Hold onto the sackcloth and ashes

The biblical expression “sackcloth and ashes” has been bandied about quite a bit these days.

Coming from Ian Paisley it may sound appropriate.

However, it sounds strange coming from journalists and politicians, many of whom haven’t an ounce of religion in them.

The biblical practice of wearing a coarse sack of black goat hair and sitting on a pile of ashes was a sign of repentance. Although mentioned in Jonah (when the repentant King of Nineveh �arose from his throne, removed his robe, covered himself with sackcloth and sat in ashes’�), in fact the practice was much more common in medieval times.

It was used extensively as a punishment during the Spanish Inquisition, particularly against Jewish and Moorish merchants found guilty of the economic crime of �trading’�.

Not only were the Jews and Moors regarded as suspicious on religious grounds, but also because they maintained trade with other infidels, thus risking the contamination of Christian Spain.

Imperial Spain, the richest nation on earth, soon saw the emergence of a pious moral majority coupled with a massive trade and current account deficit. Does this sound familiar? Well, the comparisons between 16th century Spain and 21st century America do not stop there.

Imperial Spain, like modern day America, experienced a massive windfall from the gold of its Latin American Empire. The gold and spices flowed in and this should have put the Spaniards miles ahead of everyone. They had capital for projects, buildings and manufacturing; they could build more shipping fleets and trade even more.

But they chose to spend the gold on luxury and war. Instead of Spanish merchants and manufacturers using this credit to reduce their costs and thus to export more, by 1575 Spain had almost stopped making things and imported everything. Spain even stopped producing enough food and very soon became a net importer of grain and beef.

The wealth of the Spanish Empire ended up in the workshops of Amsterdam and London, the tanneries of France and the gunpowder mills of Genoa. Meanwhile, wars in Flanders cost the Spaniards a fortune, not just in the fighting but also in the cost of imported arms.

Advisers to the king told him not to worry because, as long as the cash was coming in from the Americas, there was no need to worry about the current account deficit.

In the event they were wrong. The debased Spanish ducats fell rapidly in value. There was a series of runs on the currency and, in the second half of the 16th century, when the gold stopped flowing and Spain was up to her eyes in debt, the crown was declared bankrupt on three successive occasions – in 1557,1575 and 1597.

Now look at the United States today. It is suffering from a similar problem. Most White House advisers are telling George Bush not to worry about the current account deficit and the fact that the US needs to borrow $2 billion a day to cover its spending does not really matter.

They are contending that it can just borrow and allow the currency to fall. It seems that few US commentators believe that a falling dollar is a problem. In fact, many see the collapsing dollar as a panacea. However, there are dissenting views from those who believe that the US is heading for a long-term decline with grave consequences for the nation.

Here’s what Warren Buffet, probably the world’s finest investor, told Fortune magazine last February: �Through the spring of 2002, I lived nearly 72 years without purchasing a foreign currency.

�Since then, Berkshire has made significant investments in – and today holds – several currencies. My reason is that our trade deficit has greatly worsened, to the point that our country’s �net worth’, so to speak, is now being transferred abroad at an alarming rate.�

A few months ago, Paul Volcker, the widely respected former chairman of the Federal Reserve Board suggested that the US faced �a 75 per cent chance of a crisis within five years’�.

In his excellent book Running on Empty, Peter Peterson, the chairman of the US Council on Foreign Relations says: �America’s twin deficits are now so large and our savings rate so low, that there is a real danger that investors around the world will simply lose faith in the dollar.�

Meanwhile, Robert Rubin, Bill Clinton’s top economic guru and former US Treasury Secretary, recently warned that the US was confronting �a day of serious reckoning’�.

Last month, Fed chairman Alan Greenspan said: �The question is how large a current account deficit in the US can be financed before resistance to acquiring new claims against US residents leads to adjustment. Net cross-border claims against US residents now amount to about one-fourth of annual USGDP.�

He speculated whether �international investors will eventually adjust their accumulation of dollar assets or, alternatively, seek higher returns to offset concentration risk’�.

On the other hand, US president George W Bush believes that �the deficit is just a number on a piece of paper’�, to which US vice-president Dick Cheney added: �Reagan proved that deficits don’t matter.�

So who is right? History suggests that we should consider the Spanish example.

The only real difference between now and then is that the ripples from the US are felt instantaneously, flashing across screens in every dealing room around the world. Let us imagine that Buffet, Rubin et al are right, and Bush and Cheney are wrong.

So this time next year, we should expect Morning Ireland’s business news on Friday, December 23, 2005 – the last trading day before Christmas – to sound something like this: �The euro against the US dollar is trading at 1.59, the US dollar against the Japanese yen is just above 75.0.

�The central banks of Japan and China have been intervening in waves overnight to keep the Chinese renminbi within its new trading band and to prevent the yen breaking even higher, but it’s unclear whether either central bank can hold the line.

�Ten-year US Treasury yields are well above 7 per cent and edging up as we speak and the S&P closed overnight below 8000. After yesterday’s horrible inflation numbers, the fear is that the Fed will tighten again next week, by half a percentage point, even though fourth quarter US GDP growth looks likely to be negative and delinquencies on credit card debt have exploded.

�Meanwhile, this morning’s euro area data points to stagnation and a further rise in the unemployment rate to 12 per cent. The German and French budget deficits are at close to 5 per cent of GDP this year, the Italian deficit 6 per cent, but, given government popularity ratings, deficit reduction is now totally off the EU policy agenda.

�The Stability and Growth Pact as originally formulated has been blown to smithereens, but the European political leadership is less interested in fiscal policy than in tightening immigration controls.

�Next week,G4 finance ministers will be meeting in Beijing, with another dollar support package the prime topic of conversation. The problem is that the tariff and quota legislation going through Congress is alienating other members of the group and, given the social unrest erupting in Shanghai, the Chinese leadership is focused more on its own survival than on international economic cooperation.

�Meanwhile, the IMF has come off the fence, describing US protectionism as a �huge and highly regrettable policy error’ and concluding that the latest package of US public expenditure cuts and tax increases falls some way short of what is needed to turn the budget deficit and the dollar around. Basically, until the US can negotiate with the UN on a withdrawal from Iraq and Afghanistan and simultaneously raise taxes, it’s hard to see how the budget numbers will add up.�

Given that vista, I’ll have the sackcloth and ashes please, Mr Paisley!