This morning voters in the Irish Republic will take to the ballot box and cast their votes in a general election. After the economic “perfect storm” that has hit their country they do need a change and I hope that it will show that the ballot box as well as the gun and revolution can lead to fundamental change. As we stand in spite of the “rescue” from the EU/ECB/IMF then Ireland looks insolvent as she goes forward. Her government bond market has if anything deteriorated since the date the “rescue” was announced. As I type this her ten-year government bond yield is 9.46% which we can compare with seriously troubled but unrescued Portugal at 7.64% or the UK at 3.72%. If you compare the relative situations then it is plainly unfair that Ireland has a rate 6% higher than that of the UK as there are as many similarities as differences. Regular readers will be aware that I often argue that the shorter end of the maturity spectrum also gives us insight into a country’s finances and here we find a bond maturing in April 2013 which yields 8.03% which to my mind has even worse implications than the ten-year yield. For those to whom this is unfamiliar you can learn a lot from what is called a yield curve but my point here is that the revealing part is the gap between the official central bank rate (1%) and a yield of 8.03%. Thus in two years the gap is over 7%!
What does this mean for the Euro zones concept of a rescue?
It means that the “rescue” is not far off an utter failure. If we look again we see that to April 2013 investors want a yield of 8.03% when repayment is in effect guaranteed by the rescue plan. Behind the rescue plan we have the European Central Bank, the European Union and the International Monetary Fund. As they are willing to loan money to Ireland at around 6% (it was announced at 5.8% but rates have risen since then) I am surprised that more commentators have not raised this point. If it was perceived to be a success then Irish government bond yields should have headed towards 6%. In fact they have headed away from it!
We are back to the theme that you cannot solve a solvency problem with liquidity and until Europe’s leaders cotton onto this point there will be little improvement in Ireland’s fortunes. Also please remember that these higher bond yields for Ireland come in spite of the fact that the European Central Bank has been willing to buy these bonds to support the market and could do so again. Accordingly we do not know what the fair market price is and we can put another chalk mark on the scoreboard of false markets created by central banks. I regularly argue that such intervention is mostly beyond their abilities and skills and yet again we can see that in the words of the song there are “more questions than answers”. Sadly we seem likely to get more of this type of intervention rather than less as many central bankers appear unaware of the damage they are doing. When I read the speech of David Miles who is on the UK Monetary Policy Committee I was struck by the image of a man who felt that events happened to him and yet in terms of UK history the Bank of England has been extraordinarily interventionist. I doubt whether he appreciates the irony of this or the fact that the events he feels he is suffering from may be “feedback” from his own actions, if we look for a song for central bankers may I suggest the lyric, “Reality was once a friend of mine”.
What can Ireland do to escape her apparent fate?
In my opinion the “rescue” needs to change from being a rescue for Europe’s banking system to a rescue for Ireland. At the moment Ireland’s taxpayers are in effect taking the strain of not only bailing out her own banking system but propping up that of banks from around Europe. They could be helped by the following measures.
1. There has been a lot of debate over the fate of senior and subordinated bondholders in Ireland’s banks. These were supposed to bear some of the risk of banking but so far have not done so. Some help can be found here as there are approximately 21 billion Euros of such assets. One way of helping Ireland would be to write these down to zero if necessary. After all if we do not write them down after the sort of collapse that has happened to Ireland’s banking system when would we?
2. The interest-rate charged on the rescue package should be reduced from the current level of around 6%. When the “shock and awe” package was originally mooted and before it turned into the (incompetently designed) European Financial Stability Facility there was talk that it would make loans at an interest-rate of 4.5%. It would be better if it returned to such a philosophy. It would save Ireland some money and stop the obvious prospect which in the end is bound to happen of Irish minds focusing on someone making a profit from her misery as many Euro zone countries raise money much more cheaply than this.
3. Once the situation of Ireland’s banks become fully clear then there will need to be a debt “haircut” in addition to the above measures. Ordinarily I would recommend starting with this but I am not sure that issues such as potential derivatives losses have been fully accounted for and in addition Ireland’s housing market remains a problem. As “haircuts” are something which should happen only once then it is wise to wait although I would suspect I am not the only one wondering why information has been withheld. For example the latest accounts from the bad-bank NAMA have sat on Ireland’s Finance Ministers desk for some time now.
The solution is not easy and it will cause pain around Europe’s banks. Frankly I believe that this is the real reason why such measures have not been applied as we have seen another example of the can being kicked down the road. The essential problem of this strategy for Ireland is that the road is long and the can cannot be kicked far enough. The more cynical amongst you probably suspect that Europe’s politicians only want to kick the can beyond their own elections!
One factor that cannot now be undone is the fact that via its Securities Markets Programme the ECB has bought some 77 billion Euros of peripheral government debt of which a reasonable amount will be Irish. Accordingly banks have been able to remove loss making positions from their balance sheets onto the balance sheet of the ECB. Shareholders have transferred losses to Europe’s taxpayers. Since the programme started prices have fallen in some areas heavily so shareholders should be grateful and taxpayers should be made aware of what is being done in their name.
Those who wonder how banks are paying bonuses again might like to reread the last paragraph. It comes under the theme of privatisation of profits and socialisation of losses! Whilst there are various ways that governments are supporting banks in this way I regularly see politician’s claiming that they are against “the banks” and want to punish them. Those particularly concerned about this topic might like to ask their member of the European Parliament what their voting record is in this area and what objections they have made…….
A shock as UK economic growth in the fourth quarter of 2010 is revised down rather than up
When the figures for the flash estimate for Uk economic growth in the last quarter of 2010 were announced they caused something of a media and political storm. The report of negative growth of 0.5% was definitely not expected. If you recall the National Institute for Economic and Social Research which releases its own estimate some ten days earlier agreed with the 0.5 bit but without the minus sign! The debate had settled down with most economists expecting an upwards revision today. However this is what we have received from the Office for National Statistics.
Gross domestic product contracted by 0.6 per cent in the fourth quarter of 2010, revised down from the previously estimated fall of 0.5 per cent. GDP in the fourth quarter of 2010 is now 1.5 per cent higher than the fourth quarter of 2009.
So there is something of a shock effect in the numbers being revised down and not up. If we look for some perspective on this opening statement we get the further bad news that this means our economic growth was only 1.5% on the year. I take no pleasure from the fact that it brings it back in line with my original estimate for the year, I was happy to be wrong as we need every scrap of growth we can get.
Why were the numbers revised down?
Output of the production industries was revised down from 0.9 per cent to 0.7 per cent growth in the latest quarter. Output in the service industries was revised down to a fall of 0.7 per cent in the latest quarter from a fall of 0.5 per cent reported in the preliminary estimate. The decline this quarter was driven by a fall in business services of 1.1 per cent, together with a fall of 1.4 per cent in transport, storage and communications services.
Government final consumption expenditure rose by 0.7 per cent and is now 1.2 per cent higher than the fourth quarter of 2009.
What does this mean?
One of the themes of this blog has been that there is a danger of stagflation for the United Kingdom. As our reported economic growth for 2010 as a whole is now 1.5% and inflation ended the year with inflation at 3.7% or 4.8% depending whether you use CPI or RPI it would appear that this may well be the reality of our situation. I still believe that in the end these growth figures will be revised higher. For example the NIESR figures I referred to above suggested that in the quarter to end January the UK economy only contracted by 0.1% and as they update their figures with the official ones then they still offer a much more optimistic picture (I did speak to them on this and it is slightly confusing but if you stick with the original NIESR figures you get a more optimistic figure, they only use their own monthly estimate and then update with the ONS ones).
A bigger problem for the Bank of England
These figures reminded me of a section from the most recent Monetary Policy Committee’s minutes which I quoted yesterday.
Nominal domestic demand had increased by 6.8% in the four quarters to Q3, accompanied by nominal consumption growth of 6.3%, in part reflecting the VAT increase in January 2010. These were both above their average growth rates for the decade before 2007.
My point is that if nominal domestic demand is surging at a rate shown above and yet real economic growth is turning negative then the gap will be filled by inflation. If you look at problem you can clearly see that inflation from this source is not something that the Bank of England can blame on external factors and the clue is in the word domestic. Yet again we see a sign of possible pent-up inflationary pressure…..