December 29, 2010
We still have the financial means to save ourselvesPosted in Irish Economy · 137 comments ·
If we separated the banking system’s debt from the rest of the State, we could borrow easily on international markets
Yesterday, I got into a Dublin taxi and started nattering away about the usual, the weather, the football and, of course, the state of the kip.
“How was the Christmas?”
“Not bad, considering, less boot work, but. Last few Christmases, me back was broke from all the boot work, none of that this time.”
“Boot work? What’s that?”
The “boot work” was the act of opening the boot for bags and presents as laden-down Christmas shoppers stuffed his cab with their goodies.
This year, there was none of that. He went on to tell me that the boot work has been on the decline for a few years now, but this Christmas it just stopped.
‘The Dublin taxi man’s boot work index’ of consumer spending works for me. In fact, sometimes in economics these common-sense indicators tell you much more about what is going on in the economy than many complicated models, so beloved of serious economists.
But when the common-sense indicators are substantiated by hard evidence, we can get a very interesting take on what is actually happening in our economy and how it could be remedied by taking a new political direction over the next few years. Interestingly, and maybe appropriately for the last article of a desperate year, the outlook for Ireland doesn’t have to be that bleak. Provided we do just a few things right.
Let’s look at what is happening in the Irish economy — what the people are doing, what the Government is doing and the relationship between them.
In short, if the people stop spending, then government spending has to rise to take up the flak, or else the economy will contract. If the Government spends more than the people save, it will need to borrow the money from foreigners. This is called the net foreign balance.
By looking at the economy in this way, we allow ourselves to gain altitude. The more altitude we get the better, because it helps us to see the big picture.
Check out the chart above. It gives us a snapshot of what is happening in the economy. It puts the Dublin taxi driver’s lament into perspective and more crucially, it tells us why a recovery is not only possible, but actually likely — as long as we do the right thing.
The green line shows us how much the people spend or save expressed as a percentage of GDP. The red line shows how much the Government is spending or saving — also as a percentage of GDP. The purple line shows how much money we have to borrow abroad to finance our habits. You can see the dramatic turnaround in the economy from boom to bust in the past two years.
Up to 2007, the Government was actually running a small budget surplus (the red line). But the surplus wasn’t enough to cover the private sector splurge, so we had to finance the boom from abroad. As a consequence, we borrowed from anyone who would lend to us, forcing the foreign balance (the purple line) to plummet.
Looking at the chart, it is easy to see what has happened since. The people have started to save and pay down loans like never before. We are petrified. Private sector savings are now 16pc of GDP. As recently as 2007, the private sector was spending more than 5pc of GDP. Now we are saving more than 16pc. This is a wild swing of 21pc of GDP in less than two years.
Such a swing is unprecedented in the western world and mirrors exactly what happened in Japan in the 1990s.
This is a classic “balance-sheet recession”, where the balance sheet of the country is ruined and the banks are effectively dead. On one side of the balance sheet is property, which is still collapsing, and on the other side is debt, the cost of which is rising by the year. This means that the middle classes are now paying back what they can, selling where possible and saving because they are worried about the future.
The mirror image of the private sector saving is public sector spending. After all, had the Government not spent in response to the private sector rush to save, GDP would have fallen by close to 20pc!
Obviously, the foreign net position has improved dramatically from a deficit of 9pc of GDP in 2008 to a 2pc surplus by 2009. All this private sector saving has ensured that even at present rates of government spending, there is more than enough savings in the country to finance everything. Today, Ireland is running a foreign surplus with the rest of the world.
What does all this tell us? Well, the first thing it tells us is that the country is far from bust — in fact it is running a foreign surplus. It tells us that the EU is completely wrong. It tells us that we have no need of IMF or European funding of any sort. It shows us conclusively, that, if we separated the banking system’s debts from the rest of the State, we could borrow easily on international markets.
It also shows us that we can finance the whole thing internally if we wanted. So the situation is not desperate. The only thing we need is for the people running the place to have a basic knowledge of economics and finance.
The chart also tells us that austerity will not work, because if the private sector keeps saving, austerity will only lead to less and less spending in total, which will cause the budget targets to be missed — as happened in Japan — and public debt will rise unnecessarily.
And all the while, Ireland will run a bigger and bigger foreign surplus, which means we will export capital to the rest of the world for them to use, while projects in Ireland are starved of capital.
This is the financial equivalent of what happened in the Famine, where Ireland continued to export food while its own citizens starved — and all because no one was in charge who had the interests of the common people in mind.
Do you want a financial equivalent of the Famine, where a country with plenty of money collapses for want of credit? Do you want a situation where we export our young, educated people rather than spend money we have here on investing in them?
Can you countenance being the citizen of a country that runs a surplus on its balance of payments to allow other countries to borrow that money to invest in projects that become profitable because our emigrant sons and daughters work for them? So we export our people and our capital to raise the return on investment for foreigners?
This is precisely what happened during the Famine and we are seeing the modern financial equivalent occurring today, complete with local gombeen men profiting from doing the foreigners’ bidding.
Is this what you want?