May 6, 2009
One of the things about crises is that they tend to blow the credibility of shibboleths out of the water.
A shibboleth is a mantra to which people get attached because it is easier than hard thinking. If enough people repeat the mantra it becomes gospel, and instead of using our heads, we exchange alleged truisms. Ireland’s been exposed to enough shibboleths in the past five years to last us a lifetime.
One of these was “property only goes up”. The second was “the fundamentals are sound” which, along with “this time it’s different”, are particularly costly mantras. We also got the “soft landing” shibboleth. Or what about the one last October, “our banks are well-capitalised”?
Well we all know where these mantras have landed us. If you are not aware what is going on in our country and you have access to the internet, have a look at the following clip of the unemployed queuing in Dublin on www.youtube.com/watch?v=Cf31q4TC790. Much has been made of this clip already, but it’s worth looking at it again.
Yesterday, the ‘Frankfurter Allgemeine’ ran a story about how Limerick was like the third world, while the influential US magazine the ‘Weekly Standard’ devoted its front page to our woes at the weekend. Here in Australia, a waitress — a second generation Irish Aussie — asked me worriedly this morning: “Is everything okay in Ireland?”, having just read a report in ‘The Australian’. This was a reasonable question because, with unemployment rising at this level and tax revenue falling, there will come a time, not too far in the future, when Mr Lenihan will cross the corridor to Mr Cowen and tell him that we have “no money to pay the teachers next week”.
Make no mistake about it, countries run out of money and if this happens in Ireland you can be sure another mini-Budget will be introduced and the State will expropriate whatever wealth it can to stay afloat.
This is when things get critical, and rather than putting a plan B in place for this event, the State is again clinging to a mantra rather than examining our options.
Anyone with a basic understanding of economics knows that we can’t deflate our way to growth. The problem is a lack of demand. People are hoarding money. There is plenty of money in Ireland, but as we are hoarding, this money on deposit doesn’t translate into cash spending.
Monetary policy in Ireland is broken. The banks are now too sick to play an active role in refinancing the economy, so therefore the economy continues to contract. As taxes rise, this has the same effect as taking cash out of people’s pockets so we spend even less.
On top of this, we face the twin spectre of wages falling at a time when our debt burden is rising. Wages will fall because there are simply so many people on the dole prepared to work for less than their neighbour. The debt burden is rising because so many people who bought houses at the tail end of the boom on low interest rate deals are now facing those “enticement” rates rising.
What can we do about this? The obvious answer is to leave the euro, reinstitute our own currency, allow it to plummet to reflect the real competitive position of our ruined, feeble economy and start again. The vast majority of economists and commentators say this is not possible. In fact, they ridicule those who suggest that this might be worth entertaining.
Let me just remind you that the vast majority of economists and commentators believed the “soft landing” mantra. New ideas go through a cycle. First they and their proponents are ridiculed, then they are violently attacked and only then are they accepted as a universal truth. I suspect the same will happen to the idea of leaving the euro.
There are clearly issues with doing something as radical as this, as it would have to be coincident with a lifting of all state guarantees on interbank lending. The State could still guarantee deposits in the new currency. Many investors who owed the Irish banks or invested in Irish government bonds would get burned. But that is the nature of markets. They would be paid back in the new currency, which would have to find its value.
The new currency would fall rapidly, giving our trading sector a significant boost and making Ireland cheaper overnight for people to do business in. Clearly, the government deficit would have to be addressed through strict spending targets.
As the Central Bank would do what the US, UK, Australia, Canada and Sweden are doing now and print money, the liquidity trap that we are in would evaporate. Clearly inflation would rise rapidly, and the State would need to introduce CPI-linked bonds to refinance itself.
But lots of successful countries have done that in the past — Sweden, Finland and Israel come to mind.
There are more than enough domestic savings to cover any government short-term shortfalls. In fact, inflation in Iceland, a country which embarked on a similar policy last September, shot up but has now collapsed. Clearly, the Irish banking system that gambled in Euro would be bankrupt. But banks are only institutions and maybe that’s no bad thing because it would allow a new bank (or banks) to emerge. The price of land would fall dramatically even in the new currency but would find its level. After this, we could reboot the engine.
Unemployment would fall rapidly as it has done in practically every country which has embarked on such a policy. The Asian Tigers, after their collapse in 1997, are the best example of this rapid re-employment phenomenon. One look at the Asians or the Scandinavians should put paid to arguments about what small open economies can do.
We are already running a trade surplus and we’d run a bigger one. Our deposit base is significant. Clearly lots of money would flee the country initially, but it would come back as the domestic economy recovered quickly. Sure we’d have a lot of explaining to do politically, but we’ve to do that anyway.
There are other problems in terms of fairness. Young people with debts would benefit, middle-aged people with assets would lose out. But as most of the value of these assets will be wiped out in the grinding recession the next few years will bring, over a five-year period there might be no net change.
Obviously there are many other issues at stake, such as whether investors would re-engage with Ireland after a devaluation. Conventional wisdom says no. But conventional wisdom has been wrong from the start here.
I’ll leave you with one example of this. In 1992, conventional wisdom said that if we devalued, the economy would implode, investors would take flight and we’d pay for years. In the event, we were forced to devalue and the economy boomed.
The one thing that scares investors most is a dying asset. No one will touch it. I don’t know about you, but I’d prefer to live in a country that gives itself a chance of life, than one where the current policies can only lead to slow strangulation.