December 3, 2006

Caught between two powers

Posted in Euro · 12 comments ·

The dollar appears eventually to be going the way every economist has been predicting for the past ten years: downwards. How far it will go is anyone’s guess, but it will have ramifications. What does it mean for us, the most American-dependent country in Europe? And what does it mean for global economic relations?

An interesting way to view the global economy of the future – the theatre where we, the Irish, will have to perform – is to see the relationship between the world’s economic power blocs through the medium of geology. The earth’s rigid outer shell, the lithosphere, is broken up into an extraordinary mosaic of oceanic and continental plates. Just underneath is another layer: a more fluid, plasticky surface, called the aesthenosphere. This is the uppermost layer of the earth’s boiling core, which bubbles away below.

When the pressure in the bowels of the earth gets too intense, the core bubbles and, occasionally, where the lithosphere is thin or cracked, explodes into violent volcanoes.

More typically, the plates are in constant slow motion, sliding glacially and peacefully over the liquidy aesthenosphere.

Where the plates interact and nudge against each other, important geological shifts take place, such as the formation of mountain belts, earthquakes and volcanoes.

Probably the best known margin is the San Andreas fault in California. The fault line is about 1,300 km long and, in places, tens of kilometres wide. Along it, the Pacific plate has been grinding horizontally past the North American plate for ten million years at an average rate of about 5 cm per year (about the same speed as your fingernails grow).

There are about ten other main fault lines across the globe, so earthquakes – both on land and under the sea – are relatively easy to locate, but predicting precisely when they will happen is almost impossible, as we saw with the Asian tsunami of December 2004.

Ireland could be regarded as living on the economic and political equivalent of the San Andreas fault, where the huge continental plates of the US and Europe grind against each other. When the world’s financial lithosphere is calm, we prosper in what economic geologists might term a false sense of security. When the giants move in opposite directions, we find ourselves in an uncomfortable position. We are consistently compromising, altering, adjusting and re-balancing.

This constant juggling has had an impact on us, our political system, our expectations and national philosophy. This ‘Ameropean’ geopolitical stance is evident in the chat before elections.

Next year, for example, Irish politicians, commentators and the electorate in general will display a split personality in claiming that we can deliver the tax system of Texas and have the social-welfare system of Sweden. Our discussions will centre on the utopia of lower taxes and better health, education and social security services. You can have one or the other, but not both.

The roots of this dichotomy are old and hark back to the fact that, over the past 30 years, Ireland has positioned itself politically at the heart of Europe (initially to move out of London’s orbit). Economically, we have moved away from the European model and jumped into America’s boudoir.

The European political move has meant that our politicians adopt the language and posturing of the European left-of-centre consensus, with its ultimate promise of a strong state providing a functioning safety net (this will be evident in the minister’s budget speech).

Yet this rhetoric is in direct contrast to the realities of being part of the US economic space. We have adopted American policy on taxation, investment, trade and business attitudes. We have stopped short of the American ‘get-a-job, bum’ attitude to the poor, preferring – but not delivering – the less unpalatable European ‘the-state-will-provide-from-cradle-to-grave’ approach to poverty.

So we are a bit like a jockey riding two horses. When the horses are moving along in tandem, the jockey’s position is tenable and almost comfortable. When our European rhetoric does not undermine our American values, we – like the jockey – can ride both steeds effortlessly. But when the two horses move in opposite directions, we have to choose.

What makes Ireland unusual is that it is the only EU nation that benefits more when Europe is weak and America strong.

The fusion of monetary economics, trade flows, immigration, demography and investment flows explains this. When Europe is in recession, Irish interest rates are extremely low to reflect this. But because we are much younger than the rest of Europe and young countries spend more, we get a free lunch.

We get German interest rates that fuel the Irish boom. On top of this, when Germany is weak, the dollar is strong against the euro. This makes Ireland look cheap and hyper-productive to American investors, creating more jobs here, reinforcing the injection of German cash because, as our incomes rise, we can borrow more without necessarily feeling the strain.

In addition, we still do twice as much trade outside continental Europe as within it. So we benefit disproportionately when the rest of the world is growing faster. In contrast, we do not get a huge payback from a robust Europe.

Also, because migrants from central Europe are so essential, we benefit when unemployment is high in Germany and France, because it makes their decision to come to Ireland easier.

We are unique in the EU in that it suits us to have a weak Europe. We are bit like a parasite feeding off a bloated and sclerotic Europe, which is too lumbering and slow to swat us away.

This bizarre set of divided loyalties holds true, not just for economics, but for politics, too. When Europe is economically fragile, the ambitions of some of Europe’s more deeply federalist politicians are thwarted.

The continent can only expand when there is a tailwind of positive economics at the national level.

If people are worried about their jobs, the last thing they are going to do is support what is perceived as a pampered elite with superfluous ideas and potty projects.

This is what we saw in last year’s constitutional votes, where the metropolitan elites were out of step with ordinary voters all across Europe.

This development is unambiguously positive for Ireland. As semi-detached Ameropeans — half-European, half-American – the prospect of a strong federal Europe challenging America properly in either foreign affairs or global economics might force us to choose, which is something we are loath to do.

The art of playing both sides is that you should never commit to either.

This is always easier when the relationship between your two suitors is very slightly unequal.

The falling dollar might be signalling that the inconsistencies in America’s economy -namely the huge budget deficit, current account deficit and rapid indebtedness of its population – are making themselves felt.

Equally, the more muscular performance of Germany in the past week suggests that, cyclically, Europe might be properly recovering. This is bad news for us.

Watch these developments because, notwithstanding all the media razzmatazz surrounding Wednesday’s budget, the big global trends will have more impact on the Ireland of the future than local sideshows.

  1. Tony D

    Good article, Your quite right but I disagree on Germany, that recovery will be short lived and as for the dollar, it should bottom in the next few weeks

  2. shtove

    Will be interesting to see how low the dollar can go, what effect that has on US inflation and credit-funded spending over there. If US investment in Ireland shrivels, what choice is there but to integrate further with Europe and protect jobs by hiding behind the customs union barrier? Or will the Chinese come to our rescue?

  3. john

    Does Ireland actually need to be supported by a larger country,a few weeks ago you said now was the time to align ourselves with China and other emerging powers.
    I have heard before Ireland is too small to survive alone even within Europe,yet countries like Switzerland population about 7 million seem to manage ok.
    I would be interest to know what Ireland is lacking that makes us so dependent.

  4. Glen Quinn

    I agree. Ireland should be able to stand alone. We have very experience business people and countries like Luxemburg can manage fine.

    What is lacking in the country in order to achive this is politicians with big round balls.

    We need to redefine our exisiting tax structures to help young developing companies to grow quicker and stronger. Ireland needs to get rid of that ridiculous reinvestment tax (All profits must be spent before the next tax year has ended or the profits are taxed again at 12.5%), this tax makes companies take out larger loans and to spend all of their profits and as soons as a recession comes along, bang companies either go bankrupt or lots of employees losing there jobs or both.

    If there are no companies then there are no jobs and also no economy. The more jobs there are the bigger and better the economy will grow and then we do not need anyone, but the World will need us.

    I would get rid of corporation tax all together.

  5. laura

    I’ve been watching the dollar’s slide over the last week or so with interest, as it seems to have begun (or perhaps reinforced?) a slump. As a regular investor in US shares, I am conscious of the rate changes of the last 5 years as I recall paying much less favourable rates to buy shares in various US companies a few years ago – and noted also the differential when I came to sell some a few years down the road (though still made a neat 100% profit ;-)

    Now all the news from the US based newsdesks seem to get bleaker everyday – a “jobless” recovery, falling property prices, a massive trade deficit and considerable strains at the edges. One of the benefits of working in global companies is that you are forced to see outside the narrow blinkered mentality that a lot of people who work in the public sector and domestic companies see.

    I’m curious as to why you didn’t also mention the volatility of US equity markets over the last few weeks – the last 3 weeks seem to have been a whirlwind of succesive rises and falls – one really is left wondering if pride really does come before a fall.

    What worries me most in the Irish market is that the very aspects of the market which have built the last phase of economic succeses over the last 5 years (from 2002 on) are those which public opinion seems to be rapidly becoming hostile to: downward pressure on wages in the lower end of the job market, a healthy influx of work-hungry eastern Europeans, and a stabilisation of the private rented sector. But every day I hear hearsay of nasty, bigotted racist comments increasingly pitched against Eastern Europeans (to give you a particularly extreme example: one girl reacted to the news that the lady shot in Swords was Lithuanian with delight at the fact that another one of “them” was dead) – yet they’re a big factor in keeping the private rented sector from collapse, and wages at a stable level.

    Another concern I’d have is that there is still so little inward investment by Irish people into non-property investments. I find it particularly ominous that large property funds are agressively marketing funds based in countries where the sector has consistently fallen in value for each of the last 4 years as “poised for a rebound, after several years of underperformance.” This refers to an economy it the midst of its most severe depression in 50 years: Germany. Obviously its potential investors (idiotville if there was) haven’t read this from the popular Moneyweek column: “Commercial property investors would also be well-advised to take a look across the Channel to Germany for a reminder of the potential dangers. Deutsche Bank has frozen its €6.1bn Grundbesitz-Invest property fund. This is to prevent a rush of investors from pulling money out ahead of an asset revaluation that could see the group’s assets written down by up to €1bn. The decision to prevent people from withdrawing their money “is unique in the 40-year history of open-ended real estate funds” said one analyst.”

    What I think is the current danger is that the constant fall in value of the dollar against the euro makes Ireland/Euroland more and more expensive relative to other economies. Those who point to the “confidence” of companies investing in Ireland should take note: I’ve worked in 3 major companies since 2000. Company no.1 announced in 99-2000 that they were creating 250 new positions in the dept I worked in: in 2001, 125 of these roles were laid off. In the same year another company who I subsequently worked for boasted of its setting up of a world wide shared services centre in Cork, employing 200 people. In fact 100 of those jobs never materialised, and 50 of the remaining 100 were laid off in 2004. Lastly another place I worked for boasted of its setting up of a management centre, employing 60 people in late 2005.

    It got up to a maximum employment level of 6, and shut its doors, making them all redundant last week.

    So out of a promised 510 jobs, only 356 materialised, and only 175 remain. Since most of these jobs are financed in dollars, (and a large percentage, if not the majority of existing, pan-national jobs are similarly financed), it also suggests that a devaluation of the dollar would hit both existing and future job creation here.

    “The reality is that when overseas investors ask to be paid back, it is unlikely that the US will be willing / able to pay them and will, instead, chose to devalue its currency rather than pay back the debts which have mounted up. Once overseas investors recognise that the US cannot and will not pay back its debt without a significant devaluation (essentially a write-down of debts since they are dollar denominated), the race to the exit will begin. That this will be bearish for the dollar goes without saying.” (See

    The question is not if but when this will impact Irish jobs. If a cutback level of 15% impacts MNC jobs here – it means as much as 15,000 jobs could vanish quickly. If this coincides with a slowdown in, for example, the property market – and has an impact on dependent jobs – it wouold not be unrealistic if the actual net job loss could as much as double.

    Its quite a chilling though when you consider that this figure almost matches the entire job creation for the whole of the last 12 months! Enough for this week!


  6. Ed

    I can’t see many difficulties for Irish based Multinationals that trade with both Europe and the U.S. They can juggle around to offset the gains from one market to compensate for losses in the other. It’s the indigenous companies that are at greatest risk – to compete with U.S. companies selling into Europe and elsewhere, they will probably have to consider outsourcing some of their production to China. Someone mentioned customs barriers – well, the W.T.O. has taken care of those, so they are no longer a means of defence.
    John asks why we can’t stand alone like Switzerland – we are a much younger country and we don’t have an industrial tradition. It would take a enormous effort to come anywhere near Switzerland or Finland in terms of indigenous industrial capacity. At the moment, we can only play to our current strengths and that is providing a secure base for Multinationals in Europe. We should, however, be learning from them and encouraged to break out to produce niece products to either augment or complement their products.
    On of our main problems is that our politicians have not had exposure to big business and sometime ago when Dr. Ed Walsh suggested that graduates should emigrate to gain experience abroad, he was almost run out of town. Well we can’t have it everyway!

  7. Mark

    If I’m completely honest, I didn’t read ALL of the above, but I did read a good article in The Times today predicting a $ re-bound from a contrarian perspective. Plus I always thought that predicting currency movements was as easy as predicting the lotto numbers. Harder even!

  8. Gemma

    I read your articles every day they come out and I love the comments. I am no econmics expert in anyway and I am one of those “kid-dults” who is 30 spent my twenties have a blast all over the world and realise that I need to decide where I want to live. Therefore I am back here getting skilled up!!

    However I do feel that people are disillusioned and I feel that it is an awful pity. I think that there should be no reason why this economy should not be able to sustain its performance. I feel that Ed’s comments are right we have our advantages as being a good base in Europe for multinationals and we should focus on that strength. I feel that we should merge the education system with an ideas based system encouraging our students to be innovative in their fields. I know these comments are general but we there is no reason why we cant grow or at least maintain it.

    Catholic Guilt seems to be alive and well in this new Ireland.
    We should be happy with what we have achieved but continue to be better and be open.

    However I do agree that personal indebetedness is a problem.I am one of those sad people who has to have my money saved in order to do something after which it will be all blown. However that said maybe I am losing out in not taking more risks with money.

  9. Mairead

    The biggest problem in Ireland has to do with the lack of critical mass and sophistication in the economy. Obviously we have had phenomenal growth in the past decade but it has been rooted in get-rich-quick schemes like incentives for foreign investors and property investment. Even now, after a decade of the Celtic Tiger, an Irish person who invests in stocks and shares is rare. Most people view property as the only option when they speak about investment, which is very naive.

    If the government uses the profits (e.g. current budget surplus) from these initial get-rich-quick schemes to re-invest and encourage high-end economic activity then it might be useful but the current FF government seems distinctly lacking in imagination when it comes to economic strategy. They’re content to just let the housing market and cheap labour from immigration tide the country over.

    Ireland has been uniquely lucky in occupying the San Andreas fault, as David calls it, between the US and Europe and has profited massively from this in recent years, as David points out. The government is not tackling the long-term sustainability of this position, however, and is just prevaricating rather than trying to manage the challenge. If the dollar does take a drastic slide (not very clear at this stage how things will go) then the repercussions could be huge, not just for Ireland. The government shows no signs of wanting to face up to this, however, and is just content to allow Ireland to be buffetted along by various trade winds.

    As for Ireland being independent like Switzerland: it’s a bit late for that. That could have worked if pursued as a consistent policy since 1922 but you can’t join up to the global community and then pull out when the going gets rough as this damage confidence in the Irish economy and you would be back to square one. Protectionism is not an option for Ireland as most of our growth is reliant on a.) low interest rates due to Eurozone issues and b.) foreign investment / cheap labour. In any case the world economy is now more globalised than ever before (except maybe in the period of the British Empire just before WW1) so protectionism coming from a tiny country like Ireland would be pretty futile. We’d lose much more than we could gain.

  10. David J.

    Listen up folks, we import over 80% of our energy…does anyone think that’s sustainable? That’s our major problem but more symptomatic of a bigger problem for our future and future generations.

    Social entrepreneurship, sustainable businesses, design for sustainability, eco-innovation, eco friendly community-industry-university-government partnerships, renewables, energy co-operatives, fair trade, greening the supply chain, green education, organics, are all opportunities for us and should be buzz words but we aren’t embracing any of them in a significant way.

    We could follow ‘The Natural Step’ approach to growth and prosperity, whereby we develop sustainably and still prosper at the same time. We could actually regain a quality of life, foster better attachment with nature, educate the next generations to preserve rather than destroy. We should be protectionist in terms of our environment in Ireland but political parties have the election goggles on and are not engaging in ‘Visioneering’ at all.

    We have an opportunity to turn this ship now before we run aground.

  11. Wessel

    Some of the comments in this thread appear to wish the dollar back to higher grounds. This may not be in the interest of the American govt who is in a tight squeeze with a budget deficit that is exceeding $60 trillion and very little that can be done about it (there is the small matter of a few costly wars).

    The signs are there that in the US the foreign investment outflows have started, especially after the ominous announcement from the Chinese Central Bank on Nov 9th that they intend to diversify their foreign currency holdings.

    The bursting of the current US housing bubble is at least only halfway there, if one is to go by previous bubbles. The average depreciation of the housing median price historically has been 20%. The current year-on-year decline is 10%. The houses-for-sale to house-sold ratio is exceeding 2:1. In other words the real hardship for the ordinary US punter is still lying ahead. The ripples haven’t yet started.

    The classic tripple whammy will be completed when the Baby Boomers enter the Social Security net.

    These volcanoes put David’s comment that Ireland is the European country most dependent on the US economy in perspective.

  12. Finbarr

    Do people really expect the yanks to sit around and take it. The republicians in the US will not want to come into the next presidental election without something been done by the imcumbent to stop the economic slide. This happened in 2002/2003 also. Business friendly tax changes were the order of the day then. My point is no-one seems to think the US can do anything to help itself in it’s current slide. Obviously Bush couldn’t manage his lose change, but there are alot of aces up the sleeves policy wise to be explored by the US and expect deals to be done especially with china. Dont think the US have nothing to offer them..

    Irelands position is not so much like existing on a fault line but rather more surfing the wave that is created as this fault shifts. How well we learn to surf is as much as we can do and the waves will change as time moves on. We cant plan for whats going to happen – we are at it’s mercy. We can only try not to injure ourselves. How long can we stay up for? thats the question. Been remote and small is not helpful.

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