...a blog by Richard Flowers

Tuesday, November 23, 2010

Day 3613: There Was This Englishperson, Irishperson and Bank Manager…


It sounds like a JOKE, doesn't it, giving all of the seven billion pounds that we have cut from our spending away to save Ireland's banks.

But it's NOT.

If we can BORROW money at 2% then cutting seven billion pounds from OUR SPENDING cuts the amount we spend on interest by 2% of seven billion pounds.

BUT if we borrow money at 2% and then loan it to Ireland at 4%, we make a PROFIT on the deal and the extra interest that we earn cuts the amount we spend on interest by… 2% of seven billion pounds.

So, we use our greater financial strength to leverage a deal where we are no worse off, Ireland gets seven billion pounds of support for her banks, and in return Ireland doesn't default on the FIFTY billion pounds that she owes to British banks.

This SOUNDS like everybody wins, and that sounds too good to be true… and it IS.

What has happened is that we have taken on more of the RISK of Ireland defaulting. The British taxpayer is directly in line for the hit if Ireland cannot pay back that seven billion, and her ability to do so is moderately uncertain, and remains so as long as this trouble in the markets remains.

The house price crash in Ireland was much deeper than in Britain, and it is far from certain that the losses from money poured into overpriced equity have yet worked their way through the system.

The housing bubble – in Britain AND in Ireland, not to mention the USofA – was driven by cheap credit on the back of the Chinese booming economy. But in the UK it was, at least partly, supported by supply falling short of demand. In fact, our house prices and rents REMAIN unnaturally high because we STILL have a shortfall in family-sized housing, but that's a DIFFERENT problem. In Ireland, they too borrowed money cheaply but they built an AWFUL lot of houses that NO ONE needs.

So people borrowed a lot of money to build "ghost estates" which may as well just be knocked down. That's as good as borrowing money just to burn it. And at some point someone has to take a hit for those losses.

On top of that, though, the fundamental difference between Britain and Ireland is that we still have billions if not trillions of pounds worth of overseas assets. In spite of running a trade deficit for thirty years and more, we still haven't finished burning up the Empire. Ireland does not have such a lucky position. Their major assets remain their people, as I was reminded when the Irish finance minister was on the radio last week saying:

"We still have a highly educated and motivated young workforce and our exports are rising."

Yup, that's because you are exporting your highly educated and motivated young workforce!

Therefore Ireland's creditworthiness looks highly dodge to the markets: they've got nothing to mortgage but their own futures, and they've already done that!

This lack of state resources also makes it very difficult for the Irish government to consider coming out of the Euro and floating their own currency. A currency is only worth what the government can afford to pay to back it and in Ireland at the moment, that's paper! A floating Irish currency would NOT be the "correction" that commentators of the Europhobic persuasion contemplate; it would be a flat plummet. The consequences would be a huge spike in inflation as import prices went through the roof. Raising interest rates to control inflation would only make the government's debt situation worse. And if the government had to start printing currency to meet its day to day needs, well we're into Zimbabwe territory.

Ironically, in this way being in the Euro could actually be PROTECTING the Irish economy, not damaging it.

The argument that Britain has done very nicely, thank you, by staying out of the Euro remains UNPROVEN.

The ability to make our exports more competitive by letting our currency fall in value did not save us from the longest and deepest recession of any country in Europe (although for reasons probably unconnected to the independence of Sterling). And now the Euro is falling relative to pound making our exports more expensive in Europe, and therefore harder to sell, just at the time we are looking for export driven growth. So, yes, being outside the single currency looks like a TERRIFICALLY good plan there. That was SARCASM, by the way.

In Great Britain, interest rates are set very much with the South-East in mind, and this has often done great harm to the export potential of Wales, Scotland, the North even the South-West. Higher interest rates to keeps DOWN inflation in the South-East keep Sterling UP, making exports from the regions HARDER. But do the Europhobes suggest that those parts of the country would be better off outside the pound? No, of course they don't because the advantages of a single currency WITHIN the United Kingdom VASTLY outweigh the losses from differential export potentials.

The SAME is true in Europe.

The problem for the Eurozone, therefore, is NOT the one the Europhobes think it is. The problem, and it IS an intrinsic problem, is that BORROWING at the periphery is unregulated by the European Central Bank, in exactly the way that borrowing by Wales or Scotland or the English regions is NOT unregulated by the Treasury and Bank of England.

This is in fact the EXACT REVERSE of the Europhobic position that interest rates decided at the centre are set at rates inappropriate to the needs of countries on the edges.

(And, ironically, it's a restatement of the more regulation/less regulation argument that we all had about the banks before the collapse of 2008 proved that less regulation was every so very much WRONG.)

The Conservatories, who are supposed to be MONETARISTS, ought to know better. According to THEM, more credit = adding to the money supply = more inflation = BAD! Therefore it is RIGHT for central banks to LIMIT credit and prevent exposure like what has happened in Ireland, Greece and, well, here.

To be fair to the Conservatories in government, they haven't let ideology get in the way of doing the right thing. Master Gideon has been heard to say: "who would have thought Danny Alexander would be rolling back the Frontiers of the State while I was saving the Euro." And I have to admit that's very nearly witty.

In fact, with his put-down to the gloating Eurosceptics – "'I told you so' is not much of an economic policy." – I MIGHT have to think about reappraising the Chancer. Clearly, since getting into Government, he's been getting some good advice from somewhere. Or "Danny Alexander" as we in the Liberal Democrats call him.

The response from the left has, perhaps unsurprisingly, been rather more confused, with a mix of more Blame the Bankers rhetoric and some little-Englander why are WE saving the Irish.

There have been some calls for Ireland to be forced to increase the rate at which companies pay tax. I notice that Ms Pollyanna Toytown is joining the chorus with a piece in the Grauniad, decrying the Irish for luring companies to relocate to Dublin with their scandalously low tax rates. The hussies, she very nearly adds.

This is obviously LUDICROUS.

It's typical of the left wing to demand, nay COMPEL, an increased tax burden as the solution to ANY problem to hand.

But the case for Ireland raising their Corporation Tax rate SHOULD NOT reduce to: "it's not FAIR!"

The bloated public sectors of other European countries are hardly the fault of the Irish. Their OWN bloated public sector is another matter.

The reason Ireland OUGHT to consider raising Corporation Tax is because her government is spending TWICE as much as they raise in tax! That means sacking half the public sector or squaring up to a tax rise.

If – and only if – Ireland can pay for her public sector spending without raising further taxes then that is to be ENCOURAGED. Reducing the tax burden encourages GROWTH, which long term is the only way out of this hole. We can't all be Honk Kong, for example, which has excellent public services AND negligible corporate taxes AND astronomical growth. But we can step away from the Hard Labour model of the ever-increasing Corporate State, provider of everything and crushing wealth creation under the burden of taxes to pay for it.

What Ireland was doing wasn't BAD. They just made a FUNDAMENTAL error about where the MONEY was coming from. Be fair: so did WE!

Take away the reliance on cheap credit and a housing bubble, and Ireland could STILL be a model for a low tax, high entrepreneurship future.

And that's no joke!

1 comment:

Paul Walter said...

Excellent commentary