March 18, 2013
There are many ways to describe printing money excessively but the following quote from the Wall Street Journal’s money editor, attributed to a US official, is one of the most memorable.
“It is like peeing in bed. It feels good at first, but pretty soon it becomes a real mess.”
Whether the official is overstating the initial enjoyment is really a matter of individual peculiarity, but you get the point.
Now keep this idea in mind and think about what is happening to the Irish bond market because there has been a dramatic reversal of fortune in Irish bonds over the past few months. Has Ireland become suddenly more able to pay all the debts, which the fall in the risk premium implies? If so, it’s happy days.
But if the rally in Irish bonds is driven simply by the ECB printing money, then that’s a different story. If the ECB is swapping bad collateral for real money, giving that money to the banks, allowing the banks and financial speculators to buy up assets of Ireland in the knowledge that Ireland will be backstopped by the same ECB that printed the money in the first place, then we are in the early stages of a bedwetting episode.
If on the other hand, this week’s return to the bond market signals the start of an actual economic recovery, then we can look forward to, at very least, restful times ahead.
This is an important question because if the bond market, which is where the State borrowed money this week, is right and is basing its excitement on “the fundamentals”, then this means the worst is over. If in contrast, the market is wrong, and over-optimistic, all we are seeing is a speculative bubble in bonds – driven by too much central bank liquidity. And, just like the housing and debt bubble, this bubble too will burst leading to another financial crisis.
I am perplexed because I really want it to be the former, that is a real recovery; but I fear it may be the latter – a politics-fuelled bubble.
So is it the case that the financial markets are reacting to real opportunities in Ireland as seen through falling unemployment, proper companies being created, exports expanding and local spending and retail sales ticking upwards? This is what we all want to see, allowing us to look forward to the economy emerging from the torpor in stronger shape.
Unfortunately, the data is weak. We know that exports have slumped in the past few weeks and also it seems now that any improvements in Irish competitiveness reflect the weakness of sterling and the dollar – our two biggest trading partners – against the Euro. If the jump in competitiveness had been due to an increase in productivity, we might be in for a sustained period of expansion, but that’s not the case. Indeed the initial positive movement in Irish competitiveness, seen three years ago, may now have been down to the slump in low-productivity construction employment. Once you strip that out and account for the high-productivity, low employment sectors such as pharmaceuticals, there is no real on-going productivity turnabout.
We know that retail sales fell for the past three months in a row and that the rate of unemployment remains persistently high. Indeed as the Financial Times pointed out this week, there is a good chance that any rises in employment can be explained by the rise in immigration implying that the “quality” of the meager amount of jobs being created is falling. There are more and more part-time, temporary jobs. Indeed the recent rise in the number of people claiming they are self-employed may not be indicative of a new emerging entrepreneurial culture but may be more likely the way middle-income professionals who have lost their jobs prefer to describe their state of unemployment.
In short, there is no real change to the underlying economic picture that pertained a few months ago before the bond rally.
In addition, the moves this week by the government to try to accelerate foreclosures in the buy-to-let housing market might drain the banks’ capital. If the housing market weakens further, the banks might actually run out of capital forcing another recapitalization round.
Taking all this into account, we can see that the reasons for the bond market rally and the high-fiving we saw during the week from bond-spinners on the radio and the politicians desperate (understandably) for some financial market white smoke, might have less to do with economics and more to do with politics.
In the past four weeks, it is clear with the prom note and the ESFS deals, which push Irish debt repayments out for a dozen or more years, that the European elite – the ECB, the EU and the Troika – are underwriting Irish government debt. This will ensure that the poster boy remains the financial equivalent of a Hollister model rather than a real Irishman at the end of the night on St Patrick’s Day.
Eurozone politics explains the conundrum whereby the data are weak but the market is rallying. The market knows that someone else will pay the Irish bill in the short-term. This gives the financial markets a risk-free ride, and why would they not seize this opportunity to make money?
In the medium-term though, such a political strategy means we go further down the road of turning Ireland into a large debt-servicing machine where the willingness to pay these debts at all costs, irrespective of real growth and the willingness of the EU to subsidize such a kamikaze policy becomes the narrow-gauge barometer for economic success.
So the ECB prints money, but this money – as we can see from the M3 money supply graph – doesn’t go into the economy but into the hands of speculators. The economy then doesn’t recover, but the financial markets benefit as prices are pushed up. In terms of just how much of the movement in bonds is related to central bank moves, one of the very best financial market writers David Rosenberg of the Canadian firm Gluskin Sheff calculates that about 80% of movements in bond markets can now be related to what central banks are doing.
This appears to be what is happening now with Irish bonds. The rally is a reflection of politics not economics. In time, the positive liquidity effects of such a rally may trickle down to the economy, who knows? I certainly hope so.
However, right now, the warm trickly feeling we are experiencing is much more likely to be middle of the night, financial bed-wetting than any economic new dawn.