December 30, 2013
What we've learned from the past year -- and where we are headingPosted in Banks · 79 comments ·
Now that we are at the end of the year, here are a few things that 2013 taught us about economics, how our economy is doing and what determines where it goes from here.
HOUSES AND PROPERTY PRICES
This was the year the property market started showing signs of life. Two years ago, in January 2012, this column suggested here that Irish house prices would stop falling in 2012 and begin to start rising in 2013.
Interestingly, back in early 2013 after five years of house prices falls, the notion that house prices would rise sooner than people expected was met with derision. But that’s what happens. When things are good most people don’t think that the good times will end and when things are bad most people think things can’t ever get better.
Regarding the property market, lots of people are worried about a “bubble” re-emerging. This is not a bubble; it is merely a reflection of supply and demand.
During the boom, when a few of us were calling the boom a “bubble” and warning that it would burst, the mainstream was saying it was supply and demand. Now I am saying this recent rise is a case of supply and demand and the mainstream is calling it a bubble.
You can’t have a bubble without credit and there is no credit, or very little credit, in the Irish system. Even as house prices rose in the past few months, mortgage lending didn’t grow in tandem, actually it fell. We are seeing a cash-driven market, which is very unusual. It implies that there is no bubble because you need leverage for a bubble and there is no risk of a reversal in prices unless the banks get involved again, which they have not got the capital to do, just yet.
However, we should be aware of the societal impacts of a cash-driven property market. It means that legitimate first-time buyers are being priced out of the market by cash-rich investors. The reason is simple. Sellers prefer cash buyers and because the cash buyer doesn’t have to borrow the money at 5pc from the bank, he will always be able to outbid the first-time buyer.
RECOVERY IN CONSUMPTION
In the past few months there has been a slight pick-up in final demand in the country. This is consistent with the analysis offered in the column for years. The recession in Ireland is what is called in economics a balance sheet recession, caused by the collapse of a property bubble, which destroyed the balance sheet of the middle class. In such a recession, the savings ratio rises as those with money — both individuals and companies — save huge amounts and those in debt try to pay back what they can. Obviously domestic demand collapses. But as the people save, the Government has to spend, otherwise the economy goes into a total tailspin.
Thus the budget deficit, far from being the cause of our woes (as the government policy of slashing the budget deficit suggested), is actually the consequence.
All the private sector savings imply that there is possible “pent-up” demand, which starts to be spent when some confidence returns, which it has done this year.
CONFIDENCE AND ROLE OF UK
The best thing that happened in the past year has been the increase in jobs in the country. Why did this happen? And why did it happen in the second half of 2013?
My best guess, given that domestic demand was held back by tax hikes, spending cuts and a lack of credit, is that it has come from outside. But what was the most positive development in Ireland’s meaningful trading partners?
The European economy remained on the canvas last year and it is now flirting with deflation and record levels of unemployment. The US economy is in better shape, granted, but hardly match fit — as evidenced by the Fed’s injection of €85bn into the economy every single month.
The economy that really surpassed expectations was the UK — our biggest trading partner, home to our largest recent emigrant population, our biggest tourist market and by far the largest buyer of Irish agricultural produce.
When looking for reasons the Irish economy did better in the second half of the year, look no further than a massive boost from the UK’s much better-than-expected performance. This also propelled sterling upwards, making Irish companies competitive in Britain and Ireland a cheaper place to visit for our neighbours.
Yet, if you were looking for anyone in official Ireland to credit the UK’s role in the past 12 months, you’d be waiting a long time because as usual they are in Brussels pleading with some Eurocrat or other.
THE PROMISSORY NOTE
Last March, Ireland defaulted in all but name on a €3bn payment of a €30bn IOU. A default is when you change the terms of a debt repayment to the benefit of the debtor and to the detriment of the creditor. Defaults are always a cash-flow event. Anything that changed the contract to benefit the cash flow of the debtor at the expense of the cash flow of the creditor is a default.
By kicking out the promissory note payment to 2038, we changed the terms of the contract with our creditor and didn’t pay. Readers will know that I support this wholeheartedly and would go for a full non-repayment rather than one that is postponed two generations out into the future. That said, the interesting aspect of not paying the promissory note is that nothing happened. Before this event, many argued that non-payments would scare the market. In the event the opposite happened. The yield on Irish government debt fell, implying less risk after we didn’t pay!
Why is this? It is because, (a) the debt was not legitimate and, (b) for the financial markets, not paying the note improved Ireland’s cash flow.
Now that the precedent has been set, we could do something similar with promissory notes and the present hole in the banks, which threatens another banking crisis next year.
This year was also the year of Draghi and his threats to and nudging of the financial markets ensured that Greece — the biggest defaulter in history in 2012 in terms of sheer numbers — was the country with the best performing bond market in 2013!
It was the year when the myth of multinationals paying 12pc tax was blown apart. They, in fact, pay 2.5pc effective corporate tax in Ireland. According to the US Bureau of Economic Analysis, US multi-nationals in Ireland reported net income of €95.6bn. On this “taxes other than income and payroll taxes” payable in Ireland in 2010 amounted to €2.4bn, giving an effective rate of tax of 2.5pc.
A few short years ago, anyone who suggested that the diaspora could be a small but important economic resource for the country was laughed at. Today, almost everyone has a “diaspora strategy” of some class or other. The Gathering was one such event. It was a success and could be built on by other initiatives such as Ireland Reaching Out.
THE NEXT STEP
Looking back on the year, the economy is still much, much smaller than it was at its peak. There are 400,000 fewer people here and many hundreds of thousands of lives have been destroyed by long-term unemployment, but the local economy is beginning, very gingerly, to recover. A big deal on mortgage debts, using something like a promissory note again, could help 2014 enormously.
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