December 15, 2014
Yesterday, in rural Kilkenny, a man stopped me and asked me when the recovery would be felt in the countryside. He told me he was watching the TV and listening to the radio about the recovery in Dublin and Cork, but he wasn’t feeling it.
His question was whether this recovery is real. By this he meant, is it well founded or just hot air – and more importantly, can it spread from Dublin to the rest of the country?
My sense is that it is real and it will percolate down to the rest of the country, but it will take time. National income figures released on Thursday, along with inflation figures, suggest that the opposite is the case. They point to an economy slowing sharply in the last three months and one where retailers and manufacturers can’t pass on price increases because people simply don’t have the spare cash. However, I feel these numbers will prove to be an aberration and that the underlying economy is moving forward reasonably swiftly.
Big-ticket items like new car sales and house prices all suggest demand is strong. Anecdotal evidence like hotel room rates, advertising rates, traffic jams and crowded restaurants argue the same. Also, critically, taxes are up across the board. Unemployment is falling – and as unemployment is always the last thing to fall in a recovery, this is also suggestive of stronger demand.
Unemployment is a lagging indicator in a recovery and a leading one in a slump.
The reason is that when demand slumps, the employer has a choice: either to reduce wages across the board for all employees, or to save on labour by letting the last in go first. Normally, the unions in the firm refuse to countenance an across-the-board wage cut, so the employer fires some employees to save other ones.
As a result, unemployment spikes early in a downturn. In an upturn, employers regard an extra job as an extra cost which has to be more than covered by revenue – both actual revenue and expected future revenue. So people are employed late, not early.
Looking forward, the Irish economy is a function of the global economy, and more specifically the Anglo-American economy. As long as the English-speaking world is doing well, we are going to participate. And equally because our debts are priced in euro, we do well when the eurozone is doing poorly because interest rates remain low in euro.
For the past five years, interest rates all over have been kept extremely low as the central banks try to re-float the battered, debt-ridden balance sheets of the world economy. In Britain and the US – particularly the US – this period is coming to a close. As it does, it should push the two currencies, sterling and the dollar, upwards. This will have an added positive for Irish exporters because these are the places we export to and we will become more competitive as their currencies rise against the euro in 2015. So internationally, things look bright both for local producers and the multinationals.
Now we come to the central issue: what happens with the local economy?
For the local economy to grow, we need ‘animal spirits’ to be released. This means that people have to be prepared to open a business, take a chance and dip into savings to finance something, or borrow to invest.
It is very difficult to explain why animal spirits are released. Context is key. Humans are incredibly sociable animals and we are all affected by each other’s actions, even if we don’t know this. In the economy, when we get depressed, we get depressed together – and when we get giddy, we get giddy together.
The best way to look at this context process and how it takes hold is to consider being at a match in the Aviva. When the guy in front of you stands up to get a better view of a crucial moment, you have to stand up too. And the people behind you have to stand up as a result of you standing up – and so on until we are all standing when we actually paid to sit!
Similarly, when the price of one house rises, the prices of other houses rise because we all change our view of the world – not because anything fundamental has changed, but because other people have changed theirs. We want things not because we actually need them, but because others want them. This is context in economics. I sense it happening now in the economy.
Because of this herd impulse, the macro economy is more group psychology than personal finance. All recessions end because pessimism ends eventually. Similarly, at the top of any boom, people get far too optimistic and make mistakes that look incredibly silly with the benefit of clear hindsight. But when the animal spirits take over, we are not clear.
I liken it to falling in love.
This loved-up economic buzz is all-consuming, devoid of logic and devoid of an ability to assess risk or project ahead to assess whether this is really the right one.
The economy is only us, all of us with our flaws, mood swings, loves, madness, hunches and beautifully human, buzz-loving irrationality.
The buzz was destroyed by the implosion of the country’s balance sheet after the property crash. Nothing wrecks the buzz like debt, and too much debt eviscerates the buzz.
However, in time, as asset prices rise – which they are doing – the memory of the crash fades and people’s personal balance sheets repair themselves. In a country blighted by negative equity, rising houses prices solve a lot of these legacy problems. (They create lots of others, but let’s come back to that again.)
Very low interest rates also reduce the real cost of debt, allowing the buzz to take hold. This is happening right now.
Finally, it is often forgotten that there is a generation coming up for whom the boom period was something that happened when they were in primary school. They are unencumbered by the legacy of the 2000-2008 episode. Therefore, they live in a country which is outward-looking and full of immigrants and they have no reason to believe that they can’t take risks here and trade with the rest of the world.
Taken together with pent-up demand (as evidenced by the massive over €90 billion of personal savings in the country) and the animal spirits, this will drive the economy, because this is what always happens. It’s called the cycle.
Expansions are self-reinforcing: initially, at least. With so many people still looking for work, there are no capacity constraints in the economy right now.
The recovery will broaden outside Dublin in time. However, this too will be a function of what happens to house prices in the countryside. Recoveries always start in urban areas – economic history attests to this. They tend to spread too, but it won’t happen overnight.