What better city for a football lover to be in this week than Madrid? I have always loved Spanish football commentary. Even though I haven’t a word of Spanish, I love the rapid-fire speech, the dramatic rolling Rs, the intensity and pace of the commentators and of course, the demented celebrations when a goal is scored.
As the locals here in Madrid gear up for the Champions League final between Real and Atletico on Saturday, the only talk is of the game, its significance and how it sets up Spanish football for the World Cup where they are defending Champions.
Spain has an extraordinary record having won the Euros in 2008 and 2012 and the World Cup in 2010. The national team is not the force it was in 2010, but no one in Europe can deny the dominance of Spain over the past decade.
However, Spain’s purple patch in football has been mirrored by a catastrophe in its economy.
Almost since the day Iker Casillaslifted the European Cup in June 2008, Spain itself has remained firmly in the red. The economy has been in freefall.
Like Ireland, Spaniards were conned into thinking they could get rich buying and selling Spain to each other with other people’s money. The subsequent bust was spectacular and is still being felt in debilitating levels of unemployment and indebtedness.
As any economic textbook would tell you, when countries go through this type of contraction, prices fall. When people get used to prices falling they expect it to continue and this leads to a deflationary spiral. The very act of cutting prices prompts people to think that prices are going to fall even more next month or next year, so they hold off spending.
Deflation – which means that the price of your product is falling – is a disaster when you have lots of debt because it means that although your debt repayments stay the same you have less money. The less money you have, the less likely you are to spend and the spiral takes hold where deflation leads to less spending and lower prices. Bank lending falls and people try to pay back debt.
Those with savings save more, not less, because they are delaying spending. As such, deflation is much more difficult to deal with than its nemesis inflation.
The cure for deflation is inflation. Both Ireland and Spain need inflation right now.
Now here’s where things get interesting, because whereas both Ireland and Spain need inflation now, the fact that Spain needs it matters to Germany.
Why is this? It is because in Europe, size matters. A problem in a small place like Ireland isn’t a problem to anyone else but the Irish. However, a problem in a big country like Spain is everyone’s problem. This is why deflation in Spain – and Italy – prompted the ECB to say that it would cut interest rates again to prevent deflation taking hold in the southern periphery.
So what might the ECB do and how will it affect us in Ireland?
The ECB, which used to be a Germanic fiefdom has suffered what might be termed an Italian coup d’etat, under the Italian Mario Draghi. He will cut rates next month to help Spain and his native Italy; how this affects Ireland will not be high on anyone’s agenda in Europe but affect us it will.
The ECB is likely to cut the base lending rate from 0.25pc to zero and possibly cut the deposit rate, the rate that banks get for depositing money at the ECB from 0pc to -0.15bps. This means saving money will cost you.
Now what will this do in Ireland and how will it affect the property market, which everyone is talking about now? When this move comes in June, the headlines will say that interest rates for borrowers will fall. They will fall for some, but not all.
Here is where the existence of tracker mortgages changes the game and, counter-intuitively, the fall in ECB rates will mean that interest rates to first-time buyers might go up, not down! How could this be?
It is because banks make money by lending. So they need to lend more than they take in as deposits. This is why they charge more money for a loan than they pay out for a deposit. The difference is their profit. But with trackers they can’t charge more money on the loans because these loans are linked to the ECB base rate. So this means the banks have to charge higher margins on other new loans to compensate for the “subsidy” they are paying out on the trackers. This means that new first-time buyers could end up paying actually more interest – above 5pc – on new loans even though the official rate of interest is zero!
How will his affect the housing market? It means that the “cash buyer” is in an even stronger position to elbow out the first-time buyer because the cash buyer will have at least a 5pc cushion to bid above the first-time buyer with a mortgage. This means that the dynamic of recent months, where first-time buyers are being priced out of the market, will continue.
The fascinating and worrying thing about this story is just how little control we in Ireland have over our destiny. Deflation here in Spain is dictating conditions in Ireland far more than events in Ireland are dictating conditions in Ireland. Do you find that bizarre? I do. It is something to consider when voting this week. Every time you vote for “more Europe”, you are voting for less and less influence over your own life. And there was me thinking that our forefathers fought for democracy to have more, not less control over their own affairs!
Subscribe to receive my news and articles direct to your inbox
David McWilliams writes daily on international economics and finance at www.globalmacro360.com
Subscribe.
David, could you please do an article showing where all these “cash buyers” are getting their cash from, and how much of it there is, and when it is likely to run out? No commentator seems to have attempted to answer these questions.
Bit of an error in your description of the lending process. Banks do NOT lend out deposits they keep them as reserves. What they lend out is newly created money which did not exist previously. This is how over 95% of our money is created and this has been confirmed by a recent report from the BOE. During the boom the banks create more and more new money and become careless about the level of reserves they hold. It is this process of fractional reserve lending which actually creates the boom/bust economy we now have especially when the bankers are… Read more »
This link, an article by economist Dieter Schlichter makes a very contrary argument about deflation: http://detlevschlichter.com/2014/05/keynesian-madness-central-banks-waging-war-on-price-stability-savers/ Japan is often mentioned as a country where deflation has been disastrous. Really? Schlichter, first on how some might argue that “deflation” can also be seen as a form of price stability for savers: ‘…Martin Wolf flatly stated in the FT recently that the “low-risk-seeking saver” no longer served a useful purpose in the global economy, and he approvingly quoted John Maynard Keynes with his call for the “euthanasia of the rentier”. ‘“Interest today rewards no genuine sacrifice,” Keynes wrote back then, obviously in… Read more »
David
What you say about Europe at the end is interesting as I thought you were (at least broadly) in favour of Europe. I know you have been against Euro (as in currency) membership of course, but are you beginning to take a more sceptical view of the “European project” than before? (I may have missed developments in recent times.) Raymond Crotty campaigned against EC membership, as I recall, for the same reason you give.
Hi Jill
I miss your pieces in the Sunday Times. Also where is Constantin Gurdgiev? You two made the Sunday Times worth buying for its ‘Business Section’. It’s bland without both your contributions.
subsribe
10% of Dublin properties lie empty! People own these (silver haired generation I’d guess – the ones who take to the streets when their non-means tested medical card comes under threat), and maybe the owners have forgotten that they own them or don’t need to take in rent because they are already so comfortably well off??? Between this and 16,000 (mostly silver haired) annual property ‘cash’ buyers out there, it’s great having one foot in the grave – on the pig’s back with the pig in the grave. Now, where did I leave the silver hair dye, I want a… Read more »
Shatter The Illusionist The Dynamic :
€70,000 Lump Sum
Choice 1 – He Refuses – Tax payer keeps the €70,000 ; and
Choice 2 – He Accepts – Shatter keeps €35,000 net , Tax payer keeps €35,000 ; and
Choice 3 – He Accepts …..but ….but…but…he gives it to Charity —
Shatter claims tax relief of €35,000 , Charity receives €70,000 and Tax Payer receives NOTHING …and LOSES €105,000 .
….
Shatter The Illusionist ….supported by the invisible pen of his assistant QUINN of Labour .
“Many are called, few are chosen”
https://www.youtube.com/watch?v=EQ_Lq49Gmmo
Dennis Brown – Revolution.
You must forgive my thundering lack of understanding of economics and how it all works. I have never formally studied the system. I am confused by the comment in the above article “Deflation…means that although your debt repayments stay the same you have less money” My confusion stems from the fact that I read somewhere that he definition of inflation/deflation was something like “Inflation reduces the real value of money over time; conversely, deflation increases the real value of money” more or less anyway? Having read the Detlev Schlicter article linked by another poster I returned to my former position… Read more »
There was a very interesting comment made during the week about increasing the supply of housing – following on from DMcWs weekend TV interview on The late Late Show – not only should developers lose Planning permission on sites if they haven’t started developing them within 24 months and pay a hefty CGT on any undeveloped sites being “Flipped”, but why not also impose a higher Stamp Duty on sales of New or 2nd hand houses to Non Owner-Occupiers. Say if Stamp Duty is 6%-9% for normal family homes (occupied by the purchasers) and Zero % to 1st Time Buyers,… Read more »
In a deflationary environment cash is king at the start. People spend less on consumption goods because they think they will be cheaper later. Demand dries up. Firms sell fewer goods. Firm lay people off. People spend less and save more. The economy contracts. The govts’ tax take falls. This is where it gets interesting. The govt looks for ways to balance its’ books. It spends less and increases taxes. Firms stop taking out loans. Banks reduce their loans and their profit falls. They can’t afford to pay savers high interest rates. Savers’ incomes fall. Small private banks begin to… Read more »
Sorry, That should have read, “…a clawback over 20 years”
Well, now that All Hallows is closing down, here’s a God given opportunity for the unelected political padre Fr Peter McVerry to do something once and for all for ‘the homeless’. Your time to shine in the spotlight now Father, don’t be shy, hundreds of people depending on you to deliver free homes. P.s. I’ve just stopped paying my rent, soon to be made ‘homeless’ (Godhilpiss). I’ve booked my Ryanair one way flight home, I’ll help you out on the construction of the refit and refurb required to change the building from education to residential use, if you agree to… Read more »
So, what do you know? Well, now that All Hallows is closing down, here’s a God given opportunity for the unelected political padre Fr Peter McVerry to do something once and for all for ‘the homeless’. Your time to shine in the spotlight now Father, don’t be shy, hundreds of people depending on you to deliver free homes. P.s. I’ve just stopped paying my rent, soon to be made ‘homeless’ (Godhilpiss). I’ve booked my Ryanair one way flight home, I’ll help you out on the construction of the refit and refurb required to change the building from education to residential… Read more »
Why can we not issue a banking licence to a European bank which does not need to use one set of clients to subsidize another? We would then be able to borrow at reasonable rates?
Of course, that would mean the existing banks would fail which is of course what should have been allowed to happen (in a controlled manner) at the start of this whole process.
The decision not to do this is the decision that keeps giving (or taking).