Pay to your grave

`Dear Mr McWilliams, it has come to our attention that you bought your house in 1957 for €1,000.
‘Today, we have had it valued at €700,000. We believe that this offers you a once in a lifetime opportunity to liberate equity. Yours sincerely, Mr Bank Manager.”

My Dad called me: “Son, I’ve heard of liberating Kuwait and liberating Iraq, but what in God’s name does liberating equity mean?”

It means that one of our supposedly prudent banks is urging my father, a 74-year-old pensioner, to borrow and spend against the value of his house! Now I realise that bank managers are under pressure to increase margins, but this is taking the biscuit, don’t you think?

Yet it is happening all over the country.

We are drowning in a sea of credit and we wonder why the price of everything in Ireland is rising. Prices are rising faster here than anywhere else because money is flowing in here from outside faster than anywhere else, fuelled by our borrowing, which is more profligate than anywhere else.

Until this fact is appreciated, the debate on rip-off Ireland and subsequent worries about competitiveness will go nowhere.

This week, another report said we were the most expensive country in Europe.

Phone lines to chat shows were jammed with people complaining about the price of everything from booze to shoes, houses to steaks. Every opposition politician worth his salt pointed the finger at the government and what it should or should not be doing.

Pundits complain in public but then as night falls everyone retreats to the comfort of their own homes to read their bank statements hoping that the extra zero at the end of last month’s credit card bill was actually a dream. But it wasn’t.

We realise that we are maxed out. We have borrowed 95 per cent for the house.

€12,000 for the car which is now four years old. All the holiday bills are beginning to come in through the door.

Did we use both the Visa and the Mastercard? Do you recognise the name of that restaurant? Oh yeah that was the one we went to on your birthday, where we kicked off with two rounds of Cosmos. The car tax is up, as is the insurance. That’s the guts of a grand. Little Johnny’s school fees are due.

Another related letter was polite but firm.

The flat we bought in 2002 has been vacant all summer. It’s worth at least €20,000 more, but no one warned us about the basic mathematics of occupancy.

We can deal with falling rents, it’s the vacancy that is the killer. I’m dreading that meeting with the bank manager next Thursday. But he did say on the phone that we could put all the credit card bills into a term loan and pay them off over five years. Let’s do that.

So you borrow a bit more. Latest figures from the Central Bank reveal that in July alone we borrowed over €3.3 billion, that’s €825 for every man, woman and child in the country. Personal borrowing is rising at 25 per cent in Ireland. This is five times the EU average. This figure does not include mortgage lending.

Where does all this cash go? About half goes on mortgages and houses, while the rest is spent on goods and services. Think about what happens when this much cash comes into an economy. It cascades into every nook and cranny.

Imagine the champagne pyramid in VIP magazine weddings. Eventually every single flute fills to the brim with sticky champers. The economy works in the same way. All the borrowed cash seeps into the machine and is spent at home in restaurants and bars or it is spent on imported goods.

What impact does this have on prices?

It is very simple: the more cash in the country, the more likely prices will rise.

Cash is the lubricant of inflation. So ultimately, Ireland’s unenviable position as being the most expensive place in Europe is a reflection of our insatiable appetite for borrowing other people’s money to spend today on every conceivable thing.

Will this stop? This is unlikely and there are three main reasons why.

The first is that borrowing is a habit and hyper-borrowing is a bad habit that is hard to lose. If interest rates remain low (and that appears likely), there is no pressing reason to stop. So either you borrow more or you roll up previous borrowing to make it appear that you are being prudent.

The second reason is that the banks have to lend to make money. Bizarrely, investors these days believe that it is normal to expect banks to make 15-20 per cent return on equity.

This is ludicrous, but it is what the market demands and if this margin slips, so too will the share price. So the banks will not turn off the credit tap any time soon.

There is a final reason which is less economical and more psychological and it is, what might be termed, the new Irish Dream.

In our parents’ day, the Irish Dream was about our nation, its culture, history, the Brits, piety, political sovereignty – all the mother’s milk stuff that at least three generations of post-independence Paddies were weaned on.

Today, however, the Irish Dream is much more like the American Dream. It is about the freedom to do well. It is about the opportunity to trade up.

The Irish Dream is about joining the affluent classes. To do this we must borrow as well as earn, and this change in the psychology of the country, added to the economic backdrop, is resulting in a credit binge.

So the roadmap is fairly well signposted. Ireland will continue to experience increases in the cost of living far in excess of those endured by our neighbours.

This trend will be punctuated by one-off events such as the inflationary impact of the maturing SSIAs in June 2006 (coincidentally the most likely month for the next general election).

It is estimated that about €8 billion is held in these accounts. With the 25 per cent windfall this means €10 billion will rain down on us in the early summer of 2006. Expect the sales of cars, kitchens, holidays, second homes etc to go through the roof.

The stockbrokers are warning the government to introduce another SSIA scheme to soak up this cash. They may have a point, but their motives are a bit too transparent.

Stockbrokers want the government to reintroduce another SSIA so that there will be an incentive to buy stocks as a form of savings. The more stocks bought, the more commission the brokers get.

The bigger picture relates to competitiveness. In the old days, progressive increases in inflation would have led to a run on the currency. The falling currency would have rectified the competitiveness of Irish exporters.

This is exactly what occurred after the 1993 devaluation. With the euro, that’s not possible today. At some stage, we are going to experience a massive switch away from Ireland to a country with much lower inflation and costs.

The economy works like any small business and there comes a time in any business when the cost and hassle of switching and finding a new supplier is outweighed by the exorbitant rising prices of your existing supplier.

At that point you switch. The timing of this is impossible to predict, but when it happens the tidal wave of free cash will be replaced by an economic earthquake the tremors of which will have profound effects that will go far beyond affecting the share price of our liberating banking sector.