July 22, 2007

We think like Europeans, but spend like Americans

Posted in Debt · 18 comments ·

The inexorable fall of the dollar has exposed the inconsistency at the heart of Ireland’s economic policy.

If you are thinking about your open-walleted, pre-Christmas assault on Bloomingdales and Saks, the news this week from the international currency markets will lighten your mood.

If, on the other hand, you are worried about how you will pay for the pre-Christmas New York shopping trip, then the news will strike a note of caution.

The dollar has fallen to close to its lowest level ever against the euro. Today, one euro can buy you close to $1.40,making the ‘‘cheap’’ stuff in the US even cheaper.

The annual pilgrimage to New York for shopping used to be reserved for the superrich. Not any more. Few things better sum up the economic dilemma that Ireland finds itself in than the Christmas shopping trip to New York.

This year, it is expected that more than 350,000 Irish people will visit New York – the vast majority to shop. This figure is increasing by more than 30 per cent per year and is up 145 per cent since 2001.

‘‘Next Stop NYC’’ is the name of a tourism marketing campaign launched last year by New York retailers. It aims to capitalise on the booming Irish travel market, which according to the New York Times is ‘‘the fastest-growing among New York City’s top ten origin markets’’.

The idea that a country with just over four million people could be the fastest growing of New York’s origin markets is truly absorbing. It either shows how rich we have become, or how indebted we are — or both. Whatever it signals, the one truism is that the nation of shopaholics must have some way of paying for all this frivolity.

However, the falling dollar exposes the inconsistency at the heart of Irish economic policy. This conundrum may make it difficult for us to earn the cash to pay for the splurge and, as a result, might condemn us to a few lean years.

Ireland is a bizarre hybrid in the sense that we are in Europe but act like America.

We are heavily dependent on the US. America is our largest trading partner. It is our largest inward investor. More than 93 per cent of Irish exports come from multinationals, and the majority of them are American.

We have oriented our economy towards the mid-Atlantic and, for all intents and purposes, corporate Ireland is a province of corporate America.

In our 34 years of economic union with the EU, our trade flows with the Union have increased at only a fraction of the rate of our trade with the US. Britain remains our second biggest partner. So, as we have become European politically, we have become more Anglo-American economically.

To flourish and appear cheap to US investors, we need a strong dollar. However, now we have a weak dollar. As a result, Irish workers are beginning to look extremely expensive. But those same Irish workers, who are being paid in euro, now see America as a cheap Mecca to shop in.

In fact, most of them are borrowing expensive euro and converting them into cheap dollars to buy branded goods on Fifth Avenue that are actually made in China.

The snag is that we have to pay back our borrowed euro at some stage. This would be fine if it weren’t for the daily news coming out of the domestic economy – all of which is screaming the ‘‘top of the cycle’’.

Think about the other finding released this week – many hundreds of first-time buyers are now switching to fixed-rate mortgages. There is something desperate about this.

As the housing market continues to fall, these poor people facing negative equity have the cold comfort of a fixed-rate mortgage. This will hardly ease their pain.

What we need is not fixed mortgages, but cheaper ones for those who have them, and smaller ones for those who might pay for a house in the future.

Today, we find ourselves subject to a malign economic experiment – the country is facing a housing slump with higher, not lower interest rates. No country in the world has ever faced the prospect of negative equity and a falling housing market without the cushion of falling interest rates.

We are a test case. This brings us to the central inconsistency at the heart of Irish economic policy. As we can’t cut interest rates and allow our currency to fall, we face a long slump as falling house prices cause people to rein in spending, and higher interest rates reinforce this process.

In addition, the ‘‘falling dollar/rising euro’’ means that the trading part of our economy, which should come to the rescue, will be priced out of international markets.

The only way Ireland can recover properly is to invest heavily in brainpower and industries that can compete internationally. To do this, we need to be smart, good value and fast. Yet we find ourselves hamstrung.

We can’t cut interest rates and have a more competitive exchange rate without leaving the euro, but leaving the euro would be politically unpalatable for Europhiles, and would make the cost of repaying existing mortgages (taken out in euro) even higher for those with negative equity. So we are in a catch-22 situation.

We are now at the early stages of what could be a long unpleasant cycle. If it follows the path of most economies which have experienced domestic booms and slumps, the downturn could last three to five years.

The best thing for the economy, if we want to make this slump shorter, would be to cut and run, allowing the currency to fall in tandem with the dollar and reinvigorate our exporting sector, which used to be our dynamo but has contributed nothing to the growth rate since 2004.

But we can’t do this, because every percentage fall in a new currency would be an extra euro that the indebted home owner would have to pay. (Unless, of course, we called a moratorium – but civilised countries don’t do that sort of thing.)

From an economic policy perspective, we are facing a long slowdown. We simply have no instruments available to us to engineer an alternative. We need a strong dollar and a weak euro to thrive. How did we allow ourselves, from an economic policy point of view, to become semi-detached Europeans, yet at the same time, borrow euros like drunken sailors?

Without a radical departure from the present policies -where land speculation, financed by borrowed euros, begets more speculation and more debts – we are in for a hiding.

This land chimera only creates the illusion of wealth, while all the time, the fundamental strength of the economy and the brainpower of the people are allowed to ebb away. Looking down the barrel now, there appears to be very little alternative to a recession, the brunt of which will be borne by young worker-commuters.

If you think about it, Ireland needs a floating currency now more than ever. The next best option would be a currency link with the US, not the EU. No country has ever emerged quickly from a period of debt-deflation like the one we are about to experience without devaluing its currency.

This is precisely what the US is doing at the moment. What is good for the goose should be good for the gosling too.

But we are unlikely to get any change. Where are the TK Whitakers of the present generation? Maybe they too have been blinded by the glittering Christmas lights of Times Square when the Irish frenzy gets into full swing, spending borrowed euros on branded goods made in China and priced in cheap dollars.

  1. Rsetless

    Hi David

    Same solid logic; makes sense to most who understand the basics of credit and debit sides of the ledger. This closed financial cycle has become lob sided; the government continues to describe Ireland as an economy rather than a society. Everything they have done is to facilitate the supply side of the economy (banks; corporate tax; builders; etc) rather than deal with the deficits in society (schools; health; social housing; employment quality and sustainability etc). The employment created by the supply side is poor in quality and the culture in many Irish companies remains small minded and stingy; looking to make the quick buck. The concept of Irish companies investing for the longterm is not incentivised; certainly not to the same degree as property more importantly the attitude towards reseearch and development remains adolescent.

    You mentioned in a previous article how the government might penalise/restrict terms of loans; this makes so much sense as it would allow a large degree of fiscal control not unlike controlling interest rates. When the dust settles from the inevitable recalibration of our ‘economy’ and society is left to deal with the consequences the government needs to control credit, restricting loans (domestic in particular) to 20yrs. National debt has been replaced by personal debt, unlike the national debt, personal credit is not professionally managed. This control of personal credit limits would allow a consumer to borrow as much as they like as long as they could afford the monthly repayments; but it would put an end to the lemming run which is led by the quickest (younger consumers) with little experience, unfortunately these are the first to go over the edge and with the greatest impact on society. Even if the government continues to pay lip service to the concept of society; they should care about those most affected by the coming credit crunch as they represent the future of the governments beloved economy

  2. okaycuckoo

    Leave the euro – and watch inflation go haywire. The Gulf states are steadily depegging from the dollar because they don’t want to let that monster in.

  3. Hi David,
    Great article.

    Would you say that the lower dollar value can be attributed to the Irish jobs cuts by so many US companies, which started in January and February this year with likes of P&G,Motorola & Intel.

  4. Do the Irish really “think like Europeans”? Although it will upset some of your Europhile and Gaelicophile readers, I’d have thought you a solid part of the Anglosphere. Why it was thought necessary that Ireland join the Euro never made sense to me.

    If you’d have cut your corporate tax rates and kept your own currency, you’d be just as well off in my opinion without the worry of a spiraling Euro. And I believe the Europeans still would have traded with you.

  5. Ciarán Mc

    I agree that Ireland’s decision to enter the Euro – particulalrly when Britain wasn’t joining – may have been wrong. But I don’t think having our own currency now would necessarily be the silver bullet for our current problems.

    The Euro area is not the only one where rates have pushed up. Britain is higher. The US is over 5%. If we tied our currency to one of these instead of the euro as David suggests, then our rates would have to ride in closer tandem with these currency zones – i.e. there’d be no way we could just pull our rates to the floor now to counter a slowdown, so our rates would be high now anyway.

    Moreover, if we decided to follow no currency zone and now recreated a “punt nua” under our own control, it is unlikely we’d have much scope to lower rates – our inflation is too high. The main reason the Fed is not lowering their rate despite a soft macro-economy is the fear of inflation. Here our inflation is alarmingly high already. We couldn’t pull down rates and risk a further surge of inflation and a slide into that horrible state – stagflation. (Though we might well be headed their anyway now :-(

    On the other hand, if we had retained our own currency throughout, we possibly could have avoided the housing bubble by raising the rates real early to slow it off. But that is not gauranteed either – it would depend on whether our Central Bank was acting fully independently of government and was not playing political games.

    No nirvana out there, but yes, perhaps joining in the first place wasn’t right.

  6. [...] So are the CIPD just spouting some random nonsense into to get a news headline ? We think so. Their spin on the whole ‘expected housing market fall’ is that it won’t effect jobs. But anyone with 1/2 a brain knows that it will. Less money for house will certainly mean that there will be fewer of them being made. David McWilliams wrote at the weekend about the worrying new trend in Ireland where a high percentage of new buyers are going for a fixed rate mortgage. He says “As the housing market continues to fall, these poor people facing negative equity have the cold comfort of a fixed-rate mortgage.” [...]

  7. You say “The only way Ireland can recover properly is to invest heavily in brainpower and industries that can compete internationally”. Is this a reference to a “knowledge economy”?

  8. Cloggy

    Thanks for the very clear article. It surprises me over and over again I don’t hear this analysis from Irish politicians. Especially the fact that the exporting sector has not contributed to the growth rate since 2004 is worrying. Amongst regional economists the dominant theory is that exports provide the initial and only independent factor for economic growth in a region. A country can not get wealthier by ‘taking in its own washing’. Instead the Irish public is being made believe that selling each other houses against inflated prices is structural growth. I am shocked by the incompetence of the Irish government over the past 6 years. Never have they used fiscal policy to control growth nor has there been any talk of controlling growth. Born and raised in the Netherlands, I am used to incompetent politicians, but the FF led government of the past 5 years beats it all.

  9. Aidan

    I agree that investing in brainpower and trying to develop new export-based industries is the way for Ireland to go. However, there needs to be some kind of vision behind this. Political and industrial leaders need to work together to come up with a roadmap for the future. Unfortunately people in influential positions in Ireland are currently far too caught up in short-term measures designed to enrich themselves politically and economically.
    From my current vantage point in The Netherlands I can see some major opportunities for Ireland. Despite the boom years Ireland has had most people on continental Europe still think of Ireland as a predominantly rural place. When I look in Dutch shops I rarely seen any Irish produce for sale even in places with food from all over the world. With a bit of marketing nouse, Irish produce could do very well on the continent. The Irish Independent is always so gushing about the success of Magners cider in the UK but why should that be so exceptional?
    Education is another big opportunity. The University of Liverpool has positioned itself very strongly in the on-line distance education market. Where are the Irish universities? Any time I look for courses American, British and Australian universities seem to offer things I want. I have an MBA from an American university (Webster University) that has campuses all over the USA, Europe and Asia. I took modules in classrooms and on-line. Does any Irish university try to market itself to the world? If Trinity is such a brand university ho come it is not up there competing with the world top?
    Ireland needs to do what it is good at better and learn some new tricks at the same time. The country may be the richest in Europe but it is very poor by other measures. I remember a letter from a German penpal in the 1980s where she asked “is it because your town is so isolated and far away that it does not have a post code?”. It is now 2007 and Ireland must be the only country in the developed or developing world without a national post code system.

  10. Do we not need to first develope a strong export based economy before we move onto research?

  11. okaycuckoo

    Would Ireland outside the euro – with or without peg – be comparable to Iceland, Latvia, New Zealand?

    This Economist article addresses all three:

    The world is about to pay the price of the credit orgy. But going forward, which is better: hang on to a stable currency, or float in the hurricane winds?

    Is it europhobe or europhile to want something more like the German experience than the UK experience? Or does it just make sense?

  12. John

    I thoroughly agree with Aidan’s comment. I think in alot of ways we may have to go back to basics. Ireland has the capacity to produce top quality food, not just beef but also vegetables. I believe we have to return to developing our agriculture and food industry. There is now an ideal opportunity for this as the era of food surpluses are over so producing quality food is going to be profitable again for the first time in 30 years. Also tourism now needs a kick up the behind to get some value back into it. The professional bodies have to be taken on and allow proper competition in their ranks. Of course all these are not easy measures and require alot more effort than simply lowering corporation taxes and the watching the flood of inward investment which in many ways was too large for ireland to deal with adequately, i have always thought 12.5% was too low, 18% would still have attracted investment and would have been more sustainable in the long run

  13. Damien

    Thanks for that David!!

    Great to have you back after your break, how is the new book coming along?
    I’ve just caught up on your articles and i’m delighted to report that i’m lookimng forward to returning to Ireland in 4 weeks time!! God you paint a great picture of it!!
    When we get back would it make more sense to take out a long term lease on a property??

    Keep up the good work,



  14. Steve

    I have serious doubts that Ireland can become some sort of Silicon Valley of Europe just because we think research
    and development might be a good thing for us.

    These things can take a very long time to develop. Silicon Valley in the U.S. got it’s start around 1909 when it started as
    a site of U.S. Navy research. It also had 10 world class universites feeding it research and graduates.

    It also takes a certain mindset, culture and leadership and that I don’t see much evidence of in the
    “get rich quick by indebting others” financial buccaneering of new Ireland.

    The bad news I think is that Ireland is heading for some very difficult times.
    The silver lining (if there is one) is that we will likely have plenty of low-cost houses/apartments at some point in the near future.

  15. Johnd

    I agree completely Steve,its just not in our culture to innovate ,create or invent,so the question is how to change our culture,have cultures ever changed?
    We need to dig really deep on this and do what ever it takes, but I have a funny feeling that the coming recession could help create a serious about change of attitude.

  16. Ciarán Mc

    How much of Ireland’s IT industry could be called “indigenous, innovative, and global”? Ireland has indeed a substantial – nay huge – base of IT (comparatively speaking). But take away the Multinationals, localisation and service-based companies and what is left? I suspect not very much. But perhaps I’m too negative. The real answer is : I don’t know.

    But what are the IT areas in which Ireland can build “indigenous, innovative, and global” companies?

    How can we dig out a niche? Or are we even attempting to? Are we just going at it ad hoc? Each Irish company for itself but no ‘national’ strategy? Is that the right way?

    How on earth can we compete with the vast heritage and culture of Silicon Valley where an enormous IT-Industrial-Research ecosystem has evolved?

    On this side of the Atlantic, I know that the indigenous IT industries in places like France and the UK, though not on a par with SV, are vast nonetheless. And they can survive the shock provided by the rapid entry on the scene of lower cost locations like India and China. Let’s not forget, France and the UK have big R&D budgets in defence – and these always sustain a reasonable IT base. (aerospace, aerbus, etc). They also have automotive industries – though in Britain’s case that has shrunk to almost nothing.

    So we don’t have
    1) SV’s deep heritage and deep pockets (US)
    2) Indigenous Feed-in industries to sustain IT(France/UK)
    3) Low Cost (India / China)

    So what is to be our comparative advantage?
    What is the glue that will stick our Multinationals in place as the global scene changes?

    To be frank, I’m not so sure. But I’d love to hear an upside that I haven’t seen.

  17. okaycuckoo

    All that planning is beside the point – the original Silicon Valley was just west of Boston, but events shifted it to Calif. There’s nuffink government policy can do about that.

    Ireland’s economic future depends upon the Euro, and Ireland’s relation to the Euro. As the fella says, “It’s beyond my control.” You can whip your sword out and all that, but there are bigger forces at play.

    The US is not fucked, because they chose this course for themselves and will adapt – but the American way is about to change, and freedom of speech will become a danger.

  18. Niall

    This is a tough one to clarify, but in relation to John’s wishes for our Food Industry, he has inadvertently hit on a good example of our indigenous industry … We have become a major player in the beef market, not because of our high quality, but because we have always sold high quality beef as a “commodity product” on the world market which, basically means we’re actually selling our beef at below its real value in order to compete in world markets. That’s what gives us our competitive advantage in beef. It is the same for our so-called knowledge economy, where in Germany a Masters degree will get you by, here in Ireland a PhD will be required.

You must log in to post a comment.
× Hide comments