October 13, 2010
EVERY month in the United States, something called the ‘non-farm payroll’ numbers is watched closely by the financial markets to get an idea about where the US economy might be headed. The Non-Farm Payroll (NFP) measures the national monthly payroll of all industries except farming.
Last Friday, it was revealed that 95,000 fewer Americans were on the national payroll than the month before. This outcome was worse than most analysts had expected. Yet by the close of business on Friday, the S&P 500 share index in New York had reached its highest level since May.
On the face of it, this makes very little sense. The numbers show that the recovery in the US is under threat, yet shares (and, in fact, all asset classes, including gold) rallied on the news.
The reason is because financial markets don’t know what is going to happen in the future. They call it — euphemistically — ‘poor visibility’. But the markets know that the government has poor visibility too. So the market players are asking themselves: “What would I do if I was the boss of the Federal Reserve?”
Using this logic, the market looked at Friday’s disappointing NFP numbers and decided that the authorities would kick off a second round of ‘quantitative easing’. This expression is shorthand for printing money.
More freshly minted dollars will be coming on to the market, pushing asset prices higher. Therefore, it is sensible to buy assets now — even if successive statistics show that the economy is still weak.
There are lessons in this for us. For Ireland at the moment, the policymakers whose reactions matter are not in Dublin, they are in Brussels.
Any investor looking at Ireland will have learned by now that policy decisions and announcements from our Government are quickly shown to be either overly optimistic or just plain wrong.
It is the European Commission in Brussels and the ECB who are now making the decisions that will decide our fate. So it is quite unfortunate for us that recent ECB policy changes seem to point to less support for our banking system.
Over the weekend, ECB executive board member Juergen Stark even raised the spectre of interest rate rises by the ECB to quell inflation worries in the broader eurozone. Obviously, either one of these, if they were to come to pass, would be disastrous for Ireland’s economy.
If the ECB reduces the generous support it currently gives our banking system, then we would quickly find ourselves back in the position we were in on the night of the guarantee.
The banks would be unable to refinance their debts in the market. Furthermore, this time, another guarantee would be useless because the creditworthiness of the State is very much in question at the moment.
An ECB interest rate hike would be disastrous for Ireland’s already-struggling mortgage holders. But it is not only ECB interest rate decisions that will be putting pressure on mortgage holders.
The fact that the commission requires us to reduce our deficit to 3pc of GDP by 2014 is likely to have the same effect. There is only one place where people will be hit by the coming Budgets — and that is in their disposable income. Even if interest rates don’t change, government austerity measures must ultimately lead to income tax hikes. In addition, the Government is sure to increase indirect taxes, such as VAT.
In the US, policy decisions are expected to lead to increased liquidity measures. This will further devalue the dollar, but may keep that country out of a second great depression. This outlook also implies a rise in the euro against the dollar.
For Ireland, the decisions with which we are faced, urged on by Brussels, seem to be designed with one thing in mind — to ensure that we spend a decade in a zero-growth and zero-hope economy.
It is difficult to see how things can turn out better. We have a massive credit contraction, along with a huge fiscal contraction and a currency that is rising significantly against those of our main trading partners.
If we were a similarly sized state in the US, we would have one national labour market, where Irish people would move to another prosperous region of the union. That doesn’t happen to us in Europe.
Also the American fiscal system would make sure that our dole and welfare bills would be paid by the other US states. That doesn’t happen in the EU.
Finally, we’d probably have very little trade outside the dollar area, so the exchange rate wouldn’t matter hugely. The opposite pertains in Ireland.
So what are we to do? If we want to get the public finances under control quickly, we will push the economy over the cliff. This appears to be precisely what our Government intends.
A boss man from Standard and Poor’s (or should it be called ‘Sub Standard and Riches’, given the agency’s lamentable forecasting record in the boom and the huge fees it continues to extract in the bust) said yesterday that Ireland would keep cutting. So the people who screwed up, this Government and the rating agencies, are telling us there is no alternative!
Our other choice is if we don’t get the Budget under control, the borrowing of the State will spiral and we will be straight into the European Stability Fund, with the EU and IMF officials running the show.
The single biggest problem in our post-bubble economy is private debt and that is not addressed either by the slash and burn or do-nothing options. Traditionally, the way economies get out of a mess like this is through huge debt forgiveness and mass debt renegotiations. This is what Roosevelt did in the US in 1935. History reveals that most major economies have experienced debt forgiveness — from the US to the UK and all the continental countries.
Without comprehensive debt renegotiation — both personal and institutional — Ireland will not get out of this hole. The idea is called ‘co-responsibility’, where the debtor and the lender are both responsible for the debts they have jointly created.
Co-responsibility is the centre of modern commerce. Without mutual responsibility, no agreement between parties can work. Debt forgiveness is not radical; it is the way the world works.
David McWilliams has designed and will teach a diploma in economics called ‘Economics without Boundaries’. This is the last week to enroll at www.independentcolleges.ie.