Are we waltzing ourselves up an economic cul-de-sac without realising it? Are we making a bad situation worse?
The way things are going, our economy could contract by 10 per cent this year. This figure may sound apocalyptic but not unimaginable, given the pace of current job losses, emigration and price falls. There seems to be – among the economic fraternity at least – uniformity about the need to slash government spending. On many levels, this is understandable, but is it the right thing to do?
The following might be heresy, but let’s think about it anyway. Will history look back and say that, in 2009, the Irish government should have been spending more, rather than cutting back?
When all economists are singing from the same hymn sheet, there is a dreadful risk that the pitch will be off-key. This is particularly the case when many of them were cheerleading the boom until not so long ago. In fact, not since St Paul was on the road to Damascus have there been such conspicuous conversions to the ‘‘we all knew it couldn’t last school’’. Enough. On the surface, the mainstream arguments seem to be pretty sensible. State spending is going out of control.
The rest of the country can’t afford it. The private sector is getting hammered, so it is not just an economic question but also a moral question about who shoulders the burden. These are all logical points of view. But the major concern is, if there is no demand coming from any where else, will the downturn here not simply be exacerbated by reducing state spending significantly now?
Unlike many, I am agnostic on this – or, maybe more accurately, open to persuasion. But think about it for a second. The boom in Ireland mirrored similar booms in most Anglo-American economies. Our property obsession put us at odds with much of the eurozone in terms of recent experience. Spain is the exception, but that country was downgraded by Standard & Poor’s, the rating agency, last week.
In the Anglo-American world, the response to the housing bust has been a massive increase in state spending and an equally dramatic loosening of monetary policy. Exchange rates have been allowed to find their own level and, in the British case, this is some 30 per cent below where it was in 2007. In both countries, there are two hands of macro-economic policy at work – fiscal policy and monetary policy. Think about what is happening here.
Monetary policy is jammed by our dysfunctional banks. When they talk about the ‘‘systemic’’ importance of banks, what they mean is that the banks operate as an arm of monetary policy. Without them, monetary policy can’t work. So it doesn’t matter how low interest rates go, the banks are in no position to pass on the benefit because their balance sheet is so weakened that they are zombies. So Ireland is now operating without a monetary policy. Minister for Finance Brian Lenihan is a one-handed policy maker.
Worse still, our exchange rate is wildly overvalued, so we can’t hope for export led growth. Even when the world recovers, this overvalued exchange rate will ensure that fewer Irish exporting companies make it through this recession to be in the position to export anything in the years ahead. The only thing that Lenihan has at his disposal is fiscal policy.
So you see our conundrum. Every way we move, we are snookered. If Lenihan cuts back on government spending, nothing will replace it and demand will fall further. Unemployment rises, as does other social welfare spending and soon, whatever cuts he makes are wiped out by falling revenue and rising spending. Raising taxes exacerbates the demand dilemma further.
Traditionally, as in 1987, the fiscal contraction led to a significant capital inflow, which allowed interest rates to fall significantly. Borrowing costs came down, private sector lending increased and, crucially, the banking system, which was working, pumped money into the economy. Thus there was an immediate positive impact on the economy.
This time there will be no positive. Some economists argue with some validity that the spread of our bonds over German bonds will fall significantly if we have a fiscal adjustment. This, they say, will be the monetary dividend from cutting spending now. But even with the risk premium built into Irish bonds, we are still borrowing at below 6 per cent. This is significantly lower than where the US government typically borrows.
It is hardly a reward for good behaviour and, as the banks are zombies, there won’t be any impact on demand other than downwards. The adjustment will fail and fail again.
But does it have to be like this? Do we have to embark on a policy which makes the worst recession in a century worse? According to ‘conventional’ wisdom, the answer is yes. This is the same conventional wisdom that told us the boom was solidly founded and that joining the euro was a brilliant move for Ireland as it would give us ‘permanently’ low interest rates.
These are the same people who predicted that Polish workers laying blocks were all you needed to validate semi-ds in Dublin trading at prices of 40 times annual rents.
If we look at economic history, we see that no small country ever recovered successfully from debt deflation by cutting spending and sticking with a hard currency. The evidence from Sweden and Finland in the early 1990s is particularly instructive. Both countries suffered from the same boom-bust cycle as we did. Their banks went bust and had to be nationalised, like ours. And the initial policy reaction from everyone – the government, the trade unions, the media establishment and the senior civil servants -was that the government must reduce spending and the hard currency link to the Deutschmark must be preserved at all costs.
This adjustment failed, as ours will do, because it is intellectually incoherent unless you are prepared to entertain massive unemployment and serious social unrest. Unemployment went to 19 per cent in Finland and the budget deficit to 14 per cent of GDP. Finally, someone shouted stop to this masochistic madness.
Against all their advice, the two governments broke their currency arrangements and reflated the economy by allowing both currencies to fall. The countries recovered quickly and again, against all conventional wisdom, the competitive edge the countries garnered endured. Their banks’ capitalisation worked a treat as well.
Both countries, being small trading economies, had significant foreign debts too. Yes, these did go up, but the revenue associated with the recovery more than covered the increased debt service. Neither country suffered any long-term ramifications in terms of access to foreign capital in the future.
In the light of our own banking travails, much has been made of Sweden and Finland’s bank recapitalisation and recovery plan. What most of this discussion fails to mention is that the devaluation and subsequent printing of money by both central banks did the trick. Is it worth considering here? Surely not; it might mean replacing mantras with hard thinking. That would be far too much to ask as the economy heads for a 10 per cent contraction.
Between a rock and a hard place…………..still we shall overcome of that I’m certain. A good kick in the corrections is what we needed……
When you find yourself stuck between a rock and a hard place, please call us.
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Furrylugs, Succinct report from meeting: “As flies, to wanton boys, are men, to the Gobshites”.
Having been to Finland more than a few times over the past couple of years I think it cannot be overstated how the recession of the late 80’s / early 90’s impacted the country. People still talk about it cautiously and everyone seems to know of someone who suffered terribly but eventually found their feet again. In comparative terms their boom to bust might be moderate next to what is happening here.
David: I could suggest that Seanie Fitzpatrick adopts Augustus Toplady’s hymn as his anthem:
“A debtor to mercy alone,
Of covenant mercy I sing;
Nor fear, with Thy righteousness on,
My person and offering to bring.
The terrors of law and of God
With me can have nothing to do;
My Savior’s obedience and blood
Hide all my transgressions from view”
“intellectually incoherent” I love that. When I was a kid we’d call that Horsepower Thick. I agree in principle with targetted spending to lift SME business. That gets the internal market kicking again. We also have to get good people sitting with the MNC’s to get with their mindset. We can’t lose any more to India. But as Shane Ross exposed in the papers, the Illuminata are merely rearranging the deckchairs. When the people in charge don’t give a rattle for the country, there won’t be a masterplan. There’ll be “intellectually incoherent” mumblings to placate the peasantry whilst the powers… Read more »
Hi David, Thinking about leaving the Euro, again???? :-) > In the light of our own banking travails, much has been made of Sweden and Finland’s bank recapitalisation and recovery plan. What most of this discussion fails to mention is that the devaluation and subsequent printing of money by both central banks did the trick. Is it worth considering here? David, I think the challenge for all countries that are part of a ‘currency membership scheme’, such as the Euro, is to be able to effectively ‘devalue’ whilst remaining a part of it. It is technically possible IF the will… Read more »
This country is a joke! Over 10 years of unprecedented wealth and economic growth and what do we have to show for it? A massive and unrequired construction industry, enormous private debt, shambolic infrastructure, bungalow “bliss” and a growing posse of soon to be bankrupt Donald Trump wannabes! 93% of “our” exports are from foreign companies! The government should have put money into developing indigenous start ups. Finland has Nokia, Israel has Teva Pharmaceuticals, we have AIB and BOI! Our top three public companies are construction related three letter acronyms, perhaps they should merge and form IOU!
The hymn called ‘Ideological Fixations’ is making some of the babies in the church cry, they can’t stand the shrieking discord of the chorus. Time to turn the page to ‘Pragmatic Optimism’. First of all, Reverend Obama will leads us with a rap, then we all join in the gospel harmonies when we hit the chorus. As per his first weekly address to the nation as President. Obama intends to ‘right-size’ Government to the current circumstances. In some areas that may dictate expansion, whilst in others (pork) it will definitely entail severe contractions. The process of ‘right-sizing’ is best indicated… Read more »
Sure while your at it why not just leave Europe then we could fish our waters again ,place a few wind farms out there along with charging those English Oil cappers and we ‘d all live happy ever after ! . Biffo like the Roman Senators has gained two stone since taken his Office , and you think he is going to make a move for the good of the common paddy ?
What is the percentage GDP is our budget deficit at the moment
“Is it worth considering here? Surely not; it might mean replacing mantras with hard thinking” There are no ‘specific’ proposals coming out of government on how to stimulate the economy and balance the books! Without specifics the economy will continue to contract, more jobs will be lost and good companies with sustainable businesses in a competitive and thriving economy will close. I agree the only part of the economy which is growing is government expenditure. Even if they can ‘negotiate’ € 2 billion ‘savings’ with social partner, €47 billion is planned in current expenditure this year versus €44 billion in… Read more »
I think the most that can be achieved from this startegy is a carefull game of chicken with the EU. You are basically suggesting we pull out of the Euro and I suspect the EU will somehow give up something big in the way of policy for small struggling economy members, to keep the unthinkable from happening. Especially so if they feel they may very well add to it with the brits joining the Euro. The prize in their sights may well be the right time make such a treat…
David > Surely not; it might mean replacing mantras with hard thinking. I have been doing some hard thinking since I read your article in the SB post. I have argued here before that leaving the Euro would not be a good idea for Ireland at the moment. Perhaps joining it in the first place was not the best thing for us, but that horse has long bolted. We are where we are. Leaving the Euro would economically disadvantage us because: 1. If we introduce a new currency it will be quickly debased on the Forex markets. The introduction is… Read more »
Annual salaries:
Barack Obama €260,000
Gordon Brown €198,000
Nicolas Sarkozy €232,000
Brian Cowen €310,000 !!!!!
Not to mention the 60% pension that kicks in once he’s 6 months out of office (even if he’s still drawing a sitting TD’s salary), 50% TD pension( €45k) that kicks in if he loses his seat, and a 1.5 times annual TD salary lump sum if he puts in 20 years in the Dail (135k)!!
Hi everyone
On paper leaving the euro looks like the right thing to do, but in reality Ireland’s new currency would end up like Iceland’s or worse, devalued and restated everyday like Zimbabwe
Mon 1 new punt = 20c euro
Tues 1 new punt = 5c euro
Ireland needs to adjust and cut out the wastage in its economy so that 1 punt = 1 euro so that maybe one day when I ask the waitress in my local restaurant to just “give the table a wipe please” she’ll do it without saying “here’s the cloth, clean it yourself.”
Fiscal and Monetary policy are the two hands.Monetary hand tied behind Linehans back.Fiscal hand trying to do the right thing but being diverted away from its full function by trying to release Monetary hand.As a result aggregate demand in the economy is spiralling downward.The private sector is not being crowded out as much as frozen out by the failures on the monetary side.The corrective effects of inflation or as in our case deflation and low interest rates are also frozen because of the failure on the monetary side.The policies being pursued at present .ie public service pay and cost base… Read more »
Working without Monetary Policy now is correct , thanks to corrupt and greedy bankers and government members who have truly failed the public. So we have little choice but an election if there was any honour. As you have said before tha banks can not deliver , even though rates are cheap, as the mess is too great. So why waste and save the very peoples greed and bad behaviour with taxpayers money ! Banks like Anglo Irish need sincerely fresh and little reference to the past and present corruption , if there is a chance but as auditors ,… Read more »
War Zone Manifesto Public Announcement : It was amazing this morning listening on the 7am RTE News ,the barely audible newstalker informing us ‘ the minister for finance has made a ministerial order last night to devalue by 25% and has communicated his decision to mr trichet in advance of his visit to dublin’.The new currency is to be called ‘punt’. Shops were advised to change their pricing and continue trading both in euros and punts .The Banks have devalued all deposits held and are writing to customers to give them a choice if they want to continue repaying in… Read more »
Bankers did what bankers do, ditto, the builders, the speculators and so, and so, and so. And now the Dept’ of Finance is doing what the has always done. But we have an opportunity now to really have a really good look at the Tax Code. To prune out the silly taxes, allowances and incentives. Basically to lay waste to the thing at one swoop. Your agnosticism. The policy for cutting back makes a certain amount of simplistic sense, but the noises coming out seems to say that all are going to be cut. I hold this to be foolish.… Read more »
From an irishman Looking from the Outside in, I Live in the U.S.A.,- left Ireland over 2 years ago…Sold my Property for a ridiculus price and converted to Dollars at $1.60/Euro….. What I notice is a trend =what happens here (U.S.A) will in 6-12 months happen in Ireland….. http://www.wflxfox29.com/Global/story.asp?S=9732552&nav=menu98_3 California facing bankruptcy Posted: Jan 26, 2009 07:46 AM PST Posted by Rachel Leigh email SACRAMENTO, CA (WFLX) – If budget issues don’t get resolved this week, the entire state of California could go bankrupt. The state controller, John Chiang warns if an agreement to address the state’s $42 billion budget… Read more »
True, I agree that we need to cut out waste in the economy. All of those silly taxes, allowances etc that cost more to administer than what they deliver to the economy need to be cut out. What we need is productive government spending. Spending on infrastructure that works. More competition in building infrastructure – taking 7 years to build a rail-line between Dublin and Navan costing God knows how much and going over much the same ground as the original line that was built in the 1840s is crazy. Especially, since the line in the 1840s only took 3… Read more »
Lorcan> When Sweden and Finland had their crisis, they were lucky because their crisis were local This is a very valid point and worth emphasising again. Whilst we can look at past bubbles/problems over the centuries, from the UK in 88/89/90 to Japan, to Sweden, to Finland, tulips, etc, etc, and David knows his history of economics very well indeed, our own problem at this point in time may have some or many similarities to those instances but it is specifically unique. The details of what worked in the past on other occasions may not work now. Why? Well, the… Read more »
Iceland is predicted to contract by 10 per cent this year, so Ireland wont be alone then? I’m glad the ”cheerleaders got a good kick in the boom” though unfortunately (we’ll all suffer) the school leavers will join the hopeless, and (become possibly hopeless) the poor will suffer – as is usual – the most. This it is not a recession it’s a depression, a complete collapse of investment banking that was run on credit, and little else, and seemingly can’t be run any other way but on credit. That model has got to be replaced. You’re not just talking… Read more »
The sickly Tiger
http://online.wsj.com/article/SB123301620834517715.html
suicides in iceland and social unrest, same in Estonia, Bulgaria, Greece………..tide turning
http://www.guardian.co.uk/world/2009/jan/18/eu-riots-vilinius
http://www.guardian.co.uk/commentisfree/2009/jan/21/iceland-globalrecession
http://www.independent.co.uk/news/world/europe/meltdown-iceland-on-the-brink-1515753.html
Where is this leading, out of the eurozone, out of the EU? The first assumption that we are a small country is invalid, as effectively, we are integrated, for better or worse into the EU. Iceland inevitably will join for stability of its currency, yet consideration is given to the classic procedure of floating the currency, and inflating debt out of existence. If there were a sniff of a chance of this happening, the savings in euro would be transferred to Luxembourg and the country would totally collapse overnight. It is about time that the reality of the insignificance of… Read more »
The necessity of forcing American companies to repatriate operations, of pay punitive tax on foreign earnings in order to create employment in the United States and the redress the balance of payments deficit will inevitably curtail FDI and lead to rationalisation of existing operations. American companies currently account for 55billion euro of GDP here. Regardless of fiscal or monetary policy, or the existence of Irish banks, the prospects for employment are dismal to catastrophic, and upskilling is no solution if no one is bringing jobs here. We will have to find a way to live, beyond our current understanding. No… Read more »
David said: “Monetary policy is jammed by our dysfunctional banks. When they talk about the ‘‘systemic’’ importance of banks, what they mean is that the banks operate as an arm of monetary policy. Without them, monetary policy can’t work. So it doesn’t matter how low interest rates go, the banks are in no position to pass on the benefit because their balance sheet is so weakened that they are zombies. So Ireland is now operating without a monetary policy.” David previously suggested that the solution was to create a ‘bad bank’. That idea is gaining momentum, even in the US,… Read more »
g, thanks for the link to the WSJ article. Does not paint a happy picture!
economic “conditions are fundamentally sound.” and “the fundamental stength of the economy is unimpaired.”
Brian Lenihan in 2009? No, President Herbert Hoover in 1929/30.
I understand the need not to talk down the economy but I do worry that Mr. Lenihan actually believes what he is saying.
We are in transit to a new feudalism, with renewable energy, local agriculture and essential manufactures, connected in a global virtual neural network in cyber cottages, or urban villages. Hydro-carbon dependence is gone, suburban commuting is gone, credit is gone, global distribution production and distribution systems are specialised and traded in collateralised barter systems in which real things are bundled and valued in specific trades by brokers. The world operates as security regions, integrated under laws, enforcement and administrative control. Air traffic is severely curtailed. The compulsion to travel will be transferred to hyper-real cyber experiences. Development of essential standards… Read more »
Who is the current Minister for Labour/FAS and what are they doing to reskill workers – improve labour market efficiency/remove bottlenecks ??
I have not heard anything in this area…
“ ‘Cottage’ exporting industries if expanded would help, but we have a low indigenous base who have to struggle and compete with the environment here rather than getting major support and we are a periphery country. It also takes time. If you are a small indigeous business with export sales, what is the government incentive for taking on a new employee??? None. No tax breaks. Yet Paul Hewson and the lads (from the nort soide) plus the many that avail of tax efficiency as listed out in Form 11 and many other tax forms are still ‘avoiding’ tax, erm, being… Read more »
Irelands’ biggest challenge is to adapt. We can’t deny the crisis but with a minimum wage at some ridiculous level even with the greatest optimistic view it is easy to see why Dell moved shop, Hibernian out-sourced and more jobs will be lost.
Get to grips with the fact that the race to the bottom is inevitable in order for competitiveness to be sustainable long term. Indigenous companies are the only way forward and that needs support and encouragement and worse still, bank support.
As several people have mentioned, the recessions in Scandanavia were pretty localised, so when they decided to devalue their currency there were other, strong, currencies around to devalue against, and thus to gain competitive advantage against. Right now, most of the western world is in trouble caused by too much debt, and pretty much everyone (except possibly the Germans) is thinking “wouldn’t it be nice to just inflate all that debt away”? Some countries (UK and US ) have already gone for that option, but eventually everyone else will follow, including the eurozone. Germany won’t like it (hell, it might… Read more »
i read some journalist who say ‘there is no option’. the word option means a choice .the context they use that word is meaning ‘we must not consider anything to do with devaluation’. so they think that another fiscal policy or gov cost reduction is the answer and at the same time they are not Pragmatic neither do they give a solution except to create more confusion to their readers pretending they are making a solution appear as in aparition on a soul searching day . maybe we here in ireland might think about’pairing’ with a like minded other currency… Read more »
So the idea behind this is: “lets go back 10 years and start again” A devaluated new punt won’t mean anything because it would be just increasing productivity the easy way, but Ireland will lose that productivity the very same way it has done until now. Indeed it will be a risky movement if you think about what happened to Iceland (much closer in time than the early 1990s) and the fact of becoming “a failed country”. It will became increasingly important in the following years to distinguish between countries that can’t deal with the bad situations and those that… Read more »
This article is the best analysis on our predicament that I have read to date. It basically supports much of what David was saying.
http://online.wsj.com/article/SB123258594265704581.html?mod=googlenews_wsj
Sometimes David doesn’t get it all right, and he reminds me of a dog who gets fixated on a revolving car wheel when it comes to property. The contention that a first time buyer home cost 40 times (2.5% yield) is patently so untrue that it shouldn’t be allowed pass. I used to have a friend who when challenged to explain a point that he had made always rejoined with the statement that ” It’s a well known fact”. Who said so? – so David prove your point! If you like, I’ll start: Cost of new 2 bed Apartment in… Read more »
We will have to start printing money. Either by giving people State jobs (no pensions), Jobs in the HSE. Increase indigonous companies. Cut tax for all companies who hire new staff. Increase wages, and increase jobs.
One simple idea?
Cut Tax now. and increase it slowly over 10 years.
Sam, It really does not make sense investing in property at the start of a depression, also, did you include furnishings, breakages, and management fees (fees which or way too high in Dublin). Besides, in a couple years time, the Ivory “Tower” Building apartments will be even cheaper to buy, or to rent, for anyone who has money.
Drastic times call for drastic measures, maybe its time for Ireland to apply to become part of the US? Becoming a US state would have some advantages – US companies may not face as much pressure to repatriate their profits back to the US Mainland; dollar exchange rate would make us a bit more competitive on export markets…
Okay, okay, I know that all of this is very far-fetched, and how the hell could we be a member of the US and maintain our so-called neutrality? But might as well throw it into the mix.
Between Alan Ahearne and Fintan O’Toole there should be plenty of money to cover the government expenditure shortfall, but will those earning over 80000 sit still and take the hit? They run the game and will make us suffer relentlessly as always. Cut your costs, hoard your cash, and prepare for total meltdown,
Attacking me with “ad hominem” comments, demeans you, Robert – not me. Also it does nothing to further your position on your opinion. Address the argument.
May I suggest a new title – Who wants to be a recessionaire – Life on a shoestring The people who had the most gain from the celtic tiger should now take the most pain. The fat cats have to pay their share. Get public finances in order get the banks to free up cash for small businesses, many small businesses are at the moment being squeezed by the banks. people are going to prison for the non payment of credit union loans and senior bankers can walk away untouched for what they have done. it beggars belief unemployment rate… Read more »
By the way, I’m neither a builder nor Parlon. At the moment, I’m an investor in physical gold and geared long term currency swaps.
“Long term currency swaps” – That’s interest rate swaps in different currencies.
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Here Sam, The normal model is to allow one months rent per year for costs ( management fees remember – you are obliged to pay them and they be higher than that ) …Try inputting that back into your incredible formula! – or writing a new one to allow for it ?… Then you can allow for missing out on a months rent here and there as tenants move change over. Maybe then you can allow a little scope for a softening market and lowering rent ( I mean is the rent guaranteed over the life of the mortgage? )…… Read more »
In just the past 24 hours alone, Corning, Caterpillar, Home Depot, Pfizer, Texas Instruments, Sprint, GM, ING, Phillips Electronics and other large companies have announced more than 75,000 layoffs worldwide.
WORSE: So far in January, 52 large U.S. companies have announced 210,000 layoffs!
WORST OF ALL: This is just the beginning! And now, even the most optimistic of observers finally admit it. They now see the impact it will have on millions of Americans. But they don’t yet see how it could trample your investments.
The Great Dustbowl has arrived …All INCOME is in DANGER NOW