Should Ireland call in the EU/IMF? Also the implications of a falling US dollar

After a dull day in US and European equity trading we saw a rally in the Far East this morning. The Japanese Nikkei 225 index rose by 116 points to 9626 and equities in Australia and Hong Kong rose too. This has been followed by European equities this morning with the Ftse 100, Cac 40 and Dax rising by nearly 1% in their opening hour. The rally in the Nikkei means that the spread between it and the Dow Jones has now fallen to 968 points the first time it has fallen into three figures for a while. Much of the recent rally in the Nikkei has been caused by the currency intervention undertaken by the Bank of Japan and so far it is going fairly well with the exchange rate versus the US dollar at 85.80 and the exchange rate versus the Euro at 112.63 which if sustained will provide some relief for Japan’s exporters. Although looking at the recent history on a chart reminds me that we are only back to the levels of early August and that the rate versus the US dollar was above 90 for much of the late spring.

If we move on to see what is happening in the world of commodity prices the Commodity Research Bureau spot index has crossed the 470 barrier and is now at 471.4 with metal prices as the main component which rose yesterday. If we look back a year then over this period the CRB has risen by 87.58 or 18.6%. So a slowing world economy is facing commodity price pressures. Fortunately the oil price seems stuck in a range at the moment and a barrel of West Texas Intermediate crude is currently priced at 75 dollars,so it is not contributing to commodity price pressures.

The US dollar the Euro and the Yuan

Whilst the media focus is on the Yen at this time it is revealing to take a look at the world’s other main currencies. This week the US dollar has had its weakest week for over a year and on the dollar weighted index has fallen to 80.9 for a fall of 2% on the week. One needs to remember that for the latter part of the week it has been rallying against the Yen so it has been particularly weak against its other trading currencies. If one looks back the US dollar has been falling since the beginning of June when its dollar index value was 88.7 so we have had a 10% fall since then. Now if we apply this to the commodity price rally and add in that they are usually priced in US dollars we find that since June price rises for the rest of the world have in general been masked by rallies against the currency it has been priced in. Not quite the conventional view is it?

Whilst we are discussing falling currencies we need therefore to think of who has risen as it is a zero sum gain as they have to fall against something. We find accordingly that the much maligned Euro has been having a good run and has now risen to 1.3140 versus the US dollar. As it started the week below 1.28 this is a move of over 2.5% and a considerable rally since it dipped below 1.20 versus the US dollar in early June of this year. Another currency which is often ignored is the Chinese Yuan but it has been rallying too. Since China abandoned the peg for the Yuan which I wrote about on the 19th June it has rallied by 1.5% and is now at 6.7172 versus the US dollar. So as suspected at the time its rise has been slow but it has risen. This has not stopped US politicians from being very critical of the slow rate of progress and if one does the maths it must have fallen against the Euro and Yen.

Ireland looks as though she needs help

The situation concerning Ireland and her potential fiscal position has been deteriorating over the past couple of weeks. I wrote on the deterioration in her real-estate and banking sectors on the 1st,7th and 8th of this month. In essence the figures produced by her banks particularly Anglo-Irish have been too optimistic over time and in my view remain so.The size of the potential losses and the implications of this for Ireland as a sovereign nation which has stood behind her banking sector are mounting.There are now scenarios were these losses may overwhelm her ability to pay for them.

I have written previously that Ireland has in terms of its fiscal problems tried to do the right thing. For example she has announced cuts to her fiscal deficit of some 5.5% of Gross Domestic Product for 2010. However this severe dose of austerity has led to rising problems in a country where real GDP  fell by  7.6 % in 2009 ,following a fall of  3.5 % in 2008.  Because of the number of overseas companies based in Ireland it is useful to look as well at Gross National Product or GNP which fell by  10.7 % in 2009 in real terms, following on from a fall of 3.5 % during 2008. In addition there are rising fears that in spite of the haircuts it has imposed on the portfolios it has received the Irish national bad bank or NAMA may end up making a loss.It was originally projected to make a profit of around 2.5 billion Euros. Another example of the problem is that  yesterday NAMA announced that the government will definitely be guaranteeing the 2.5 billion Euro Commercial Paper programme being used for short-term funding of NAMA projects. This adds another 2.5 billion Euros to the sovereign debt. To give some perspective to the numbers being quoted Ireland has a population of around four and a half million and according to her National Treasury Management Agency she had a National Debt of 87,236 million Euros at the end of August.

One irony of this situation is that up until the credit crunch Ireland had sound public finances. Here is a statement from the National Treasury Management Agency from 2005.

Interest payments on Ireland’s national debt are just one fifth of what they were 10 years ago, according to the National Treasury Management Agency.

In its latest annual report, which was published today, the NTMA said Ireland’s total national debt had also been reduced to the equivalent of around eight months’ tax revenue.

The General Government Debt/GDP ratio continued to fall – to 29.9 per cent at end 2004 (32.0 per cent at end 2003) and continues to be one of the lowest in the EU.

This contrasts with other nations and for example with my own country the UK where our government at that time was loosening the fiscal purse strings. You may ask where did it all go wrong? The answer is in a property boom mostly financed by the banks which turned to bust and a banking sector which dwarfed the size of the underlying economy. Even on the Irish government’s rather optimistic projections the Anglo-Irish bank will require some 25 billion Euros of support. Pretty much everyone else’s estimate is higher and sometimes much higher.

So a weaker economy after the declines of the past two years is facing ever higher losses from a banking sector which itself is very dependent on liquidity provided by the European Central Bank. There have been efforts recently to project a path forward for Ireland most notably by the Economist magazine and other have followed with this type of analysis.Even on optimistic assumptions such as a 3% economic growth rate it feels that Ireland will still have a fiscal deficit in 2015 and that her national debt which in her calculations correctly in my view includes an allowance for NAMA unlike the official numbers has it rising to 121% of GDP.

One can add something to this. As I pointed out earlier in some respects Gross National Product is a better guide for Ireland’s economy because of the number of overseas companies based there and as it is smaller than GDP for her then the numbers deteriorate further. Now all analyses of this type are only as good as their assumptions but such figures are troubling particularly if you factor in a world economy which is showing signs of slowing with obvious possible implications for Ireland’s growth rate.

Irish Government Bonds show the strain

Last night Irish government bond yields closed higher with the benchmark ten-year maturity closing above 6% again. Looking at this mornings prices a theoretical ten-year Irish government bond is now trading at approximately 6.15% (in case you are wondering why I say theoretical she actually has one a bit shorter and one a bit longer). One might reasonably wonder what plans the ECB has as last week it stepped in to buy Irish government bonds at lower yield levels than this. So it could step in again. But unless it is willing to keep buying such purchases do not solve the problem. Even if it does keep buying we are then left with the issue of an exit strategy which is a familiar theme, or rather perhaps I should say lack of exit strategy as has often turned out to be the case in 2010.

I took a look at Ireland’s yield curve last night to investigate the position. In case you are wondering why let me give you some figures, Greece was supported by the euro zone with funds which cost around 5% and the last time I looked at calculations for the European Financial Stability Facility or EFSF then funding from it was costing 5.23%.Now if we look at Ireland’s maturity spectrum we see that at last nights close her bond which expires on 18/4/2016 which yielded 5.11% is pretty much on the threshold. All longer bonds are more expensive. Indeed if we look at the fact that IMF funding is much cheaper and that she has recently relaxed the criteria for funding it must be very tempting for Ireland’s government to call her in.

Conclusion

One needs to be slightly careful as under her current projections Ireland has funded her borrowing needs for 2010.So we are discussing secondary rather than primary market prices and yields for now. However these do not allow for the deterioration in her banking sector particularly Anglo-Irish bank. As the focus turns to her then there is the danger just like Greece of events moving more quickly than politicians,officials and bureaucrats can cope with.Also markets can ebb and flow and today’s crisis may become tomorrows fish and chip wrapping but Ireland’s problems are unlikely to go away for any period of time.

As Ireland has strengths that Greece did not have for example she ran a much better fiscal policy before the credit crunch and took more decisive initial steps to respond she in my view could add to those strengths by again acting decisively and calling in the EU/IMF to help her. For once a country could get ahead of events rather than just respond to them. Also Portugal is weakening again,although this is much less talked about, and in such an instance there may be further advantages from acting first.

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12 thoughts on “Should Ireland call in the EU/IMF? Also the implications of a falling US dollar

  1. I can see the Irish ‘crisis’ taking a breather but not going away. So much of the real estate risk to the banks and nama is built on complete and incomplete white elephant buildings. The prospects of big improvements in valuations of vacant commercial property needs a really good imagination.

    The Irish deserve some rewards for “doing the right thing”. However I fear,as ever, that life just isn’t fair.

  2. Hi Shaun, thanks again. I am not so sure Ireland have handled this very well. I remember in September 2008 its government jumped in very fast to guarantee not only depositors but creditors of its banking sector. It wasnt clear to anyone then what sort of due diligence had been done on the loan books but I remember bad feeling that they were trying to attract deposits competitively from the UK. Since, we have seen them create a bad bank with haircuts which might not be sufficient and have I read of,now, the creation of another bad bank. How many bad banks and haircuts will be needed. It makes Alistair Darling look positively churchillian in stature.

    I have said before that The BIS Quarterly Review in June said ” Banks headquartered in the United Kingdom had larger exposures to Ireland ($230 billion) than did banks based in any other country. More than half of those ($128 billion) were to the non-bank private sector.”

    It would be interesting to know what proportion of bad Irish banking assets are domiciled beyond the Emerald Isle. Any stats on this?

    • Hi Shire
      As ever the picture is somewhat confusing. I have read that of the total assets in the National Asset Management Agency or NAMA then the amount secured on UK assets which includes Northern Ireland (a matter always best to check for obvious reasons) is either 20%,27% or 33%.So they do not seem entirely sure themselves as the range is wider than you might reasonably expect.

  3. aren’t we really saying here that the Irish cannot bail out their banks ? Aren’t they bankrupt then ?

    or was it they tried to bail them out but should have let them go a la free market style ?

    giving they are in this hole I see no practical advice other than collapse and default

    P.

    • Hi Paul
      In essence Ireland has tried to do the right thing with her public finances which to be fair in general has been Irish policy for some time as I illustrate in my article. However the size of the banking sector to her economy was and indeed is a risk. As the performance in the banking sector has deteriorated due to ever more bad property loans and it looks like there are more disappointments to come this questions Ireland’s ability to pay as we go forward.Having guaranteed the banks in various ways and recently extended part of such schemes my point is that the problems are mounting and Ireland can only reasonably afford so much.
      So right here and now Ireland is not bankrupt but the numbers are turning against her and for her to get out of this on her own then she needs an ever more favourable wind so to speak. One way of getting cheaper financing is to go to the EU/IMF/EFSF…..Such cheaper financing woud help the numbers going forwards and would help to give her a breathing space.

  4. But will the EU be so generous. How will German voters react to paying for Irish citizens? It was a struggle last time to get the money for the Greeks.
    What is Bank of Ireland doing by moving to UK? Trying to lower the guarantees of 100,000 Euro to the UK standard £50k, on their UK Post office financial accounts?

    • Hi cityunslicker and welcome to my blog.
      As to the EU well it made available 60 billion Euros from its own funds and then the Euro nations put together a Special Purpose Vehicle or EFSF of 440 billion Euros. Having put this theoretical firepower together I think that their commitment to the Euro project will mean they will use it if they consider it necessary. So this time around they do not need explicit individual assent like last time when countries individually approved aid for Greece. This saves embarassments like Slovakia voting no for instance. It also saves asking German voters or their representatives which I tend to agree was probably wise from the point of view of a Eurocrat.

      The issues with this are as follows. Should Ireland and/or Portugal ask for aid there is the problem of the aid they have promised Greece much of which is yet to be paid. If I remember rightly about the agreement others have to take up the slack and at current yield levels they are probably already in that position or close to it. As to the EFSF then everyone will have to agree to whatever country that asks for help to be omitted from the list of contributors. Then it will have to issue its own bonds to pay for the aid.

      So its unwieldy and has lots of potential problems to my mind with the bond issuance. At what point the German taxpayer will realise that they are the main bankrollers of this is hard to predict. As we stand now after Greece’s exclusion Germany is responsible for 27.92% of the EFSF. Once the bonds are issued I think they may well wonder if they are on the hook for more than that.

      The IMF promised to provide 1/3 rd of funds and in the shorter-term could step in whilst the EFSF sorts itself out. A bonus their for the German taxpayer is their share is much lower…

    • Hi Mr.K
      I did see that headline and it was somewhat over-dramatic I think. The days price action in Irish government bonds would be an odd pattern for a rescue! The ECB did buy in small amounts and then retreated to the sidelines in what was a confused pattern of intervention . As Ireland is a small market it could easily step up and squeeze the market. Perhaps the sort of theories I have been espousing are hitting home and the ECB is now thinking of exit strategies before it enters into things but more likely perhaps a bit of Friday afternoon torpor…

      Anyway as things stand the Emerald Isle certainly has not been rescued.

  5. Couple of points –

    – Whats this about BoI ‘moving’ to the UK?

    – The Irish problem could be solved by cutting the bloated, obscene and grotesque public wage bill. 30-40% is needed but the govt have not cut anything because these workers are their prime constituency.

    – David McWilliams is the only one who has called this crisis correctly at almost every point. His latest article makes for grim reading. Capital flight/controls anyone?
    http://www.politics.ie/economy/138533-mcwilliams-money-will-start-leaving-country.html

    • Hi passing-by

      I have made my comments on the Croke Park Agreement in my article of today.

      As to Bank of Ireland there is much yet too happen as indeed you could say about many of the Irish banks. I was always troubled by the way they provided products for the Post Office. Not because I have anything against Ireland but because the Post Office traded on British advertising which for a time used Roger Moore to emphasise this. Whereas many of the savings/investment products came under an Irish banner and Irish protection…

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