August 12, 2013
The other week, when in Henley in England, I spoke to an English couple from Exeter who had recently visited Dublin. They loved the city but said that they didn’t do any shopping because the place was far too expensive. They couldn’t understand how a country suffering from 14% unemployment and emigration, while the domestic economy was on its knees could have such expensive retail prices.
They put it down to the Euro and they were mostly right. If we had a currency commensurate with our weakened economy, that currency would have weakened dramatically from 2008-2013 to reflect the collapse in the domestic economy. This devaluation would have helped Ireland to become more competitive again quickly. Wages and prices would have fallen dramatically making Ireland a fantastic place to invest. But that didn’t happen.
The English tourists had a good time, but didn’t spend what they had intended to because the country is too expensive largely as a result of trading in a currency, which is far stronger than the weak Irish economy can sustain.
If the tourists had been Japanese and found Ireland expensive that wouldn’t be too bad, but they were English and the English are our biggest source of tourism. This is why the exchange rate with Britain matters hugely.
The currency any country trades in matters enormously because it sets the price for everything. If a country want to bring local prices down Vis a Vis foreign ones, the quickest way to do this is via your currency. Otherwise, a country will face years of girinding down wages and prices in order to achieve something, which can be attained easily via currency devaluation. This grinding down of prices and wages is exactly what peripheral Europe and Ireland are involved in now.
Given that, ridiculously, our political and policy-making elite has tied us to the Germany economy, the single most important price in Ireland is the sterling/euro exchange rate – over which we have absolutely no control.
Therefore we should pay very close attention to what happens in the UK economy not least because Ireland and Britain do €1 billion a week in trade together.
The big question this week from the UK, is whether Britain on the cusp of a new housing upswing, which will boost consumer confidence and kick on into retail spending, driving down unemployment and pushing up tax revenue?
A housing recovery may seem like an unusual question particularly as many of its banks are still extremely fragile, some are still owned by the State and when the memory of the last housing boom and bust is still fresh.
But the signs are there.
UK banks advanced over £5 billion new buy-to-let mortgages in the second quarter of the year – 21 per cent up on the previous quarter and nearly a third higher than a year ago. This was the highest level since the third quarter of 2008 and significantly this was before the policy change announced by the new Bank of England governor Mark Carney last Wednesday.
The Carney revolution at the Bank of England has been quite spectacular and last week he said that UK interest rates would stay low at 0.5% until unemployment, now at 7.8% hits 7%. This is a massive change in central banking policy because in the past ten years the Bank of England only really worried about the rate of inflation.
Now we have Carney, taking the Bernanke line and linking interest rates to unemployment. This policy of picking a target in the future and saying that interest rates are linked to the achievement of this target at some stage in the future is now know as “forward guidance”.
The Bank of England doesn’t expect unemployment to fall to 7% until the end of 2016. Interestingly the Bank said that even if the rate of unemployment fell below 7% it didn’t automatically man that interest rates would rise.
Interest rates in the UK are at the lowest in the Bank of England’s 300-year history. And because the recovery is so shallow in the UK, the Bank is happy to keep them there for a number of years. Now obviously if inflation were to increase dramatically, all bet are off. But this doesn’t look even remotely likely.
The Bank also said that it would continue to fund the British government’s borrowing by buying gilts in whatever quantity it saw fit as long as unemployment remained above 7%.
So people now know that interest rates will be low for a considerable length of time, and the banks are lending again and on top of that the UK government has put in place new tax incentives for the buy to let machine to crank up again
Regular readers of this column will know that I am no fan of housing market driven upswings in activity, however, what is interesting from an Irish perspective is what this new policy will mean for us. Lower interest rates should push down sterling, particularly against the dollar. Against the Euro, sterling mightn’t fall too much because the Euro crisis is far from over. Indeed, the likelihood of another volatile chapter in the on-going Euro saga is extremely high.
The implication is that Ireland will remain very expensive for English tourists.
From a macro-economic perspective, what is interesting in the response of the UK is that fact that their policy makers are prepared to abandon all sorts of rules and regulations and throw the kitchen sink at the economy because the rate of unemployment is 7.8%. The British top brass find unemployment above 7% absolutely unacceptable.
In stark contrast to the Irish elite is doing nothing much when the rate of unemployment is almost twice the British level. The contrast between our policy makers and those in the UK is extraordinary.
Our central bank which controls the monetary response to an Irish crisis – a crisis which was largely of its making given the terrible financial regulation of the banks and housing market in the Noughties – should be actively engaged in adopting policies aimed at reducing unemployment.
If that means changing the currency, to allow Irish costs to fall on international markets, admitting that the Euro adventure was a monumental mistake and reverting to the Irish Punt, then so be it.
If it will not entertain this – and this is not something we should consider lightly – it behooves the central bank to tell us exactly how our unemployment queues will be shortened by the present monetary policies. What exactly is the mechanism and what exactly will be the catalyst?
In the UK they are taking risks when faced with 7% unemployment, in Ireland we sit on our hands when faced with an unemployment rate of twice that! It is quite unbelievable.