December 12, 2013
Bailout Exit. If goody goody Ireland is the model student, how come bad boy Greece is the star performer?Posted in Banks · 357 comments ·
On May 1, 2003, President George Bush stood on the bridge of the USS Abraham Lincoln. Behind him a massive banner was unfurled, which read “Mission Accomplished”. The president declared success in Iraq and assured the American people that the victory was his, Saddam was defeated and there would henceforth be no more combat operations.
The vast majority of American and Iraqi casualties occurred after this date. In fact, the Iraqi insurgency kicked off after the American mission was declared accomplished.
When I hear our government spin doctors declare that “exiting the bailout” signals a “mission accomplished” moment, I am reminded of Dubya.
The economy here is turning slowly, not as a result of government policy but in spite of it.
The combination of a credit crunch, an overvalued exchange rate, higher and higher explicit taxes, stealth taxes of all sorts and a massive fiscal contraction is a recipe to poison even the healthiest economy, let alone one burdened by negative equity, broken balance sheets, which is actually one-fifth smaller than it was in 2008, and has 400,000 fewer people living in it.
That all these potentially fatal attributes couldn’t kill local business stone dead is testament to the achievement of thousands of small Irish businesses who have managed to stay open in the past few years.
The recovery, which in recent months finally began to make some dent in unemployment, is still fragile and could be derailed easily. So it must be protected.
Part of protecting the economy is being honest about it, being truthful with the people as to why things are happening and being alert to any unexploded financial landmines.
So concerned was the IMF about the unexploded landmine deep inside the banks that in its latest Fiscal Outlook, buried deep in the report, is a suggestion that a “capital levy” might be levied on wealth in the event that debt levels are not being brought down quick enough.
This is what happened in Cyprus where deposits over €100,000 were impounded to “bail in” the banks.
On page 49 of the report, the IMF makes this suggestion explicitly. These reports are never published without the people at the top agreeing to everything.
If we are to be honest, Ireland is exiting the bailout with gross debt as a percent of income, actually higher than it was when we went into the bailout. If Ireland were a company, it would have gone through a restructuring, yet it has more debt at the end of the restructuring than the beginning while still being cash-flow negative.
You would also imagine that leaving the bailout would also correspond with the country not having to borrow yet more every year. But this is not the case.
But why are the financial markets so keen to finance us if things haven’t improved significantly?
The answer to this question brings us a bit nearer the truth.
The Government has been very keen to spin “exiting the bailout” as a sign that Ireland is uniquely virtuous and is very different to the other countries that were similarly in the bosom of the troika.
The EU also wants to spin this line because, as leading indicators all over the eurozone turn down and deflation haunts Spain, Greece and Italy, the EU needs a victory. Olli Rehn and his mates in the ECB desperately need to argue that the way out of the crisis is to lumber the debts of others on to the shoulders on innocent taxpayers, while reducing rapidly government spending and increasing taxes.
But the interesting thing is that Ireland is not the best performing asset in Europe in the past 18 months. The best performing asset has been the IOUs of Greece. Greece is a country where GDP shrank 3pc in the past three months and where deflation is gripping the economy. Yet yields on Greek government IOUs have come down from 30pc to around 8pc. The same has happened everywhere. Italian, Spanish, Portuguese and Irish bond yields have all come down in unison.
But if the Greeks are performing better than us, surely there is something else going on that is driving the risk premium in Ireland down than just Irish-specific news?
The key is Mr Draghi, the ECB boss. He has said he will “do whatever it takes to save the euro”. This means he will use the central bank’s balance sheet to buy the debt of governments in difficulty if needs be. Two years ago, he unveiled a scheme to force banks to buy government IOUs. This caused yields on peripheral government bonds to move downwards. Mr Draghi’s scheme worked as follows. The banks went to the ECB with bad collateral. They gave this to the ECB and the ECB gave the banks cash in return. The banks were compelled to use this cash to buy government bonds when they were yielding 5pc, 6pc and 7pc. This obviously meant that the banks could get a “free” interest rates “pick-up” by buying the bonds at these high rates. The ECB, in effect, underwrote the risk. This caused bond markets all over peripheral Europe to rally and it also made the profits of the banks much healthier.
The reason people are prepared to lend to us and lend to the Greeks is that they know that Mr Draghi will buy all the IOUs if he has to. So the first thing to appreciate is that Mr Draghi is the main reason Ireland is exiting the bailout.
The second issue outstanding is the fact that the Irish banks are still more or less bust, and what happens if they need more money? Where will it come from?
A capital levy perhaps? Now that’s something to think about before we declare Mission Accomplished.