July 22, 2010
Why are interest rates for Irish debt rising? Because the risk of a blowout here is rising — it really is that simple
IN THE summer of 1787, determined to show foreign ambassadors the might of Russian power in the newly subjugated Ukraine, Catherine the Great organised a boat trip down the Dnieper, past modern-day Kiev.
Her trusted field marshal — who was also her lover — Prince Gregory Potemkin organised a series of mobile villages to appear as soon as the imperial barge, stuffed with innocent and gullible foreign dignitaries, came into view.
When the boat came within earshot of the river bank, the villagers would break into a spontaneous, sycophantic chorus of praise for the empress, giving the perplexed foreigners the impression that not only had Russia pacified Ukraine, it had also managed to win over the local peasantry — which was no mean feat in the 18th Century.
As soon as the imperial barge turned the corner, the villagers would dismantle their villages and rebuild them overnight further downstream, with a view to performing precisely the same malarkey the following day.
This continued each day for over two weeks. The overwhelmed foreign dignitaries then reported back to Berlin, Paris and London on the marvel of the Russian conquest and pacification of Ukraine.
Thus was born the ‘Potemkin Village’ approach to economic and political progress. Over the years, the Russians perfected this approach of half-truths, misinformation, disingenuous analysis and obfuscation.
Russian governments perfected the art of identifying culprits on whom to pin the blame for their own failings: Jews, Poles, profiteers, priests, intellectuals, kulaks, enemies of the revolution and so on.
Typically, if there is a problem, a few culprits are rounded on and grandiose decrees are announced to fight the evil, whether it is economic, social or political.
Our Government behaves the same way. The truth is always secondary to the spin. So during the ‘binge’ (because it wasn’t a ‘boom’, it was a splurge), the Government accused the few who saw through the hype of “talking down the economy” and tried to pin the slur of “doom-mongers” on others.
Now, we know what was going on. Yet, despite this, no lessons have been learned. We see again today the Government complaining about too much “negative” comment. They just don’t get it.
Analysis is not about positive or negative anything, it’s about the truth and telling it like it is. And in truth, the situation is getting worse.
We are not turning any corners. In contrast, we are being subjected to a series of economic Potemkin Villages — such as guff from silly politicians — that are designed to obscure.
Before we get bogged down in more spin, let’s look at the facts.
The Live Register is at 444,900. The ESRI predicts that 120,000 will leave the country in the next 18 months, on top of the 100,000 who have already gone in the past 18 months.
Government income is only covering 70pc of its expenditure (that is before accounting for the bailout of Anglo.)
Our national debt is heading inexorably towards 100pc of GDP, driven by both our falling GDP and our rising debt.
And now that the State is paying nearly 6pc interest on our debt, this means that the debt-to-GDP ratio will spiral out of control. A simple rule of thumb on debt dynamics is that if a country’s debt gets to 100pc of its income, the growth rate has to be greater than the rate of interest on the debt in order for the debt to stabilise.
Our growth rate will probably not hit more than 6pc again in a generation. So without huge increases in taxation and deep cuts, the deficit will spiral out of control. But the more you cut and tax, the less the growth rate and the more the efforts to cut the debt fail. This process — known in economics as a ‘failed fiscal adjustment’ — occurred all over the world in the 1980s.
This is why the markets are penalising Ireland. As pointed out by Paul Krugman, the Nobel prize winner for economics, far from being rewarded for our orthodox, IMF-friendly deficit-cutting programme, the markets are charging us more for debt. Why are interest rates for Irish debt rising? Because the risk of a blowout here is rising. It really is that simple.
The internal inconsistencies will overwhelm the whole effort.
Think about it. The latest NAMA loans transferred from Irish Nationwide have a discount of 72pc. This is just junk.
It means that the value of the loans extended against property during the binge have fallen by 72pc. And we are supposed to pay for this.
Because of this collapse in loan quality, the banks — which we are stupidly trying to save — need to get money from somewhere, anywhere. So yesterday, they announced that mortgage rates for 300,000 people will be increased.
What do you think this will do? In a situation of rising negative equity, rising unemployment and rising taxes, higher monthly interest payments will obviously lead to increased defaults.
The ‘haircuts’ we are seeing from the ‘big guys’ in NAMA will be repeated for the ‘little guys’ all over the country in the form of mortgage default.
This is why the financial markets are worried — because they see the steady path towards bankruptcy. And investors realise that there will only be a recovery when the return on equity rises dramatically. This will only happen if either we become considerably cheaper or productivity rises rapidly.
We can’t get manifestly cheaper while we are in the euro and we can’t raise productivity unless we have a massive increase in investment — but investment is collapsing.
So we are stuck, staring down the barrel of bankruptcy.
Instead of this honest — if admittedly unpleasant — analysis, we are forced to listen to so-called economic commentators bleating about practically inconsequential press releases from multinationals who might want to employ a few dozen people here and there.
But by focusing on these tiny scraps, some parts of the media are behaving like propagandists for the State. They then appear surprised when the facts on the ground don’t match the rhetoric of the spin.
This press-release approach to analysis is the Potemkin Village of modern Ireland — and obscuring the truth does nobody any favours.