January 4, 2016
Over the past few weeks, some readers of this column have been a bit perplexed by my confidence about the economy and why I believe that the basis for this recovery is stronger than at any stage since the mid-1990s, when Ireland truly was experiencing something of a miracle.
Let us examine, ahead of work tomorrow, why there are reasons for guarded optimism. I am not going to cover every single factor that impacts on the Irish economy as that would be way beyond any article; instead I am going to focus on two critical aspects that affect the trajectory of the economy.
The first aspect is what is going on in the United States and the second, less important, observation is what is likely to happen in our local economy.
This article will not be without its own paradoxes. How can we be optimistic about Ireland – one of the world’s most open economies – when world growth is slowing down?
Surely if world trade is slowing, countries that do most trade should slow quickest? I will answer this conundrum in a moment by explaining that these two things can be true at the same time.
Initially, however, let’s examine where the US, the single most important country for us, is in its economic cycle. The US is seven years into an economic cycle that began with near bankruptcy after the collapse of Lehman.
After seven years of zero interest rates, the US has fixed its balance sheet. Given that it experienced a “balance sheet” recession, this outcome is a roaring success. This was exactly what the Fed set out to do in 2008/9.
The rise in rates, two weeks ago, is a valedictory moment. Mission accomplished. Unemployment is down, the budget deficit is down, house prices and asset prices are up and corporate indebtedness is down.
Unfortunately, the only factor that has been absent in this recovery is large-scale corporate investment from large US companies. This is the American paradox.
But the paradox will shift this year and Ireland will be a prime beneficiary.
The seven-year cyclical recovery process in the US will continue for some time. A growing US is always good for Ireland irrespective of what is happening in the rest of the world.
But there is something else going on which plays in our favour. Let me explain that “something else” by leaving the US economic cycle and examining the structure of the US economy. If we tease out the odd structure of the US, it will allow us to understand (a) why the US is different to the rest of the developed world, (b) why Ireland can do well in 2016 and (c) why Ireland can do well even if the rest of the world slows.
The key to all this is exports. Big economies that are dependent on exports produced by domestic companies are in for a fright in 2016.
Consider the structure of the three big economies outside the US: China, Japan and Germany.
Japan used to be a major exporter and exports are now about 18 per cent of GDP. Germany is the world’s fourth largest economy and it exports just under 50 per cent of its GDP.
China, the world’s second biggest economy, exports 26 per cent of its GDP. All these are very vulnerable to the fall in world trade that is happening.
Now think about the contrasting position of the US. It is the producer of nearly a quarter of the world’s GDP yet its export rate is only 13.5 percent of GDP, of which about 40 per cent goes to Canada and Mexico.
What differentiates the United States from the rest of the world is both relatively high domestic consumption and relatively limited exposure to foreign problems.
What is remarkable about the global system is that the United States, which should have a very high dependence on exports given its size, has a very limited one. America is exceptional and isolated.
And as problems rise in the rest of the world in 2016, this isolation will benefit the United States.
These problems could be European such as another refugee crisis when the weather improves in the spring, another EMU implosion, Brexit, Catalonia leaving Spain or France electing the National Front. Or they could stem from Asia, with the implosion of the Chinese banking system or tensions with Japan.
And, of course, we have emerging markets problems everywhere you look, while the Middle East is experiencing capital flight for obvious reasons. All this means more capital flows into the isolated US, driving up the dollar. But if there will be problems in the global economy and if big exporters like Germany are set to suffer, why won’t little exporters like Ireland suffer too?
Here is the answer to the American paradox and to some extent the Irish paradox. As the dollar rises, corporate America will look to invest. But where can it invest?
Corporate America has to invest in cheaper offshore locations to avail of the stronger dollar. Where might these locations be? Well, obviously Ireland is one.
In time, accumulated profits need to be invested. Boardroom America can’t keep buying back its own shares or playing other financial tricks, particularly as share prices are now very high.
It will have to return to the old way of doing things, and this means old-fashioned investment in productive capacity.
As a result, I believe that Ireland will see a significant increase in productive investment from multinationals. This will propel the exporting side of the economy.
On the local side, the recent stalling in house prices is a good thing as it reduces any “overheating” problems and it helps to break the link between banks, house prices, credit and personal debt.
Savings that were hoarded in the crisis are being drawn down slowly and this is underpinning retail sales.
As this process seeps into the economy, unemployment will fall further.
Ultimately the local economy is moving in the right direction.
It doesn’t need any more stimulus, but tax cutting on an already overtaxed workforce is a political certainty, so we have to factor it in. This implies domestic demand will remain strong.
Taken together with the paradox of US investment here in Ireland, it is difficult to see the economy being nothing but more robust in 2016.