The weekend just gone saw an acceleration in the crisis affecting Ireland. This time the moves were political as her Prime Minister fulfilled the second part of Karl Marx’s suggestion about history, first tragedy and then farce. It was only this time last week that Brian Cowen was canvassing opinion in his own Fianna Fail party which led to his declaration on Tuesday that he had won a vote and would remain in charge. So tenuous is his grip on reality that on Saturday he resigned as leader of Fianna Fail whilst claiming he could carry on as Prime Minister. Yesterday the Green Party left the coalition supporting him meaning that in the vote of confidence called for this week he is likely to lose.
The Impact of this on the Irish Economy
Whilst the Irish budget was passed the Finance Bill and hence the Memorandum of Understanding with the International Monetary Fund has not been. So Ireland is not yet eligible for any cash from the ECB/EU/IMF troika. There are further problems for Ireland as at the end of February Bank of Ireland requires around an extra 1.5 billion Euros of capital and Allied Irish Bank requires another 6 billion Euros. This capital injection may yet take place under the control of the current government and may be one of the reasons it is trying to hang onto power.
Any new government may look to change the current government’s policy. One area where I suggest they start is the interest-rate which was negotiated on the IMF part of the bailout deal. According to the IMF it offered the money at an interest-rate of just over 3% for 4 years and then rising to 4%. This somehow metamorphosed into the funds being borrowed at a fixed-rate of 5.8%! A much fuller explanation of this is required and a better explanation is required from Ireland’s Finance Minister Brian Lenihan who has recently claimed that the deal cannot and then can be renegotiated. Which one is it Brian? I wrote about issues with the interest-rate charged back on the 29th of November and illustrated it with a quote from the IMF itself.
At the current SDR interest rate, the average lending interest rate at the peak level of access under the arrangement (2,320 percent of quota) would be 3.12 percent during the first three years, and just under 4 percent after three years.
Again how did that become 5.8% and who was responsible for this?
This does matter because many interest-rates in Ireland are below it. For example the exact rates are not published but it is believed that the bad-bank NAMA has in effect loaned to property developers at around 3%. Most Irish mortgage rates are considerably below 5.8%. For example most standard variable mortgage-rates are around 4%. So in effect the Irish taxpayer is borrowing money to bail out its banking system at 5.8% so the banking system can loan it out at 4%. The insanity of this is plain and whoever negotiated this should be ashamed of themselves.
Added to the problems for Ireland came around a week ago when the state funded Economic and Social Research Institute downgraded its economic growth forecast for Ireland’s economy from 2.25% to 1.5% in 2011. This is important for two reasons. Firstly Ireland needs every scrap of economic growth she can get and secondly the current Irish government’s four-year plan assumed average economic growth of 2.75%. This always seemed consistent with this government’s previous thoughts on the economy i.e hopelessly unrealistic, but going forwards a new government will have to deal with the consequences of this.
Whilst in the short-term the current political turmoil may raise the yield on Irish government debt from the 8.85% its ten-year maturity closed at on Friday I think that some good may come out of Mr. Cowen’s farce. As a believer in democracy I feel that it is a good thing that Ireland’s voters are likely to get their say sooner than previously expected. Much is up for debate in addition to proposed reform of the interest-rate on the rescue package. For example the structure of the bad bank NAMA is up for debate too as the current administration has shrouded much of its actions in secrecy and let’s face it this government has been incompetent in most of the things it has done. So a fresh look at NAMA would be good.
So the ball moves into the court of the Irish opposition who now have to come up with policies rather than slogans. It remains to be seen if they are up to it. I will make two further suggestions. One is that the situation going forwards looks so poor that I feel the nuclear option of rejecting the IMF/EU/ECB rescue and a defaulting on some of the debt should be on the table. If nothing else it might get an interest-rate on the deal that leaves the possibility of Ireland being solvent at the end of it. Put another way as we stand Ireland is very likely to have to have some form of default so it might be best to get on with it. My second suggestion is driven by the last week where several ministers have left the Irish government. They received salaries of around 191,000 Euros per year and will get pensions related to this. If they were of such value Ireland would not be in the position she is in and Irish ministers should take a considerable pay cut to say 150,000 Euros per year.
The possibility of the Euro zone buying Irish,Greek and Portuguese government debt.
This idea has been floated for a while now. It would involve in effect the whole seventeen nations of the Euro zone either guaranteeing the debt of the peripheral nations by issuing Euro zone bonds on their behalf or the Euro zone buying existing bonds in the markets. To my mind either scheme merely suppresses symptoms rather than providing a cure. The problem then shifts from the taxpayers of Ireland, Portugal and Greece to the taxpayers of the whole Euro zone. For the scheme to have any chance of success it relies on the taxpayers of nations like Germany not spotting this. As German longer-term interest-rates have been rising over the past couple of months this does not seem likely. If we go back to the lows of last summer German ten-year bond yields have since risen by 1% as it is.
The latest suggestion is that the rescue scheme the European Financial Stability Facility could buy peripheral government bonds. This is an odd suggestion as I have reported many times that the EFSF is short of firepower so adding another burden to it would reduce it further. Actually the EFSF is so flawed it would be best to scrap it but that is unlikely and the next couple of months will see various plans to modify it. Currently Germany shoots these plans down as soon as they emerge as she can see that these plans shift potential burdens onto the shoulders of German taxpayers.
A Two-speed Euro zone
This is one of the fundamental problems of the Euro zone and it has been highlighted by some survey data released this morning. The Purchasing Managers Index has shown strong growth continuing in Germany. On a scale where a number above 50 shows expansion German manufacturing registered 60.2 and German services registered 60. When you see that the overall reading for the Euro zone was 56.9 for manufacturing and 55.2 for services you can see that some must have been performing much more weakly particularly if you add in that France has been performing well too.
Whilst this is only a survey it has proved to be reasonably reliable. It adds to existing data which leaves officials and ministers in the Euro zone with the headache of trying to impose a single exchange-rate and a single interest-rate on what is a two-speed Euro zone.
This week the US central bank will meet and on Wednesday evening UK time they will let us know the results of their deliberations. If we look at the performance of the US economy since they last met and try to assume a mindset of a FOMC member then this looks like a meeting unlikely to change much. There might be a change of nuance in the statement issued but it is very unlikely that there will be any real policy change. They are hoping for an improvement in the US unemployment situation and whilst the last headline figures were favourable they will realise that the underlying situation is much more patchy and uncertain.
One change is possible however and that is that we may see two dissenters to official policy rather than just one. Regional bank presidents serve a one-year term so initially one might think that as Mr.Hoenig retires after his year ( a rather honourable year in my opinion where he has dissented at every meeting) there would be no dissenters. But Mr.Fisher and Mr.Plosser who join the FOMC have both expressed reservations about current policy, so we will see if they have the courage of their convictions.
There is a saying in the UK that “if you pay peanuts you get monkeys”. The credit crunch has seen many examples of people who are very well paid whose performance would insult that of your average simian. Do you think that the statement holds true? And more importantly perhaps I would be interested in readers thoughts as to why the reverse of the statement has proved to be untrue in so many cases. As an example I present Ireland’s well paid government which has led her to economic collapse.