Tuesday, April 14, 2009

Ireland, ECB & Recent Commentary

Reading Ambrose Evans-Pritchard (Sunday Telegraph, 12/04/09) strikes me as an interesting case-study of stranger than life UK views of ECB - a mixture of truth, more truth and, all of sudden, bizarre ranting...

Judge for yourselves: “If Ireland still controlled the levers of economic policy, it would have slashed interest rates to near zero to prevent a property collapse from destroying the banking system. The Irish Central Bank would be a founder member of the "money printing" club, leading the way towards quantitative easing a l'outrance.”

I am far from being convinced by these arguments. Given that the ECB rates are at historic lows, an independent Irish Central Bank would only have room to move on further, say, 75bps-100bps down maximum. So what would have happened in this case?

Evans-Pritchard claims that “Irish bond yields would not be soaring into the stratosphere. The central bank would be crushing the yields with a sledge-hammer, just as the Fed and the Bank of England are crushing yields on US Treasuries and gilts.”

A maximum 100bps cut in rates would imply that Irish yields on 3-year paper would fall by ca50bps from their current levels. This assumes that the markets will take the same credibility to Irish Government commitments on fiscal policy stabilization as under the ECB oversight. This is highly unlikely. Instead, I would expect Irish yields to rise to 7-8.5% range on 5-year paper – consistent with the market pricing in double-digit deficits through 2012. Has Mr Evans-Pritchard ever seen John Hurley? or the dynamic trio of our Politbureauesque Leaders? Can anyone have confidence in their governance abilities? Being bootstrapped in the long run by the ECB does have a positive impact on our credibility and not having our currency managed by the corporatist consensus Government that we have at the very least insulates us from the monetary policies of disaster.

“Dublin would be smiling quietly as the Irish exchange rate fell a third to reflect the reality of trade ties to Sterling and the dollar zone,” says Evans-Pritchard.

Ok, but how is such a devaluation consistent with yields falling for Irish bonds? Unless these bonds were issued in Euro, devaluation would have acted to increase yields as FX risk increases would have driven bond prices down. In fact, I would suspect that the fall in our currency woud be deepr than that - say 60% (30% to restore references to the UK/US and 30% to reference the unttrustworthy Government). Such a fall would wake up even Mr Hurley - pushing him to raise interest rates to stave off a run on the Punt. The yo-yo of Irish monetary-fiscal-monetary-fiscal... debacles will commence.

“Above all, Ireland would not be the lone member of the OECD club to compound its disaster by slashing child benefit and youth unemployment along with everything else in last week's "budget from Hell".” Clearly, Mr Evans-Pritchard has failed to read the Budget. Our Government did precisely the opposite of what he claims – retained excessively lavish welfare benefits and current expenditure, taxing its way through the entire fabric of the middle class earnings and wealth creation incentives. Even child benefits and youth unemployment benefits cuts that Mr Evans-Pritchard claims to be welfare cuts are predominantly transfers to the middle and lower-middle classes. Majority of our poor are on permanent (not unemployment insurance) welfare and are collecting different types of child benefits.

“But what caught my ear was his throw-away comment that prices would fall 4pc, which is to admit that Ireland is spiralling into the most extreme deflation in any country since the early 1930s. Or put another way, "real" interest rates are rocketing. This is torture for a debtors' economy. You can survive deflation; you can survive debt; but Irving Fisher taught us in his 1933 treatise "Debt Deflation causes of Great Depressions" that the two together will eat you alive.”

I agree with Evans-Pritchard on this: real interest rates and the combination of debt and deflation will be drivers of misery for years to come. What is even more egregious is that our debt is actually growing, not shrinking and that this process will accelerate as Brian Lenihan pillages through our pockets.

“Mr Lenihan hopes to shield banks from the calamitous consequences by creating a buffer agency. It will soak up €80bn to €90bn in toxic debt - or 50pc of GDP. He borrowed the plan from Sweden's bank rescues in the early 1990s, but overlooks the key point - it was not the bail-out that saved Sweden's financial system, the country recovered only by ditching its exchange peg and regaining its freedom of action.”

Evans-Pritchard forgets couple other things that also helped to save Sweden – a rapid growth in the US and subsequently global economies during the 1994-1998 period that helped Sweden’s exports and capital inflows, and a robust programme of reforms that saw large scale privatizations and markets openings in many sectors of previously state-controlled economy.


yoganmahew said...

Mr. A E-P also seems to fall into the view (along with most of the commentariat) that Irish exports to the UK are more important than Irish imports from the UK, thus a fall in sterling is bad for Ireland.

Given that we have a huge balance of payments deficit with sterling (we import far more than we export), I cannot see how this view is correct? Should we not be cheering from the rooftops about the fall in sterling?

TrueEconomics said...

Indeed, yoganmahew - you are right about imports. And you can also add to your example another dimension: we are importing from the UK also via shopping in the Northern Ireland. This 'trade' activity is not acounted for in the national accounts data simply because we have no actual numbers as to how much we are spending there. Unofficially, some surveys of consumer purchasing in the North show that RofIreland shoppers now spend close to the amounts spent by the natives there. This trade too floursihed because (in part) of the cheaper sterling.