March 15, 2009
The other day, I went autograph-hunting with my son. We’d seen the rugby team at our local hotel, and nothing would come between a six-year old and the prize of an autograph. So off we went. The image of a giant Paul O’Connell bending down, while on his knees, to sign a tiny little man’s autograph book will stay with me for many years.
Likewise the excitement on a six-year-old’s face, his whole body shaking with the thrill of being picked up with one enormous hand by smiling Jamie Heaslip and popped up on the Number 8’s broad shoulder. Peter Stringer, Jerry Flannery and Tommy Bowe could not have been more decent, chatting away to the young fella, who could hardly contain himself. This is what sport and sporting heroes are all about.
Paul nattered away for awhile on the game, the championship, Munster and Ireland before the topic eventually turned to the economy. He professed to not having had any interest in the subject before this crisis, but now couldn’t get enough of it. Interestingly, he explained that the implosion of the economy was having a profound impact on these players.
He spoke of the fact that, in the past, international players, in a city like Limerick particularly, could have depended on a job in an insurance company, a bank or a car dealership when they hung up their boots, but not anymore.
The giant Irish lock – a man you’d have behind you in any scrap, a man who has faced the haka without flinching, who has stood up to and intimidated the hardest men in international rugby – was afraid. He feared the future. Make no mistake about it: this recession is going to affect us all.
This is why it is depressing to hear the uniformity of opinion backing the government’s emergency budget proposal. When the mainstream economic profession, the Department of Finance mandarins and the commentariat are foursquare behind any idea, it is time to worry.
Remember, none of these guys in the mid-2000s saw the bust coming and, possibly more to the point, back in the mid-1990s, none of them predicted the boom, so why trust them now?
A possible reason to explain why they did not see the boom coming nor the bust on the horizon is that they do not think like economists. They seem to have scant regard for something called the economic cycle, which in Ireland is largely driven by credit.
We experienced a credit-driven taxation boom as abundant credit flowed into the economy, which made the exchequer figures look great a few years back. Now we are experiencing a credit-driven taxation bust as credit has left the country. This is the crux of the issue.
Ireland is going through what is termed a massive de-leveraging period. At the height of the boom, the banks were lending 160 per cent of their deposit base to the domestic economy. A significant proportion of this tsunami of cash found its way into the government coffers and bloated the tax take.
Now the opposite is occurring. We are in a liquidity drought, where there is precious little new lending. The banks are trying to get their lending back to a ratio of one to one with their deposits and loans, so credit dries up and the tax take suffers.
No amount of tax hikes or expenditure cuts will change this. We are confusing economic and liquidity factors with accountancy and the balance sheet. An elementary mistake, clearly, and one which could be excused in Leaving Cert student, but not in paid professionals.
The upshot of this monumental policy mistake is that this budget will not make the underlying dynamic of our budgetary dilemma any different. In fact, it is guaranteed that we will be faced with another emergency budget in the late summer or early autumn. The cuts and tax hikes will do nothing to bring the liquidity back, and therefore tax hikes and expenditure cuts will beget simply more of the same – further tax hikes and yet more cuts.
This conundrum needs to be explained clearly. In a monetary union a liquidity crisis does not need to be permanent. The only reason membership of the euro is of any benefit to Ireland is if we regard the ebb and flow of liquidity as temporary, as a state like Connecticut does in the US.
When investment opportunities present themselves again in Ireland, money will flow back into the country. So, for the moment, the key thing is to hold the line, to preserve jobs and dip into this huge European pool of savings to tide us over. Cutting the number of teachers or reducing the number of beds in our hospital won’t change the big picture, but will undoubtedly affect many people’s lives detrimentally.
None of the above means that we should not be concerned about the public finances, but we need to disentangle cause and effect. Clearly, we need to broaden our tax base over the coming years, which will imply raising taxes on wealth, housing, corporations – and modestly on income.
Obviously there are expenditure areas that need to be reined in. But equally, we have to be ready for the next upswing, and so we need to have the infrastructure in both human capital and physical capital in place before that.
Ireland should implement a seven-year fiscal plan now, which would allow us to broaden the tax base gradually with the key notion of delivering proper services and productive infrastructure. Nobody needs to panic.
Cutting wildly now and raising taxes simultaneously is not the answer. In fact, this will precipitate another fiscal crisis – and another and another. Ireland’s problem is one of liquidity, and this is a short-term dilemma in a monetary union.
As this column argued last week, some time in the next few years, this problem will right itself, either through a Euro-wide bond issuance, a national recovery bond or through the international cycle playing out its course. We simply need to think clearly and stop behaving like accountants, terrified by the tyranny of the balance sheet.
We have loads of scope to borrow, both internally and externally and, more significantly, when liquidity flows again tax revenue will skyrocket and the deficit will disappear as quickly as it emerged.
There is no alchemy; this is just how the cycle works when monetary policy works. Today, monetary policy is not working, because the world is hoarding money. But this will pass after a period of interest rates at zero per cent.
It is crucial now that the world – and Ireland- creates inflation, not deflation. If we haven’t the stomach to print money (which would be by far the easiest exit route),we need to turn on the taps through government borrowing.
We are in exceptional times so we need exceptional measures. Like a good rugby team, you never learn nor win by doing the same thing all the time. If plan A is not working, shuffle the pack, try plan B,C or D until you find something that does the trick.
Nothing can be ruled out. In rugby parlance, we are sticking with the conservative economics of Eddie O’Sullivan, when what we need is the inventiveness and freshness of thought of Declan Kidney.