Yesterday was a day where problems in the Euro zone took centre stage and in particular we had another installment in the slow-motion car crash that is the Irish banking and property market collapse. This has become so severe it has affected the creditworthiness of it as a sovereign nation too. I remember when Ireland announced the 2 year blanket guarantee for her banks which started in September 2008 and wondering if they could afford it with bank liabilities equal to just shy of 400% of Gross Domestic Product.Since those early days and after further study I realised that in fact for Ireland Gross National Product was and is more important for her than GDP,this is not good as it is lower and indeed on its measure Ireland is not out of recession. So two years down the road the question remains can Ireland afford it?
Number Crunching
According to the Financial Times the rescue of Ireland’s banking system is estimated at 50 billion Euros and she has a population of approximately 4.5 million. That means a cost per head of 11,100 Euros . The arithmetic gets worse if you exclude children, the long-term sick and the unemployed, according to the OECD Ireland’s unemployment rate was 13.6% in July, as they are unlikely to be able to help much.
If we look at Ireland’s national debt to GDP ratio this is now estimated to cross the 100% barrier. If we take the cost of funding at say 6% we can see a sort of trap here. Ireland will have to pay 6% of her GDP per year just to stand still if we consider this to be an interest-only mortgage and ignore any repayment. This is the danger of letting interest rates rise whilst governments dither and one of the reasons I suggested several weeks ago that she should call in the IMF/EU. As you know I consider GNP to be at least as important and for the second quarter of 2010 it was 81% of GDP (CSO of Ireland figures).Accordingly my maths can now be altered to 7.4% of GNP for an interest-only mortgage.
Market Response to the banking report
I praised the Central Bank Governor’s report yesterday as it looked credible and markets seemed to think the same. If we look at Ireland’s ten-year government bond yield it dipped by around 0.1% to 6.63% so better but still grim. If we use the alternative measure as to how far out she can fund himself more cheaply than applying for European aid we edged out from 2013 to 2014. So overall there was a short-term gain and a reward for some honesty.Many will wonder and I am one of them that such honesty if it had arrived earlier would have been likely to leave Ireland in a better position than where she is now.
Just to add to the situation this mornings Purchasing Managers Index came in at 48.3 on a scale where a number below 50 indicates contraction.This is the first time in seven months that the reading has dipped below 50. Also input costs continued to rise sharply in September. I am always cautious about survey results so let s hope that this one is wrong as Ireland’s situation is difficult enough.
Spanish GDP Figures
I reported yesterday that an anonymous email had produced some calculations suggesting that Spanish GDP had been overstated by some 14.3%. As you can imagine this created something of a storm and the Financial Times eventually took the offending article off its website. This move was wrong in my view and I would like to praise the two journalists who published this report.
Essentially the email suggested that if you compared measures for the Spanish economy such as underlying data for its service sector they indicated more of a slowdown than the official GDP figures have indicated. Furthermore an analysis was done which compared Spain with countries who have had similar rates of unemployment like to quote one example Latvia and this showed a discrepancy between reported growth rates as everyone else had higher levels of contraction.
The counterpoint to this was that there are different data sets between underlying service sector indices and the components which are used in GDP so we did not have a like for like comparison as the report implied. In addition there was an argument that some of Spain’s registered unemployment are in fact employed in her black economy and that this was a factor in the discrepancies. There were arguments that Spain’s “black economy” is particularly large and that this is a factor. For those unaware of what a black economy is then it is economic activity which avoids the usual channels usually for the purpose of avoiding income tax or sales taxes, for example paying by cash without paperwork. There is also talk of a change of methodology by the Spanish statistical service in 2008, although of course conspiracy-theorists will regard this as evidence rather than a rebuttal!
Comment
I do not know whether this email was politically inspired and anyway I only look at the economics. Whilst some of the figures produced here can indeed be challenged the answers often pose their own questions.For example in a so-called austerity period claiming to have a large black economy leads to the question why isn’t Spain doing more to collect these taxes? In addition I have reported before on manipulation of Spain’s fiscal statistics and have spotted that somewhat strangely youth unemployment appears to have stopped growing.
So I feel that we have the reverse of the situation yesterday in Ireland. Mr Honohan emerged with more credibility and for all the hot air and furore generated by what I assume some of which was from the Spanish state, in my opinion Spain emerged with less. I also notice that Goldman Sachs aka the Vampire Squid was in with an extraordinarily fast rebuttal which considering the nature of some of its involvements is likely to heighten rather than reduce suspicion that something may well be wrong here. The proper response should be a considered one from Spain’s statistical body INE and I await it.
Greek Tax Amnesty legislation is passed
Yes you did read the headline correctly, I checked it from several sources! Greece plans a tax amnesty as a way of getting some revenue in the short- term and has now passed the necessary legislation. The rational behind this move is that in her plans for this year actual revenue collection has disappointed and in a version of robbing Peter to pay Paul she feels that further mortgaging her future is the correct tactic. This of course ignores the fact that even larger problems await her in the future and she will now be weaker when she meets them. It also contradicts a pledge in PASOKs manifesto when it was elected. I can only echo this statement in Kathimerini.
Rather than looking for an excuse on the grounds that it is impossible to settle outstanding cases and collect debts to the state, the government should have imposed strict measures to make sure this happened. Cases involving tax evasion must be fast-tracked through the judicial system so it is clear to all that there will be no escape. A campaign of systematic inspections of suspects would bring in a great deal more money than the tax amnesty is expected to. But the government once again chose the easy path – the route that has brought us to the verge of disaster.
There is a plain moral hazard here just at the time that Greece needs her people’s support for her austerity plan. The supervising bodies, the EU/IMF and ECB have so far supported Greece in her austerity plans but I cannot see how even the most rose-tinted spectacles I can think of can possibly support this. Also it reminds me that in spite of her tax increases, Greek tax revenue continues to struggle which implies that her economy is struggling more than has been officially reported a matter I have discussed often.
As for economic figures then the PMI for Greece which was reported this morning did improve a little from 43 to 44.7 but remains well below the 50 boundary showing that according to this survey her economy is still contracting.
Commodity Prices continue their rise
The Commodity Research Bureau spot index rose to a new high of 487.37 yesterday. This means that it has now risen some 29.8% on a year ago so we are clearly in a phase of commodity price rises. If we look at yesterday’s rise we see that the phenomenon of “agflation” was again at play. For example the fats& oils component rose by 2.6% on the day,the livestock component rose by 1.7% on the day and the foodstuffs component rose by just over 1%. This reminds me of my article on Adam Posen’s speech where he said that there were no inflationary influences if I recall correctly. I have posted my reply to his speech on a section for economists on the Financial Times website to see if he replies as he did ask for a debate but I digress.
At the same time we are seeing new highs in the price of gold which has gone as high as US $1315 per ounce this week. Rises in gold are sometimes seen as a signal of inflation fears but of course there are plenty of economic fears at the moment which may be driving the price higher.
Notayesmanseconomics's Blog 
Shaun,
As ever, thanks for your great articles.
I know this has nothing to do with today’s article, I wanted to ask what people thought of Meredith Whitney’s (if I remember correctly, she was the one who called that Citigroup would reduce their dividend in 2007, just before the financial crisis) 600 page report, “The Tragedy of Commons”. I haven’t read it, as I believe you need to sign up to her web site, and be accepted, before you can download the report. However, I did see her CNBC interview where she says that the vast majority of US states are far too indebted, and since about two-thirds of town halls are funded through state funding, there is a possibility that some town halls could become backrupt, since the states will hold to their cash, to fund their budgets.
Finally, she believes that after the US banks issue their profits in the coming weeks, that there could be as many as 80,000 banking job losses, starting in early 2011.
What do people think of her evaluation, do they think that she could even be partially right, and if any of the town halls/states become backrupt, what consequence does that have for the rest of the World? And do people really think that there could be 80,000 banking job losses next year?
Hi Robert
Thanks for the compliment. I havent read this particular article yet but I have followed from time to time the problems of the various US states. California gets the most publicity but there are others in a worse position. If you search through on CNBC they did a slide-show a while ago on state finances but it is not for those with a weak constitution!
Some compare the weaker states in the US with the weaker peripheral euro zone states and they have a point. Where the analogy is weaker is when one looks at measures to deal with it as the US is a federal state and therefore has federal powers such as tax collecting and the ability to collectively borrow which the euro zone does not. This does matter although it has its own implications and as just one example the recent falls in the US $ and talk of QE2 are related to this. I do not mean state problems cause either but they are factors in the cause.
It is just a reason amongst many why the US needs some economic growth and why any indications of it are watched like a hawk by the fed.
Just to throw a possible spanner in the works I remember about 20 years ago that investors assumed the UK would bail out various local councils and we did not…..
There is a big difference between national/local funding in the UK and federal/state/county funding on the US. Essentially in the UK much of local governments funding comes from central taxation ,the amounts granted are based on formuli that take some account of local need.Furthermore spending and borrowing decisions fall into tight control mechanisms. So whilst local authorities can still make poor decisions and may have to make cuts from time to time,the prospect becoming insolvent is remote.
The position in the US is radically different states and county are dependant heavily on sales and property taxes to get by with only patchy federal support. Accordingly in a downturn receipts collapse and demands for services go up.Also US local bodies have much greater freedoms in treasury management and are pretty free to get ripped off left,right and centre in derivative deals with banks which they do not understand.
So muni default is a real threat. The question however is how much contagion threat into the financial system does it pose? Tough question to answer but as much muni debt is held by individuals for tax reasons,it may be fair to assume that the systemic risks are not as great as that say for a further lurch down in real estate values. Obama and the Fed will have some tough calls to make on local authority debts ,do they act as lender of last resort (with all the consequent moral hazard) to keep essential local services running?
Hi Shaun,
How does Ireland get its deficit to below 3% of its GDP by 2014, given this new information. I understand that they already needed to find fiscal consolidations of, averaging, 2% of GDP year on year to 2014. I can see they have already cut current and capital spending, phasing out MIRAS ( remember that!), introducing water charges, cutting public sector wage bills, adjusting retirement ages, introducing universal national insurances, two-phased income taxes, property and carbon taxes – what else will they need now to do?
Hi Shireblogger
I do remember MIRAS,wasnt it Nigel Lawson who began the scrapping of it? As to Ireland she is left with real difficulties particularly if you use the more realistic GNP measure.
I think there is now a danger that Ireland spirals downward a la my article on Latvia so I think that a lot of care is needed. I think that the Croke Park Agreement needs to go so that everyone is taking the strain. Also rather than specific tax raising measures I think that Ireland needs to go to the heart of the cronyism that appears to be at the heart of her political life. Also she needs genuine banking reform and could start with some of the bank bond-holders sharing the pain and get a real grip on what is systemically important and what is not as she may have to let things go that she has protected so far.
So for the rest of 2010 my emphasis would be on tidying things up and reform rather than tax rises on a weak economy. In essence the liabilities she is supporting are simply too large and a start needs to be made there. Otherwise recession could head towards depression….
As to the 2014 target it might be best to quietly abandon it in the circumstances. If she ever needed EU aid the time is now, but other poorer countries are unlikely to support any such plan.