February 4, 2009
Uncertainty is spreading like a virus in a crechePosted in International Economy · 166 comments ·
On Monday afternoon Killiney Hill was full of delighted children, squealing at the sight of snow. Many had never seen snow before. The children screamed as they threw snowballs and rocketed down the side of the hill on makeshift sledges.
However, the most striking aspect of the scene was not the unexpected snowfall and the dozens of children, but the huge numbers of fathers with them.
These men, all in their prime with young families, mortgages and up until recently careers, are the newly unemployed face of middle class Ireland. If something is not done quickly, their number will swell to hundreds of thousands.
While much of the media attention has focussed on partnership, the most terrifying news this week was the collapse in car sales.
In January, car sales fell by 67pc from 47,609 to 25,929. The Irish car industry is going bust. The economy is seizing up. No-one has any cash and companies without cash-flow are going bust. This week alone three friends of mine told me they are going out of business.
While the Government and the social partners play musical chairs in Government Buildings, out in the real world, the Irish economy is moving steadily towards bankruptcy.
No-one in the partnership charade seems to realise that to pay the bills, we have to generate income. We only generate income if we can sell our goods for a profit and with some of this profit pay tax. If this is not happening or if we can’t sell, either at home or internationally, the State runs out of money and we default. This is a process that is well under way here and no amount of interviews with the Taoiseach will obscure this.
Let us be clear what is happening here and why this has got nothing to do with a pay round. A pay round is based on the old economic of inflation.
The dynamic is grounded on the premise of keeping costs down, so that the difference between costs and final prices is sufficient to make decent profit. But this misdiagnoses our problem. Ireland’s problem is that a monumental housing and debt bubble has just burst. This has causing the forced sale of assets which has caused an enormous contraction in the nation’s perceived wealth.
Deflation takes hold and it causes people and companies to go bankrupt which leads to the banking system imploding and the economy moves into a depression. As people feel that deflation is around the corner, they put off spending until the future when they feel they will get a lower price. So how do we get out of this?
The first step in getting out of the problem is realising what your ailment is. Old-fashioned economics tells us that when the price of something falls, the demand rises. Well this is not always the case here. In fact, these days because the country is gripped with fear, when the price of something falls, the demand does too. To understand this better, let’s construct a little picture of what is going on in the economy.
Let’s be trivial and call the dilemma of the Irish economy, the ‘Midnight at the Olympia’ model of deflation. Do you remember Midnight at the Olympia? Cast your mind back to the early to mid-1990s before the pub licences were liberalised. One of the few places you could get a late drink was Midnight at the Olympia where you could pay a tenner and get two extra hours drinking if you could bear 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. He did not realise that when he stood up, he forced you to react. In fact he was totally unaware of your presence at all.
Then you stood up and this had a negative impact on a person two rows back and so on. Deflation works in precisely the same way. You decide not to buy a car because you think prices will fall and, unbeknownst to yourself, your decision affects someone else, who because you won’t buy concludes that car prices will fall further and he doesn’t buy.
This takes hold all over the economy and very soon the price of everything is falling. Like a theatre where everyone ends up standing because of the actions of one person, an economy can experience a reinforcing deflationary spiral as everyone pulls their horns in.
Economic insecurity and uncertainty works like a virus in a creche — once one child gets it, everyone does.
This is what is happening in Ireland and it threatens to overwhelm the Irish banks who will see a wave of defaults this year initially on mortgages but then on credit cards, car loans and all forms of short-term credit deals that propped up the bubble economy.
The problem is that the only way we can prevent the economy from contracting in a deflationary spiral is to engineer inflation by pumping money into society, dramatically easing credit conditions and forcing people to spend.
This means, when our banks are frozen in a zombie-like state, expanding government expenditure. Ireland has chosen to do the opposite and deflate into deflation. Expect more idle fathers on Killiney Hill and every other public space in the country as the Irish economy moves now into freefall.