January 17, 2010
We are moving into the next big phase of the Irish downturn. The first phase was the crash itself; the policy response to it was containment at all costs. The second phase is the debt deflation phase. This is the phase in which anyone with substantial debts, no matter how dexterous or clever they looked in the boom, will go bust. Be warned: countries as well as individuals are likely to go to the wall.
History tells us that there are two types of bust: the long bust and the short bust. In general, the bust will create other policy responses, some organised, some forced.
There will be political change too – though this will be of secondary importance because the latitude to move is narrow. The long bust is the one our government has embarked on, and it involves deflation, denial and ultimately borrowing today to postpone the reckoning, in the hope that time will heal all and something good will turn up.
The long bust is based on mortgaging the next generation for the sins of the previous one via the bond market and its magic facility, the 20-year sovereign bond, which allows one generation to screw the next.All politicians opt for the long bust, because it holds out the hope of redemption and a prolonged career.
The short bust involves taking the pain now -Â writing down the debts, selling bust banks for free to someone who would do a deal with the old creditors (who are stuffed anyway). It also involves changing the currency to allow us to export more and import less and, obviously, it opens the possibility of generating a bit of inflation to make sure that the old debtors have some life left in them.
Changing the currency also allows us to see the true nature of our debts valued in a currency that has some relationship with the underlying real weakness of the economy and thus our actual – rather than imagined – ability to pay debt back.
Ultimately, from a financial perspective, both busts will involve a great transfer of undervalued assets from those with debts to those who are debt-free.
Debtors will not pay what they can’t, and most old creditors will lose out. Some people will pick up bargains, but most will be traumatised.
Rather than ‘the worst being over’, as was the pathetic spin over Christmas – a time when people are allowed to believe in Santa – Ireland is moving into the second lurch downward. Anyone with a passing knowledge of financial history or basic economic theory would know that this is the likely trajectory. It’s a pity no one in power appears to be armed with these basic job prerequisites.
Ultimately though, the long bust will run into an even more severe debt crisis. This will allow the cycle to start again with a new class of owners and a large class of debtors, some of whom will have defaulted and recovered, while others will have thrown in the towel. With mass default will come the realisation that you can’t turn a nation into indentured debt slaves nor can you condemn the next generation to some sort of Victorian debtors’ prison.
Therefore, we – that is, Ireland – will probably not pay the debts of our banking system. At the moment, if we were to pay the creditors (the bondholders) of our banking system, it would cost â‚¬94,000 per worker. This isn’t going to happen – not even in Jean-Claude Trichet’s wildest dreams. To meet them in full would be both morally and financially wrong. Debts that can’t be paid won’t be paid -that’s the way it goes. There is likely to be significant debt deferral, if not outright forgiveness, for thousands of homeowners. That’s democracy for you.
For the moment, the government is engaged in the typical opening stages of the second phase, which involves borrowing to pretend it is in charge; sadly, it is not. Pathetically, there was a little cheer when Ireland borrowed â‚¬5 billion at only 1.6 per cent over the rate at which Germany borrows, and there is the insistent spin put out which involves us and looking down our noses at Greece, which has replaced us as the dunce of the class.
We should instead make common cause with the other nations that are being bullied by the European Central Bank (ECB) and Germany – Spain, Portugal, Italy and Greece – and say: ‘‘Hold on, boys, you lent the money, it’s as much your problem as ours.”
Why doesn’t Trichet attack Germany for not spending enough? Why doesn’t he advise Angela Merkel to force the Germans to spend the surpluses they have irresponsibly built up? The EU and the eurozone need Germany to spend as much as it needs Ireland, Greece, Spain and Portugal to save. But no, Ireland’s mandarins and politicians don’t have the brains or the balls to see this, so we – in typical fashion – are trying to suck up to the big boys in the hope that we will be looked on kindly, rather than pointing out they are part of the European problem too.
We are only at the opening chapter of the second phase. Let the debate commence.
On a related point, in the past few days it has been hard not to detect schadenfreude about the plight of Bernard McNamara.
Some of the comment has been positively gleeful at the collapse of one of our biggest developers. Why should this be the case? Is it just down to the great Irish habit of shameless arse-kissing when a lad is in demand and then an unmerciful kicking when the same lad is down?
If it is, we had better grow up, because McNamara is a microcosm of our country’s financial predicament. If he can go under, so can this country. In fact, if he goes, it’s likely that Ireland won’t be long after him.
By this, I mean that there is no difference between McNamara’s business plan and that followed by the rest of the country. He borrowed money to invest in property in the hope that he could sell the stuff on to someone else for a higher price. Was that not the country’s basic business plan?
It certainly appeared to be the plan of some of the country’s richest folk, as evidenced by the row between the clients of Davy Stockbroker and McNamara. The ‘high net worth’ clients invested â‚¬63.5 million to part-fund – in what is termed ‘mezzanine’ finance – the Irish Glass Bottle site deal in Ringsend, which was supposed to be worth â‚¬412million.The site is now worth a fraction of that and the house of cards has come tumbling down.
This is no different to the rest of our national loan book, except for the fact that, in contrast to our government, McNamara could no longer borrow to paper over the cracks.
We can still borrow, but this is just part of the long-bust strategy. When you have private sector debt that is three times GDP – before you take into account the fact that public debt is moving towards 70 per cent of GDP and prices are falling by 5 per cent a year – the short-bust is the best of the bad options.