January 9, 2014
Why are we applauding ourselves for borrowing to live like Germans?Posted in Banks · 238 comments ·
THE “red eye” flight, 7am Dublin to Dusseldorf, is half-empty. You can sense from the resigned, matter-of-fact way most of the passengers behave, that the people — mainly men — are veterans of this route. However, Irish business people in Germany are still a rare enough breed.
Like many German cities, Dusseldorf has plenty of hidden gems but, like much of Germany, it is an undiscovered part of the world for most Irish people. Indeed, the blind spot towards Germany is odd, given our politicians put so much faith in the political class of the Federal Republic.
Few Irish people visit Germany each year. Fewer than 7,000 students learn German in school and beyond Bayern Munich, Mercedes and a few other car brands, not many of us could name many modern German institutions.
That said, the future of Ireland is intertwined with the future of Germany to such an extent that their Bundestag gets a butcher’s at our budget before the Dail does.
As the EI 692 got blown around the place by the tail end of Hurricane Christine, the morning’s papers are full of backslapping over the NTMA borrowing again this week. To the rational person, such celebrating must seem quite extraordinary. It is as if the newspapers are living in some bizarre parallel universe where not being able to pay your bills is a good thing — something to be cheered.
Let’s be clear: the reason that the country is borrowing again is that we can’t pay our way.
In its most simple terms, borrowing to run the country — after five years of austerity — means we still yearn for a lifestyle we can’t afford. Rather than adjust to our means and adopt a lifestyle we can afford, we rent a lifestyle we can’t.
When seen from a relative country perspective, we covet a German lifestyle but as we can’t earn this lifestyle, we lease it.
But who do we lease it from? We lease it from those who are prepared to lend to us, at a reasonable, indeed, very low interest rate of 3.3pc.
If others are prepared to lend to us, surely we have become a better credit and this is a sign of success?
Well, yes and no.
Yes, in the sense that Ireland is seen, by the international markets, as a very low risk. No, in the sense that there is no fundamental economic reason for Ireland to be seen as low risk.
As risk reduces, so does the interest rate that a country must pay on its IOUs. Normally, interest rates fall because the overall debt burden has fallen. This makes perfect sense because as the debt burden falls, there is less of an onus on the debtor (in this case the country) to come up with money to pay the creditor every year. The debtor’s balance sheet is therefore improving.
So interest rates should fall in response to falls in the overall debt burden. The debt burden falls if the growth rate in income improves because debt is always expressed as a percentage of income. If income rises, the ratio of debt to income falls. Unfortunately, this has not happened in Ireland. In fact the debt-to-income ratio has got worse, not better. Look at the chart, which I swiped from the website of the Nobel prize-winning economist Paul Krugman.
Figure 1: Getting worse quicker!
What we can see is that Irish interest rates have fallen — which is good; during a period when the actual public debt has risen — which is bad.
This development makes no financial sense.
However, it is what is happening all over Europe. Again look at the chart. We see that as debts have got worse, interest rates have fallen. How could this be that interest rates are falling at a time when debts are rising? The only way to explain this is that ultimately someone else is going to pay our debts. There can be no other explanation, or at least, this is what financial markets think.
But who could be that buyer of last resort?
I was thinking about this question as we landed, passed through customs and drove out on to the Autobahn. Sitting in the lovely “Zum Golderen Einhorn” cafe in Dusseldorf’s old town, the answer to the question comes. Of course, the buyers of last resort must be these people all around me. These industrious, frugal Germans might not realise it yet, but the people who are lending money to Ireland think that, at the end of the day, these Germans will pay the bill.
HOW otherwise could Ireland’s debts be still rising but our interest rate on that debt be falling? If the Irish growth rate was taking off like a rocket, maybe growth would reduce the debt, but this isn’t likely to happen. At best, growth will still be about half the 3.3pc rate of interest on the new IOUs.
Has anyone told them that they are on the hook to pay for a lifestyle that the Irish, Spanish and others want but can’t afford?
And what if they say no?
The last few months of coalition building in Germany have been one long argument about, amongst other things, how to ringfence the German taxpayer from the bills of the periphery. Despite the fact that the German politicians — right and left — are adamant they will not pay, the financial markets are behaving as if the redoubtable Germans will eventually stump up.
If they do not, there will be a massive bond crisis in Europe and Ireland is likely to be in the firing line. My guess is that the ECB will start buying bonds this year in order to save the Germans the strain, but this too is up in the air.
As for Ireland celebrating the fact that we are getting more in debt, it reminds me of a day in my local in 2005 when a developer was buying drinks for his mates to celebrate the fact the banks had lent him, that day, some unfeasible amount to buy some site or other. We know how that story ended.
On the day the Irish establishment celebrates more and more borrowing, do you think I should share my 2005 story with the German woman enjoying a coffee at the next table?
DAVID MCWILLIAMS’S DAILY FINANCIAL UPDATE IS OUT NOW ON GLOBALMACRO360.COM