February 21, 2010
Business in Ireland is on its knees. Ask anyone involved in the retail trade, the advertising world or, more tellingly, anyone looking for a job, and they will tell you the same thing.
Nothing is happening, absolutely nada. So what are we going to do about it?
The government was slapping itself on the back last week as the National Treasury Management Agency (NTMA) managed to borrow yet more money. The government’s spin aimed to show that, in some way, Ireland has pulled away from the other delinquents in the eurozone. What it didn’t tell you is that we are paying more for money than either Spain or Portugal.
The facts are as follows: not only has our government failed to distance Ireland from the other vulnerable members of the Euro club, but we are still regarded as a greater risk than Spain or Portugal .This is despite the fact that the financial markets have been focusing attention on them, not us, in the past few weeks.
There are a number of reasons for the gap between the government’s spin and the facts, but the one I would like to focus on is the most obvious. Our Department of Finance – which is at least partially responsible for this mess – seems to believe that economic success is measured by whether or not we can borrow on international markets. But when you have a single currency and an EU backstop as good as in place, bond issuance tells us very little about the economy.
The truth is that Ireland doesn’t have a recovery strategy aimed at reigniting economic growth and employment. We have a debt management strategy aimed at pleasing the bond market. The way we can titillate the bond market is by promising that the next generation will pay for the mistakes of the last generation, and that the relatively poor (the citizens) will pay for the very rich (the bank creditors).Why wouldn’t the bond market like to hear that?
It’s win-win for them and lose-lose for us.
Is it any wonder investment banks are patting us on the back? They have managed – together with the mandarins in Merrion Street and Brussels – to turn Ireland into a large debt-servicing vehicle for past debts whereby we are capitalists in the boom, when a few get very rich, and communists in the bust, when we are all responsible. By limply playing this game, rather than thinking for ourselves, we preserve the Euro status quo and no one – least of all the political elite – gets embarrassed.
But what do we, the people, want? Do we want an economy that is capable of growing to reduce unemployment? Or do we want an economy which simply exists to service debts? The choice is pretty simple. If we want the former, we have to act radically to save the day. If we are satisfied with the latter, then a prolonged period of unemployment and emigration lies ahead.
Let me sketch out to you what is likely to happen in the years ahead, if we stay with the present course. Before we do that, let us remind ourselves where we are and how pathetic the government’s misinformation actually is.
The Irish economy has contracted in nine out of the last ten quarters. Unemployment among young men is over 30 per cent and rising rapidly. Emigration is, not surprisingly, increasing. Prices are falling by 4 per cent per year, which means that the real interest rate – the interest rate adjusted for inflation – is close to 10 per cent for most loans.
The banks are broken and are in a competition to get deposits in the door – rather than loans out the door. We are facing a monumental contraction of credit, as banks try to pay back money they borrowed from shortsighted, and ultimately reckless, creditors in the boom. That gap between loans and deposits is â‚¬120 billion, close to 100 per cent of GDP.
On the national balance sheet, the asset against these loans is property, which is so worthless as to have ‘‘no market’’ for it. We have over 300,000 ordinary people in negative equity. And the rest of us are underwriting Nama, and God knows how much it will cost.
Despite this vista, Ireland is lamentably uncompetitive. If you take the reality of people shopping in Newry – which is the most common-sense test for Ireland’s lack of competitiveness – we are still way too expensive.
Against this background, it isn’t surprising that the government’s fiscal deficit has ballooned. In fact, it can’t do otherwise. And with prices falling, people are postponing spending and therefore credit is contracting.
This means retail sales and employment are likely to keep falling, which in turn implies that tax revenue will be weaker than expected and government spending higher than expected, so the Department of Finance’s budget estimates will not be met. This spiral is amplified by the fall in the working population as immigrants leave and young Irish people up sticks, pushing down house prices further.
These characteristics are the vital ingredients of what used to be termed by economists in the 1980s ‘‘failed budget stablisations’’. Economic history is full of examples where a government tries and tries again to stick to a budget target, largely at first, by cutting spending. When that fails, it raises taxes and ultimately, when that fails, because it stalls the economy, the government gives up. It comes under public pressure, while the financial markets stop giving it the benefit of the doubt.
Caught in the vice of a public that has got used to a certain living standard which is now slipping away and a bond market which realises that the rhetoric soars way above the reality, the government, or a new one, goes the other way and reverses policy.
This precipitates capital flight, irrespective of the currency regime, because capital is fleeing the twin risks of taxation and default. The entire edifice crumbles in chaos and we start again.
Membership of the euro almost guarantees this outcome, because the state can neither inflate away debts nor devalue to energise the exporting sector and to generate the growth that is necessary to pay the old debts.
Ultimately, in a democracy, something has to give. What gives is the status quo, and normally with it, the exchange rate commitment. This might seem a bit over the top to you, but the story of all crises is that what seems extreme now becomes logical, what is radical becomes consensus and what is termed impossible today becomes probable as events change.
The best historic example of this was the collapse of the gold standard in the 1930s. In the 1920s, the only voice arguing against the gold standard was JM Keynes, and he was regarded as eccentric. By the mid-1930s – in the face of the depression – all countries had abandoned the gold standard as an anachronistic relic and had begun to inflate away old debts to get the economy moving.
The gradual questioning of economic orthodoxies takes time. It might take years of needless underperformance where unemployment remains incredibly high, real interest rates do too and defaults are the norm, not the exception. Ultimately, the old way – in our case, adherence to the euro – is thrown out. The only question economic historians of the future will ask is why didn’t we act earlier and prevent all the pain.
At the moment, even suggesting such ideas is heresy. But so too – back in 2002 – was forecasting that we were in a credit/ housing bubble, after which houses would collapse in value and banks would fail.
I truly wish this wasn’t the case for us. I wish we could avoid having to make the hard decisions, but we can’t. Looking at the trough we are now in, it is difficult to see an alternative. However, if we do what is logical, there is nothing to stop this country growing rapidly again very soon.
That’s the prize. Isn’t it something we should entertain? Or are we going to do what we did in the bubble: attack the dissenters and slap down sceptics with the refrain ‘this time, it’s different’?