February 26, 2013
Britain is among those few countries in the world that issues its own currency, determines its own interest rates and has no problem in getting foreigners to buy its debts – debts that it determines how and when to pay and at what value. This ability to borrow from foreigners in your own currency and pay them back at a value of your own choosing is an amazing economic and financial advantage.
There are a few other countries in this benign position: Australia and New Zealand, Canada and, of course, the US, Japan, Sweden and Norway. We used to have this advantage, but we gave it away when we joined the euro. Now we are, in essence, borrowing someone else’s currency – a foreign currency – and conditions in Ireland have no bearing on that currency. Longtime readers of this column will know that, here at least, a country’s currency – to use the words of the great American central banker Paul Volcker – is regarded as “the most important price in any economy”.
When the currency is overvalued or pegged to a much stronger currency or, in the Irish case, subsumed into a foreign currency, the trading sector of the domestic economy suffers dramatically – unless it is a part of the US supply chain. In contrast, the protected sector and the public sector get a massive subsidy because they get paid in a currency in which they never have to generate any foreign sales. The local protected sector gets paid in a currency it is not required to generate from selling its goods and services. So these people are smiling.
In contrast, traditional exporters who obtain the majority of their inputs in the local economy and turn these inputs into something they can sell abroad, suffer enormously if the currency is overvalued.
A country that adopts a permanently overvalued exchange rate for political reasons, as we have done, will become an economy with small exporting companies, a large public sector addicted to debt and a tax-induced multinational sector that is not sensitive to local prices because (a) it uses precious few local inputs other than the labour, and (b) it is part of a global supply chain, where exchange rate movements are exploited in the multinational’s treasury department.
A country like this will also get into debt quickly because the debt markets confuse a yield arbitrage (a gap in interest rates on government bonds) within a monetary union – such as the difference between Ireland’s interest rates and Germany’s – with the country’s ability to pay the debts in the future.
Of course, it will not be able to pay debts, because it is incurring debts to maintain the living standard of the protected sector. This living standard – which allows people to buy foreign cars and gadgets – is rented and mortgaged, not earned.
As such, an overvalued exchange rate acts as a massive subsidy to the domestic sector over the local exporting sector. The only way the standard of living can be maintained, if it’s not earned, is that it must be borrowed or it falls.
When a country’s unemployment rate is at 15 per cent (and would be higher were it not for huge emigration at a time when wages are also falling), few can argue that our exchange rate rising against our major trading partner, Britain, makes any sense. It is, in fact, very damaging.
There has always been a bias against local Irish small business in the corridors of power in Ireland and in the minds of the professions-obsessed apparatchiks who run Ireland and don’t actually earn the currency they are paid in. Even so, having our currency rising against sterling right now is beyond comprehension.
Sterling is falling rapidly right now and Moody’s decision to remove Britain’s AAA rating could lead to a further drop. This is being welcomed in Britain because it will give British manufacturing and services a chance to export. The country is caught in an austerity brace, where cutting public expenditure in order to reduce debts is causing the debts to remain stubbornly high because income is falling faster than debt is being paid down. This unpleasant process is called deleveraging and Moody’s move reflects the problems of achieving this.
In order to survive deleveraging, an economy needs to give its exporting sector a chance. If it can reduce the price of its goods on world markets, there may be just a slight possibility that it can get growth from exports. If these are real exports which employ local resources, such as machines, technology, land and labour, then everyone benefits.
Because the output gap – the difference between actual production and potential production (measured by unemployment) – is so great, imported inflation is not a real worry. In fact, given the huge debts, a bit more inflation would be a godsend.
This is what the British are trying to engineer via a sterling devaluation.
Now, what impact would a permanently lower sterling have on Ireland?
Well, here are the facts of our economic relationship with Britain. This is the real situation, not in the Teutonic fantasy world of our mandarins, but in the real world where we all trade and try to earn a crust.
After 30 years of Ireland tying its currency and criminally ignoring the sterling exchange rate in a bizarre effort to force more trade to Germany, officially-neglected Britain is Ireland’s largest export partner after the US. We export around €14.265 billion-worth of goods and €15.052 billion-worth of services per year to Britain.
Ireland imports more from Britain than from the rest of Europe combined: €16.686 billion in goods and €10.108 billion in services in 2011. Every week, €1 billion of trade is carried out between Ireland and Britain.
When it comes to trade in goods that have huge knock-on effects in terms of people’s real lives, as opposed to trade in industries that can overstate how much is made here for accounting reasons, Britain’s importance is even more significant.
According to Bord Bia, Britain is Ireland’s number one export partner when it comes to food. €3.2 billion-worth was exported there in 2010, up 2 per cent on 2009. Irish beef, for example, accounts for 60 per cent of the British market. Ireland produces enough food to feed 36 million people, while Britain has a food deficit. Ireland also happens to be Britain ‘s top food export partner, importing an estimated £3 billion-worth in 2012. Altogether in 2011, British ports imported 6.63 million tonnes of freight traffic from Ireland, up 6.3 per cent on 2010.
As well as that, the Republic is Northern Ireland’s second-largest trade partner. Forty per cent of NI exports go south of the border. Much of this trade (67.9 per cent) is done by SMEs, which are the lifeblood of Irish business and Irish employment.
This is the reality of the Irish economy as it is, not as we might like it to be. Without exchange rate flexibility, we get larger unemployment and lower wages as we are already seeing. This makes legacy debt harder to pay and exacerbates the squeeze. Yet the headlines this weekend are about how our state is going to borrow more in June and this is reported as a sign of success.
Hard to swallow.