Is the bailout for Ireland enough? This is not a good question to ask at a time when Portugal needs one too

On a rather extraordinary day the economic and financial turmoil which had been inflicted on the Emerald Isle of Ireland suddenly escalated into political turmoil as well. The Green Party which had been present as part of the ruling coalition on Sunday at the Budget and bailout negotiations held a press conference and called for new elections in January 2011 and two independent TDs (MPs) said that they would not support the new budget. By the end of the day the Irish Prime Minister Brian Cowen had announced that he did indeed intend to call an election in a press conference where some vitriol was aimed at him as he looked somewhat hapless. Irish electors in Donegal Southwest will get their opportunity to express their opinions on Thursday as a by-election is due there and as the balance in the Irish parliament is very tight at best for Mr. Cowen their votes may turn out to be particularly significant.

Market Response

I had suggested the following yesterday.

If we remind ourselves of what happened after the “shock and awe” package was announced back in May of this year then equity markets surged and government bond yields in the peripheral Euro zone nations fell substantially. However around a  fortnight later Greek government bond yields began to rise again. As markets tend to learn from experience more quickly than politicians then Ireland is likely to get a shorter window of opportunity.

As it turned out my economic and financial view was added to by the political turmoil and Ireland saw something of a turnaround within the day. If we look at the situation concerning Irish ten-year government bond yields then we saw a close for last week at 8.1%, an improvement early yesterday towards 7.8% and then a retreat in the afternoon to 8.09%. So pretty much back to where they had started the day which must have been a big disappointment to those of the IMF/EU/ECB and indeed the UK and Sweden who were announcing their rescue plan. And these yields were only achieved because the European Central Bank came into the market again to buy Irish debt under its Securities Markets Programme. This morning the details on last week’s buying under the SMP appear to be delayed, I do hope someone’s alarm clock did not break down!

In terms of currency movements the Euro fell by 1% against the US dollar and now stands at 1.36 and also fell by 0.66% against the pound. So probably again not what European leaders wanted although as I have pointed out many times in the past what might do some good for the peripheral Euro zone countries is a sustained fall in their exchange rate i.e exactly the reverse of what we have heard the Euro zone call for. Should there be a “peripheral Euro” as was suggested in the comments section yesterday then it would trade a fair bit below the current one which would be to the trading benefit of those countries although there would be inflationary issues and financing foreign-owned debt would be more expensive.

Will the plan work?

Whilst we are still short of details and these are important because as I have written often in the past there are quite a few problems and issues with the EU’s rescue vehicles we do have a general picture. In the long-term I see them doing little for Ireland’s solvency but after yesterday we are in danger of the plan not working in the short-term either. One way of improving things would be to improve the terms and lend to Ireland at a lower interest rate than expected but that has its own problems such as can the relevant vehicles the EFSF and EFSM borrow at such rates?

One matter which does not get much discussion is Ireland’s ability to pay the money back. With all the debt that is about to be piled on her combined with more economic austerity one would have to say the chances are much lower than Europe’s leaders are implying. I notice that the UK Chancellor mentioned that dangerous word “usually” when talking of international repayments and this word is dangerous because we are in unusual times.

If one considers how much aid Ireland will require I am starting to question if the proposed 90 billion or so Euro rescue package will in fact be enough. After all we still do not know the full-scale of Ireland’s banking problems and the history of them is that they have got worse as time has gone by. The problem is that if you raise the size of the bailout then you raise the size of the problem of it ever being repaid.

Should Ireland get any money at all? Using per capita GDP

I decided to look at the issue from a different perspective. I have suggested in articles in the past that many poorer countries in the Euro zone would in effect be asked to put together some money to help richer Ireland and furthermore that one of the ways she had become richer was by having lower tax rates which may have poached business and income off them. To put some detail on this I have looked at the per capita GDP figures for 2010 calculated by the IMF for the Euro zone.

At the top we see Luxembourg at 79,000 Euros and then the Netherlands at 35,500 Euros but then we get Ireland on 35,000. So she is third out of sixteen. But let me keep going. The next group is at least within reach. We have Austria 33,800, Finland 33,000,Belgium 32,600,France 31,043 and Germany 30,982. But we have a few rather detached such as Italy 25,900, Spain 22,800, Cyprus 21,200 and Greece 21,100. Then some who must crick their necks to look at Ireland’s exalted position Slovenia 17,600,Portugal 16,100, Malta 14,200 and Slovakia 12,300.

Now these numbers are not perfect as a measure but at least they are all in the same currency. I would for example liked to look at GNP figures too because of Ireland’s particular issues which make in more important for her. However if you look at this from the point of Slovakia with a per capita GDP which is only 35% of Ireland’s you may well wonder why you are paying for loans to her.

As regular  readers will know I have challenged the way that the UK has rushed to give aid to Ireland particularly as her blanket bank guarantee damaged UK banks when they were at their weakest. Well if you make the same comparison of per capita GDP and do so in US dollars you find that the IMF feels that Ireland will have a per capita income of US $45,600 in 2010 and the UK’s is US $36,300. Yes we too are bailing out a country which by this measure is richer than us.

 Fears of International Contagion

Portugal

There is much less news in the media about Portugal but regular readers will know I have analysed her situation on several occasions. To put her problem in a nutshell there is the fact that her economy grew very little in the good years which meant she fell behind her peers. I put a graph of her economic growth on here a while back and for those that did not see it then it showed a downward trend since 1990. So even pre the credit crunch she had problems which were masked by the fact that overall for Europe times were good. Now of course they are not and I am reminded of the effect of this by the per capita GDP figures I have used above of 16,100 Euros per capita or put another way only 46% of Ireland’s.

So when Portugal’s Finance Minister talks of Portugal’s banking system being stronger than Ireland’s he may well be telling the truth but he is also missing the point. Worries about Portugal centre on her (in)ability to find some economic growth to help with her fiscal deficit and national debt problems. These have not been helped by recent figures showing that rather than reducing as expected and promised her deficit has in fact been increasing.In the first ten months of 2010 Portugal’s fiscal deficit has widened with public expenditure actually being some 2.8% higher than the comparable period in 2009! This meant that Portugal’s core state deficit rose to 11.885 billion Euros in the first ten months of 2010, which compares with 11.67 billion Euros in the first ten months of 2009. As these figures keep repeating they correspondingly reduce the credibility of Portugal’s government.

To add to this according to Reuters opposition politicians are questioning Portugal’s figures.

Pedro Passos Coelho told a meeting of his Social Democratic Party items like state-run companies’ debts were not included in the overall public debt, which the government puts at 82 percent of gross domestic product this year.

He said that the “true” total public debt stood as high as 112 percent of GDP, while the budget deficit should be at 9.5 percent of GDP, far above the minority Socialist government’s target of 7.3 percent for the end of the year.

“The state has for many years been removing from the budget a series of activities, which has made a large part of our numbers fictitious,” he said in televised remarks.

Accordingly pressure is now on Portugal and there was little relief to be found yesterday. When the “shock and awe” rescue package was announced by Euro zone ministers on May 10th/11th peripheral bond yields fell. However yesterdays proposed bailout of Ireland did not help Portugal at all as her ten-year bond yields remain at 6.9% and as she does need to borrow this year she is most definitely not able to suspend government bond issuance in the way that Ireland has been able to. If she has to borrow at 6.9% then her long-term solvency will too be called in question.

Unfortunately there is more disappointing news for Portugal.  According to Bloomberg news European Economic and Monetary Affairs Commissioner Olli Rehn said Portugal’s economic problems are “very different” to those of Ireland and its government has taken “bold decisions” on the deficit. So far little has happened without Commissioner Rehn predicting exactly the reverse in his role as an anti-seer.

Comment

I have argued before for decisive action in these matters and feel that Portugal too should call in the IMF and whatever other help she can find. This is because contagion fears are rising and because her government appears to be saying one thing and doing another. One of the problems in this is something of a vicious circle in that it is partly higher expenditure on debt interest which has increased public expenditure which worries markets which raises interest rates which increases public expenditure……

Whether the Euro zone’s rescue vehicles are up to two rescues at once is debatable and I have my doubts. In my updates including ones on the 25th June and more recently on the 17th and 18th of November I have questioned their setup and likely effectiveness. From the point of view of the UK we may well see the begging bowl at our door again even quicker than I expected perhaps the special circumstances this time will be that she is our oldest ally.

As a point of record I sent the letter I had written to the London Evening Standard to the Chancellor of the Exchequer late Sunday night early Monday morning and will let you know if I get a reply.

 

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23 thoughts on “Is the bailout for Ireland enough? This is not a good question to ask at a time when Portugal needs one too

  1. Excellent article as usual. However, I was wondering about the measure of national wealth that you used. Slovakia’s total external debt is around $52 billion or roughly $10,000 per capita. The total external debt of Malta, admittedly a very small country, is a measly $4 billion or thereabouts which comes to about $9000 per capita. Recent figures indicate that Ireland’s total external debt is (can this be true?) $2.2 trillion and rising. This would imply that each Irishman and woman owes a total of about $500,000 to external creditors. You talk about the Slovakians and Maltese ‘cricking their necks’ to look at the Irish. But does this pain in the neck arise from looking up or looking down – way, way down? Surely we’d need to measure wealth net of debt owed to ‘outsiders’?

    • Hi Brendan welcome to my blog and thanks for the compliment.

      As to my analysis I was trying to measure income per capita to get an idea of the position of individual’s relative income rather than wealth. now it is not perfect as the numbers may look precise but are rarely that accurate! Also one would need relative price levels amongst other things. But it is a guide when you have such wide disparities…

      One could do the same for debt and debt per head but as I will reply to Mr. K in a moment debt levels are of little help without asset values too as a proper balance sheet needs both.

  2. Shaun,

    I’m not an economist, so am not competent to offer an economic analysis. Having said that, I would like to express my impressions of the current situation, so that I can learn from those who are more knowledgeable.

    I feel that we are seeing a bank insolvency crisis, a sovereign debt crisis and a political crisis all at the same time. The bank insolvency crisis is that, basically, the banks in most of Europe, including the UK, are insolvent. The attempt to keep them liquid despite their insolvency is the main driver of the sovereign debt crisis in Ireland and (potentially) Spain, France and the UK. Alongside that, we have sovereign debt problems which are long-standing and/or not linked to banking insolvency: Portugal, Belgium and Italy come to mind. The political crisis involves a number of conflicts (pro and anti Europe; pro and anti Euro; pro and anti inflation; pro and anti fiscal union).

    My hunch is that the key driver in current events is the bank insolvency crisis and that, unless and until it is decisively tackled, energy spent on the sovereign debt and political crises is wasted and produces weird distortions such as (as you point out) poorer Slovakia being asked to lend money to richer Ireland.

    I’d be interested to know if you think there is anything in this story.

      • Hi KG
        I did come across something on this issue yesterday. It was unattributed but the claim was that the FSA had suppressed a profit warning from Northern Rock on the grounds that it might lead to panic and a run on the bank. So even if one did try to challenge a bank one is likely to find the regulators being economical with the truth to coin a phrase.

    • Hi Ian
      If you look at my updates on Greece I wrote quite a few articles arguing that her bailout was in fact indistinguishable from a bailout of her banks. So far if you put it in terms of a game of rugby the ball is going down the three-quarters line at increasing speed but in the end you either run off the pitch or run out of players if you keep going in the same direction…..

      • On the rugby theme you were making analogies to the attendance of their rugby games and their economic problems. At the weekend the stadium was packed and they would claim their economic situation improved, for about a day.

        Great game by the way.

        • Hi Fletch
          I enjoyed it too and it followed on from another improved England performance so a happy Saturday on the rugby front. It was also good to see a main international on free to air TV as I fear that too much payTV coverage could damage what is a minority sport.
          As to my analogy I had been thinking about that and had come to the conclusion that Ireland were playing the biggest draw in world rugby the AllBlacks ( New Zealand to those who do not follow the sport). Accordingly we saw that there may still be the same demand for the highest quality events and maybe less for those perceived as not being quite so good. Also in the boom years there has been an expansion of rugby internationals in the Autumn and maybe that has had an impact. In addition maybe the AllBlacks are such a draw that you had to buy the tickets some time ago…..

          As a final suggestion I have thought that Ireland in recent years has had something of a “golden generation” of rugby players but has not really got the success it might have. Am I alone in thinking this?

  3. Another excellent article, Shaun. I am also not an economist, but wondered what you felt about the following analysis:
    1. Ireland joins the Euro.
    2. Interest rates drop, making everyone feel richer.
    3. Property prices rise as they become more affordable in interest payment terms
    4. The Irish now feel richer and go out and buy a Mercedes, again on cheap credit
    5. For a while, Irish banks lend the money, but then decide that property is more lucrative
    6. German and British banks lend money to rich Irish to buy the Mercedes
    7. The Irish banks have more money to lend for property, which goes up again, until foreign banks join in the fun
    8. A tiny whisper goes round that the property cannot be worth that much.
    9. The music stops. Property collapses. Tax receipts from property collapse. Jobs go. The Poles leave Ireland, sucking out demand.
    10. The Irish banks are now bust, as they have lent too much on property. The foreign banks are never going to be repaid.
    11. The Irish government tries to promise everyone that they will get their money back. Someone does the maths and works out that this is untrue. The ECB replaces all commercial lending to Ireland.
    12. By now, the Irish have no way out and capitulate to EU/IMF etc
    13. The next stage is that a whisper will go round that Ireland is never going to pay back the IMF/EU (how could it?) and default is the only option.

    • The problem is that with some variations the conclusion (default is the only option in the end) applies to other EZ countries also (for sure Greece, Portugal, but probably to Spain and others). What will be the consequence of a domino of such defaults to the global economy? to the UK?

  4. A quick question for Ioannis or anyone else qualified to comment on the Greek economy?

    Today, while reporting that Greece has got the go ahead for the next installment of cash from the IMF/EU, Bloomberg reports that the IMF has concerns that tax revenues are not at the levels which Greece had promised. This however was apparently more than offset by Greek Government spending also coming in at lower levels.

    I remember reading in the comments section here a few weeks ago that the Government in Greece was actually withholding payments for wages & vital services as a way of (presumably temporarily) reducing state spending.

    Can someone please comment on whether this is still the case?

    Also just reading this article on Citywire and wondered why it is assumed that the EFSF couldnt simply be expanded to fit Spain in too? Surely at this stage a few more zero’s on the computer screens couldnt make things any worse?

    Once again thanks for the great blog Shaun.

    Zak.

    • Hey,

      Yes. What you describe is accurate. Namely, the Greek State only pays on time and with 1st priority, the wages / salaries of the permanent public employees. However, in other categories, there are variable delays.

      Are you a supplier waiting to be paid from the state coffers? On hold.

      Are you a substitute teacher who is paid on an hourly basis, and have outstanding receivables from 2009 or even earlier on? On hold.

      Are you a city council wanting to renovate your roads using a joint EU-Greece funded program? On hold, because the EU funds (quite often, 75%) are there, but will not be made available if the Greek funds (quite often, 25%) are not there to fund the project.

      Are you a business wanting to receive a VAT return? On hold for indefinite amounts of time (1 month, up to many months) until the Ministry gives the “green light” to process your return.

      Are you…

      Well, the list is quite large really. The so-called “Public Investment Scheme” is getting thinner and thinner as time goes by, with infrastructure works grinding to a halt according to the well-known principle of “No money, no honey!”. However, this is not unusual, delays in public works etc are pretty much the norm over here.

      What is unusual is that, even if legal, regulatory, bureaucratic, and other hurdles are somehow dealt with, the credit line(s) to run a project simply do not exist anymore.

      As for tax receipts themselves? Ah, the irony…

      ***The Greek Tax System in a nutshell***

      1) If you are an employee or do have direct income from something that is cross-referenced (for instance, income from rent), you’re screwed. You do have to file a tax declaration form every spring, however you cannot “hide” or “cook” your income from such sources, and thus you pay in full. You, along with indirect taxes such as VAT, are a hell of a percentage of the Greek tax base. Congrats. See 2).

      2) In 1), we do not say that taxes should not be paid, of course not. However, all the categories of people who are able to fudge their income data, do so. This is why you see instances of doctors having their practice in Kolonaki (=most expensive central area in Athens), yet somehow declaring a yearly income of <10,000 EUR. These folks appear to be poorer than an entry-level employee of a random company. Aw. Poor them.

      3) The system is so overly bureaucratic, with minimal electronic infrastructure in place, and widespread corruption in the ranks of tax collectors, that nobody ever catches the people doing what was described in 2). And if they do, hey, a bribe will shut their mouth for quite sometime.

      However, if you are a business HONESTLY attempting to pay your taxes and evade nothing, then, due to the chaotic system, you may comply with X law, but violate parts of Y law. Thus, the tax collector can write you a fine. You can also bribe him to keep him from forcing you to shut your business down with a $LOL fine. The bribe is mandatory, mind you. Yeah. Not cool. Even if you swallow this once or twice, eventually you "go dark".

      —————–

      For all these reasons, tax receipts are way below the targets set from the troika. People being able / forced to pay do pay, people fudging don't pay as usual, and the system has not changed, yet, to be able to increase its tax collection efficiency and reduce corruption.

      I heard that the current "tax & revenue offices", literally hundreds nationwide, will shut down, and all collection / fines / etc will be managed by 10 large offices nationwide. This might help decrease corruption a bit, since "commands that must be followed from central administration" is harder to ignore than "commands that are given from me to my friend in the local office".

      And once more, I wrote too much, and tired you. Apologies. The Greek reality is so picturesque that I could literally write a blog of Shaun's size, however I don't have the time to do that at the moment.

      PS:

      Shaun, and fellow commentators, I found this article quite interesting: http://www.bbc.co.uk/news/world-europe-11818910 . I begin to form in my head the idea that while Greece has made many mistakes…we are not alone, not in the least. The worst (or best, in terms of comedic value) are yet to come.

  5. In my amateur opinion, I can’t see how Ireland, Greece or Portugal can possibly dig their way out over the long term. At some point, Angela Merkel is right; the bondholders and banks will have to take a dandy haircut. As Kyle Bass has pointed out, world debt has grown from $60 trillion in 2002 to $188 trillion today.. and many of the most indebted have horrible demographics such as Japan.

    I’m also curious Shaun.. can you comment on that CIA website that claims Ireland’s debt is at $2.2 trillion, just above Japan’s ? I’m assuming this includes “implied debt”.. ie.. backstopping bad banks

    • Hi Mr.K
      I had a look and it now appears to be claiming that the debt is US $2.37 trillion. It defines it as “This entry gives the total amount of public foreign financial obligations”. It looks high to me as when Ireland’s banking sector was looked at back in 2008 then its liabilities were estimated at just under four times her GDP which gives us say a third of the number quoted. So it is hard to know where they think the rest comes from.
      Also if you think of a balance sheet then debt levels on their own have some value but only come to their full value when you compare them with the assets held against them.So far in the Irish crisis the main problem has been a fall in the asset values underlying the debt.

  6. It might also be worth mentioning that state benefits are substantially higher in Ireland than the UK, for example old age pensions and out of work subsidies. The UK is not a rich country on a per capita basis (and especially on a PPP basis as well), a fact at rarely appears in the explanations of our economic situation.

  7. Hi Shaun
    You will find Patrick Honohan’s speech to Ireland’s Chareterd Accountants today of support to you in much of your comments. What strikes me is his comment on adequacy of stress testing and that more is to be done in 2011…..what occurs to me is that there has been a concentration on capital adequacy as if investors dont worry about liquidity. Liquidity is surely at the heart of everything. The July CEBS stress tests were over-concentrated on capital adequacy wrongly, in my view. Liquidity is the key as this sorry episode continues to teach. Isnt it?Where are the global regulations on this?

    Thanks for your articles, again.

  8. …Portugal… ten-year bond yields remain at 6.9% … If she has to borrow at 6.9% then her long-term solvency will too be called in question. (also related, Irish yields are at ~8% and Greek yields at ~10%).

    I would like to throw a wrench in the works if I may.

    Many commentators today look at the sorts of rates above and speak of them as being “high”, as indeed they are on a relative basis in comparison to the sub-5% 10-yr rates that we see today for the less-risky sovereigns. Also (perhaps even more importantly) they also note that these sorts of 8%+ rates are also unaffordable for quite a number of countries given the amount of debt they have outstanding, and really the only hope for longer-term solvency is for these countries to be able to finance their debt at substantially cheaper levels (say 5% or even less).

    Here I’ll throw the wrench and point out that 8% is *NOT* a high interest rate for 10-yr good-risk government debt, if looked at with any historical perspective at all. In fact it seems pretty reasonable to me to think of 8% as sort of a baseline number for AAA longterm government debt over the past 40 years, and place a mental asterisk next to the last 15 years along with the note “unusual times and circumstances here”.

    • Hi Dan
      I have argued before that it looks like we may be approaching a turning point for long-term rates but let me put it another way. I started my career in the mid/late 80s and ever since then long-term interest rates have been falling. Now there have been ebbs and flows but in general a declining trend. I remember in the 80s asking a firm of fund managers why they had bought a particular gilt stock at a yield of 15%. I have just looked up the equivalent 15 year gilt yield for tonight and it is 3.84%. So my financial career has coincided with long term interest rates falling and not only in the UK…

      It has provided quite a boost to world growth which no doubt many politicans have ignored and taken the credit for! Also if the fund manger held them as they intended too then they turned out to be correct.

  9. I agree with Ian this is entirely a banking crisis dressed up as a sovereign debt crisis (certainly for Ireland and the UK). This ‘bailout’ is yet another sub to the banks of UK, Germany and France in the main. When is this going to stop, we have gone beyond classical capitalism the bondholders of these institutions must take their medicine of mal-investment anything less will destroy our societies

    • Hi Jason,
      I seriously fear that its too late already. It will only take one country in the Eurozone to default and the game is up. All countries are then doomed to a cascading multi-national default, jumping quickly from nation to nation as the whole financial system collapses. And lets face it, there WILL be a default. Nobody really believes otherwise anymore do they?

      The size of all these bailouts in the coming months/years will, perhaps fortunately, be meaningless as each country in turn refuses to pay its debts to another and it all gets written down or even written off completely.

      Only when this happens will the investment banks FINALLY get the rewards they deserve.. total bankruptcy across the whole sector & perhaps even world wide, (apart from the vampire squid ofcourse because.. well just because thats the way it always is).

      The only issue confounding me is why the people of Europe are allowing this slow motion car crash to continue for even just one day longer? I guess maybe we have the shockingly one-sided news media to blame for that?

      Zak.

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