the allowed lending
    criteria used by building societies or commercial banks. Or
    is this seen to be too interventionist/centralised in that
    it removes decision making from those “best placed” to take
    the risk?

  14. Seán

    Ireland is not unique, too much cheap credit, thanks to the
    central bankers, has created a global liquidity bubble.
    There are several asset bubbles accross the world, mainly in
    property and stocks (Check the Middle-East stock exchanges)
    and one by one these are popping. Anyone want to buy
    property in Shanghai?
    The Americans have been printing $$$ like there’s no
    tomorrow, and have created a global ‘ponzi’ scheme, whereby
    Americans print paper to buy goods from foreigners who use
    it to buy other pieces of paper in the form of US treasuries.
    As interest rates and energy prices go up in the West this
    will slow spending and countries depending on their export
    sectors for growth will face enormous excess capacity….
    Ireland won’t be alone when this bubble pops, taking my job
    with it.

  15. eoin


    a 70% collapse would see us back to 1997/8 levels. More than 6 years.

  16. Eoghan

    “We at the Federal Reserve considered a number of issues
    related to asset bubbles–that is, surges in prices of
    assets to unsustainable levels. As events evolved, we
    recognized that, despite our suspicions, it was very
    difficult to definitively identify a bubble until after the
    fact–that is, when its bursting confirmed its existence.”

    Alan Greenspan
    Federal Reserve Chairman
    Jackson Hole, Wyoming
    August 30, 2002

    But for anyone who’s looked at economic history the
    Japanese experience is a classic example of mania, panic
    and ‘revulsion’. In that light, there must be concerns
    regarding the current situation in Ireland.

    Just because the property cheerleaders and bulls insist the
    emperor has the finest new clothes shouldn’t deter those
    who see the reality from pointing out that “the king is in
    the altogether!”

    Keep up the good work David, there are plenty of us who
    agree with your position … the scary thing is … if/when it
    does go pearshaped … it’s a long, long way down from here.

  17. John Callaghan

    Jeez David …………… what have you started? Returning
    emigrants afraid to buy a home: banks going bust and
    property values falling by 60% to 70%! Are you sure you
    want to be responsible for all this?

    Surely most people buy a house as a home, not as a
    tradable asset. For the vast majority of people, so long
    as they continue to live there and can pay their mortgage,
    negative equity has the same effect on their everyday life
    as positive equity …….. zilch! We know that today’s
    mortgages are within affordability limits. So unless
    interest rates go absolutely crazy and/or we have massive
    job losses, home owners will not become forced sellers.
    They’ll just continue as before albeit without massive
    increases in the values of the homes they live in.

    Banks go bust when borrowers can’t afford to meet their
    obligations. The underlying security loans (houses in
    this case) only become relevant if the borrower can’t
    pay. That brings us back to interest rates going
    absolutely crazy and/or massive job losses.

    Have you any reliable evidence (as opposed to hope or
    fear) of this doomsday scenario? If it happens, are you
    sure our main problem will be the price of houses?

    Why don’t you just let the emigrants return in peace, buy
    their homes and enjoy being here and let the banks get on
    with the business they know better than you?

    16 March 2006

  18. Pete


    It depends want you mean by “interest rates going
    absolutely crazy”. The Euro base rate has gone up 25% (2%
    to 2.5%) in 3 months, that’s a little bit crazy. Most
    pundits are predicting it will reach 3% by the end of this
    year, if they’re right that will mean that interest rates
    have gone up 50% in a year. That’s going to sound
    absolutely crazy to all those FTB working couples spending
    one entire income on mortgage payments.

  19. Arthur

    Yes indeed, another very strong article illustrating how and
    why the emperor has very few clothes.

    All bubbles need a little prick, i.e. a small but decisive
    external shock that lets the scales fall from everyone’s eyes.

    It usually takes the form of a weakening currency, that
    requires substantial rate hikes to stem, to put the pinch on
    the most exposed and start the cascade, avalanche,

    A weakening currency normally means either the smart money
    is getting out or foreign friends, less likely to be
    infected with the mass hysteria, spot an economy riding for
    a fall.

    That indeed has happened here before a couple of times
    during our brief economic sovereignity from the pound
    sterling and those episodes were painful for anyone exposed
    to the vagaries and short attention spans of the un-holy
    fraternity for foreign exchange traders.

    However, our current situation seems to me to be unique in
    economic history.

    We are an island economy with a separate tax and fiscal
    regime but with a fixed exchange rate to a currency whose
    rates or integrity we can have no impact on and whose
    masters (political and monetary), hopefully, will go to some
    to length to help out their child-prodigy.

    It’s as if a pint-sized version of Argentina had actual
    USDollars as a currency.

    So, it seems to me, that no matter what heights of lunacy
    are scaled, domestically, the spiral will continue to ascend
    until global interest rates rise.

    When will that happen? Fours years after Germany starts
    strong economic growth again. Whenever the US decides that
    it should stop printing dollars. When the Chinese peasant
    starts to agitate for farm subsidies. When Japan starts to
    breed again. That is, IMHO, not for quite some time to come.

    None of which negates the absurdity of the price bubble, it
    just reinforces the old adage about “the bigger they are the
    harder they fall”.

    By the way, did anyone else notice that British Land, after
    15 years here as an investor/developer, have quietly sold up
    and moved out. It brings to mind another old saw about
    whether if after 20 minutes at the poker table you can’t
    figure out who the patsy is, it’s probably you!

  20. paraic

    “All bubbles need a little prick, i.e. a small but decisive
    external shock that lets the scales fall from everyone’s eyes. ”

    This is not true of many housing, ponzi, or stock bubbles. For instance the
    nasdaq crash was not related to any increase in interest rates,and just
    happened. Japans fall is blamed on an interest rate rise a few months before,
    but this is a weak argument, as interest rates had been continually on the rise
    in the eighties and the effect was not immediate.

  21. Declan

    Hi David, another excellent and interesting article.
    Just in response to John Callaghan, comment about
    house/homes not being a tradeable asset.
    That’s a very valid point but I am not too sure if John
    realises the amount of property that is held for investment
    I recall reading somewhere that in recent years
    approximately 2 out of 5 newly constructed houses are sold
    to investors. Then a drop in value of property does become
    an issue especially if you are looking to liquidate your
    Combined with reduced rental yields, these investments no
    longer look sound.
    I would recommend that people watch what the big investors
    are doing. It’s NOT a coincidence that AIB has sold some of
    its portfolio of property and that it is looking at further
    Sale and Lease backs.
    It is not a coincidence that AIB does not do 100%
    mortgages, and they have not got involve in the mortgage
    battle with new entrants in the market!
    The longer this bull run continues the deeper the and more
    painful the consequences of a property collapse. The
    worring thing is, as usual, the last investor on the ladder
    who can least afford it (in relative terms) will be hit the

  22. Vicente

    Great article, interesting coincidences with spanish buble.

    “Hi David, another excellent and interesting article.
    Just in response to John Callaghan, comment about
    house/homes not being a tradeable asset.
    That’s a very valid point but I am not too sure if John
    realises the amount of property that is held for investment
    I recall reading somewhere that in recent years
    approximately 2 out of 5 newly constructed houses are sold
    to investors. Then a drop in value of property does become
    an issue especially if you are looking to liquidate your

    With those overvalued prices everyone acts as an investor. People thinks about property as an asset which value will not decrease in the future. If people would act as a consumer, would only measure house prices in years of salary, so would not spend more than 3 or four salary years.


  23. [...] the changed reality to being in a massive currency area with no control over monetary policy – and points out regularly that [...]

  24. [...] Are you insane? He’s been predicting the crash for years – this random article is from March 2006. Ireland’s kamikaze capitalism David McWilliams Archive Check out his [...]

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