October 20, 2014
The traffic on Paseo de la Castellana in the centre of Madrid is backed up. This is another sign, according to Spanish commentators, that things are looking up. Just as parts of Dublin are doing well while the rest of the economy is still shuddering from the after-effects of the deepest recession in living memory, both Barcelona and the capital city of Spain are growing rapidly.
Like Dublin, there is a housing shortage in Madrid and Barcelona. This is hard to fathom after a massive property crash, but – like in Ireland – in Spain the houses were built in parts of the country where no one wanted to live.
Walking around the heart of old Madrid, the comparison between both economies is quite interesting. Politicians here in Spain are saying that the recovery is under way and the economy is growing rapidly, yet most people can’t feel this yet. But they probably will.
Like in Ireland, there is a changed mood and this will permeate through the society in time.
It is interesting how both Ireland and Spain are now regarded as doing well while Germany, where I was earlier last week, is faltering. If there was ever evidence that the eurozone is deeply dysfunctional it is the fact that the two countries that were most affected by too much lending in the boom are now recovering, while the country that most people regarded as the frugal dynamo of the continent is now faltering.
Ruling politicians in both Spain and Ireland are saying that austerity is over, which is difficult to understand when both countries still can’t pay their way in the world. If you regard running a budget deficit as an indicator that you are borrowing your living standard from someone else, then both countries’ present standards of living are rented not earned.
However, that’s not to say both economies won’t earn in the future.
What drives economics is human nature and it is very difficult to predict. The economy is an exercise in group psychology, rather than cold science. No one really knows why the economy turns and why it heads up and down. While there are some rules, most of it is impossible to predict because it is so difficult to predict how we behave.
For example, last week listening to the radio I heard one of our politicians crowing about how his policies were working and the new growth rate was evidence of this. Yet no one stopped to ask him why, just one month ago, his own government’s growth forecast was half of what it is today. If he was so confident about why his policies were so uniquely responsible for the recovery in Irish growth rates, surely his own forecast last month should have reflected that?
The truth is, when the herd moves from greed to fear, optimism to pessimism, it isn’t easy to explain. It just happens.
Humans are unbelievably irrational animals, driven by all sorts of excitements, depressions, giddiness and mood swings. Everything you do influences me, even though I don’t usually realise it. And my decisions affect you and vice versa. As JP Morgan observed: “Nothing so undermines your financial judgment as the sight of your neighbour getting rich.” Equally, nothing puts the wind up you more than hearing a good friend has been laid off.
When we are optimistic, we are impossibly so. We think nothing can go wrong. We dismiss risk as something that doesn’t happen to us and we take the plunge confidently. And optimism is infectious. We spend money we don’t have in the belief that our income is going to be bigger next year.
Humans are hard-wired optimists. It may have something to do with survival and evolution, but we must go on – and going on is driven by hope. We always think this time it’s going to be different. When we become optimistic about the economy, we behave like we are in love for the first time. We get giddy, we dispense with logic and we fall headlong into a new adventure.
We also become over-confident. Most of us inflate our abilities. For example, men everywhere inflate their intellect and social skills. We believe we are more able then we are. A recent study revealed that 95 per cent of American men believe they are in the top 20 per cent when it comes to social skills. We exaggerate in lots of areas and our belief in ourselves is where we start.
In economics, this optimism is reflected in more borrowing, more spending, more investing and more debt because we believe we are going to be richer tomorrow as a result of our own genius than we were yesterday.
Similarly, when we get depressed, we become withdrawn, self-doubting and afraid. In economics, this is reflected by a slowdown in spending and more saving.
Because my behaviour affects yours, you feel the vibes from me both on the upside and the downside.
It is almost impossible to time when human nature changes, but we know that when it does the herd can move from pessimism to optimism quickly and unexpectedly. This is what happened in Ireland and Spain. The indomitable spirit – which drives all of us forward, is taking over.
After years of savings, pent-up demand is being released – and as this happens it becomes infectious.
There are a few rules of economics, which will help us along from here.
For example, like the Spanish economy, the Irish economy is growing quite significantly, yet the global economy of which we are both a tiny part is slowing down rapidly. Europe, with which we share a currency, is facing deflation, yet Britain and the US are doing quite well. This is good news for us. We do well when Britain and the USA are doing well and when Germany is doing badly.
This is because we have lots of debts and our interest rates are set by Germany. Therefore, we need Germany to be struggling. In contrast, our two biggest trading partners are Britain and the US, so we do well when they are growing.
Germany, the dynamo of the eurozone, is slowing down, and the ECB – our central bank – is prepared to print money. This cash could well find its way into the Irish economy.
However, ultimately the recovery of the economy is about you and me and our psychology.
The economic conditions this year are not really different from last year, yet last year the economy contracted. Why was this? It was because the animal spirits were muted. Over the last few months, they’ve been let loose. What triggered that?
Hard to say, but let’s not argue against it.