Debt, The EU, And Greece

http://baselinescenario.com/2010/05/...

The Very Bad Luck of the Irish

Debt is terribly, terribly toxic, and yet people constantly argue with me that the US isn't headed for exactly the same place. Debt for consumption items, like unnecessary wars and welfare, is the absolute worst thing a government can do.

Leaving the Euro would be even worse, in many ways, because it would let them paper over their problems instead of actually dealing with them. Being on an external monetary standard forces a government into fundamental fiscal honesty. When governments can print their own money, backed by nothing, they essentially never stay honest.

We aren't going to leave the euro. I remember the punt and when it wasn't tagged to sterling or locked into a fixed exchange rate it got the sh1t beaten out of it on a daily basis. If Ireland left the euro now we would be eating of leaves by the end of the year.

goman, that article is not painting the full picture. Yes Ireland has a low tax environment for corporations but to suggest that major IT and drug companies do nothing else in Ireland but funnel money through it is just wrong. Ireland is one of the worlds leading exporters of IT goods and drugs because we have an English speaking, well educated workforce that is in the eurozone. Leaving the euro would actually take away one of our advantages that we have.

I may add as well that Cameron seems to have finally revealed his true colours on Europe yesterday. It seems the British Prime Minister wants the euro to succeed.

Cameron wrote:

"I think we were right not to join the euro and I think were right to stay out of the euro. But let me be absolutely clear, it's in Britain's interests that the eurozone is a success, that the euro is a successful currency, that the eurozone economies recover,"

Can we stop this silly talk of the euro failing or countries leaving it now?

Axon - Being in Euroland has nothing to do with the good part of your economy. It is being close to England and Europe and spending money on education. Neither of those thing have anything to do with the Euro. Perhaps your growth rate would not be so break neck the past 11 years if you were not part of the Euro, but I think it is more of a coincidence than the reason. What I see is that the vast majority of your growth was private debt aka Ponzi financing. The delevaraging of this debt is the recession and high unemployment (12.6%).

Yeah, they have a debt problem, not a currency problem. But cheating their creditors won't help.

Plus, probably most of the debts are denominated in Euros anyway, so they'd really be f*cked if they tried to go onto their own currency.

Goman linked that article at the top of this page.

Note that even your wording in your lead-in is partial giveaway of the problem, the "Irish Miracle". You don't get miracles in economics, generally speaking. They happen occasionally with big technological shifts, but that didn't really happen in Ireland. It felt like a Miracle because a huge amount of debt got issued, causing the economy to grow like crazy. Big debt issuance always feels fantastic, it's the methamphetamine of economies. The withdrawal, however, is severe, much worse than growing at a slow and steady rate.

Simon Johnson and Peter Boone wrote about Ireland in a recent Economix column. Can't speak to the merits of their conclusions, but it paints a different picture of the Irish Miracle.

IMAGE(http://jirl.files.wordpress.com/2009/07/homer-doh.jpg)

Its called the "Celtic Tiger" not the "Irish Miracle". It was named after the tiger economies in the far east which saw the same growth and ironically the same crash :).

But seriously, Ireland was and still is an export led country mainly in IT and pharmaceuticals and a world leader in both. Up to 2002-3 our economy was quite sound and if we had stuck with that model we would have weathered this current crisis far better. What happened was the Irish compulsion with owning your own land reared its head and we went on a buying spree that was just incredible. Centuries of absentee landlords and evictions proved to have scarred us far deeper than we could admit.

From 2003 to 2008 we embarked on an insane policy of house buying that was exactly as you describe, goman, a Ponzi scheme. The government received huge tax returns from stamp duty and bloated our expenditure on the back of it. It not only failed to suppress the property bubble but did everything to inflate it. Some of us saw it for what it was and tried to warn people but frankly the vast majority of the country didn't want to hear the truth. I remember a close friend actually spitting in rage because I wouldn't buy but continue to rent. He is now paying a mortgage on a property that is so crippling that he is thinking of folding. The government, on the other hand, are now faced with a reduced tax take and a budget based on far higher incomings.

The party was over before Lehmans went bust but once that crisis hit it blew the door off. There are people now saddled with debt that they will never pay off or if they do will it will prove to be an awful investment. However, to suggest that this was or is the majority of our economy is again false. Our exports are going gang busters this minute thanks to the devaluing of the euro. We are still one of the world leading exporters in IT services and pharmaceuticals with more moving here. We need to get our house in order but if we do we are very well placed if or when the global economy recovers.

And goman, trust me on this one, the punt is not something anyone sensible wants to go back to. Business thrives on certainty and the punt was anything but that. I said it before, people converted their savings into dollars or sterling to avoid the punt. Having your own currency is all well and good if you are the US, UK, Germany or Japan but its very different once you don't have the resources to back it up. The EMU, fixed exchange rate and finally the euro gave us a huge boost that the companies coming here explicitly state is an advantage. After living with both, I agree with them.

Mind you, I think this is all a derailing

.

It was named after the tiger economies in the far east which saw the same growth and ironically the same crash.

That's not irony, that's cause and effect!

Malor wrote:
It was named after the tiger economies in the far east which saw the same growth and ironically the same crash.

That's not irony, that's cause and effect!

The irony was everyone was have supposed to have learned the lesson. Thankfully those same economies have recovered well since their crash so it seems the model does work. We just need the US, UK and the EU to pick up. In the meantime, the fiscal straight jacket that the ECB is imposing will keep us from damaging our growth in the same way the IMF sorted out the Asian Tigers.

I'm just interested to see what the other PIIGS do over the coming months and years. The member states are beginning to talk tough about countries that break the Growth and Stability pact but the proof of the pudding is in the eating. This week everyone will be watching the markets.

Axon - My point was during your weak punt days, Ireland did invest in education. This reaped rewards even before Ireland went to the Euro as seen in the growth rates in the 90s. The Euro was not adopted until 1999. The fiscal straight jacket of now is actually making growth worse as seen in the numbers. The Growth and Stability pact only works when you are a growing economy. The GDP is going down. The makes the Debt/gdp go up. Your public debt was fine when you were a growing economy hence it was not public debt that got you into this problem. The private debt of the 2000s is what made you grow as seen in your housing bubble. But it also might have hindered real growth (IT and pharmaceuticals) as seen in the deleveraging.

Here is a good article in what I am trying to say.

http://www.boston.com/bostonglobe/id...

To put it back to the topic. Greece however is slightly different since they lied and hid their public debt during the . They also were governed by a Conservative government until last year who did not enforce taxes and grew their military to be the 2nd highest per GDP in all of Europe. There was a private debt binge in Greece as well.

The EU debt situation as comedy.

Talking about the east asian 'tigers' as a lesson which others should have learned, due to the economic growth and later crash is a bit exaggerated. Even if the crash was a unavoidable effect of the way the economies had grown (which it to some degree was I would say), it was a trade-off very few would have wished undone. The growth in East-Asia by far outweights later economic problems.
Which I would say is the case for Ireland as well. They have had real growth, real benefits for improving business in Ireland which the current crisis in Europe hardly will undo (Of course stupid politicians everywhere will prove me wrong I'm sure).

Shadout: I think the primary difference there is that the Asian Tigers grew by private debt issuance, rather than public. Once the debt was realized as bad, and cleared the system, the economies resumed growth.

Public debt, however, can't be reneged on without terrible consequences, so the situations are very different.

Your public debt was fine when you were a growing economy hence it was not public debt that got you into this problem.

Wow, you're really not getting it, are you?

When the government goes into permanent deficit mode, the economy becomes dependent on that flow of money. Gradually, the debt burden chokes off the ability to add further spending, or accelerates further debt growth if the government is determined to keep up spending levels. Eventually, the debt must either be repaid or defaulted on, and the whole segment of the economy that's dependent on the debt issuance has to dry up and blow away.

Debt has to be repaid. The increased growth now, during debt issuance, is offset by decreased growth later, during debt repayment. If you didn't use the debt to build things that will repay it, your standard of living on the far end will be reduced more than it was increased in the now, via the magic of interest. Borrowing for consumption, for things that don't generate wealth, is almost always a bad idea.

So yes, the public debt DID get them into the problem, because it made people dependent on it, and it's now a burden they have to carry when the economy isn't doing well.

By your analogy, if I go into methamphetamine withdrawal, because I felt fine when I was taking the meth, clearly it couldn't be the meth that was at fault.

Malor wrote:
Your public debt was fine when you were a growing economy hence it was not public debt that got you into this problem.

Wow, you're really not getting it, are you?

When the government goes into permanent deficit mode, the economy becomes dependent on that flow of money. Gradually, the debt burden chokes off the ability to add further spending, or accelerates further debt growth if the government is determined to keep up spending levels. Eventually, the debt must either be repaid or defaulted on, and the whole segment of the economy that's dependent on the debt issuance has to dry up and blow away.

Debt has to be repaid. The increased growth now, during debt issuance, is offset by decreased growth later, during debt repayment. If you didn't use the debt to build things that will repay it, your standard of living on the far end will be reduced more than it was increased in the now, via the magic of interest. Borrowing for consumption, for things that don't generate wealth, is almost always a bad idea.

So yes, the public debt DID get them into the problem, because it made people dependent on it, and it's now a burden they have to carry when the economy isn't doing well.

By your analogy, if I go into methamphetamine withdrawal, because I felt fine when I was taking the meth, clearly it couldn't be the meth that was at fault.

Spain during the Boom had no public or sovereign deficits. They actually had a surplus. Hence it was not sovereign debt that got them into this mess. But private debt that is not getting paid back and the pubic has to backstop with deficits now.

If that's true, great, because it gives Spain the ability to cushion some of the blow... they're not already weak from going into debt in the middle of a giant boom.

I did misspeak somewhat there, because both you and I both know that government debt issuance wasn't the primary cause of their bubbles and busts. That was definitely private-sector issuance, driven by the monetary and derivative inflation emanating from the US. But countries like Greece and England, and maybe Portugal, kept running large deficits even in boomtime. So, now that the economy's in trouble, that irresponsible debt is a millstone around their necks. Big chunks of their economy are dependent on that debt. Stopping the deficit spending now will compound the pain, but at least in the case of Greece, it doesn't appear they have any choice.

If Spain doesn't have much long-term debt, then readjusting its expectations down to what the economy actually produces should be much easier for them than it otherwise would be. And if they started in a strong fiscal position, I could see scaling in the cuts over a few years, absorbing the losses for awhile, as long as tbe debt gets paid back when the economy stabilizes. But whatever they do, they need to avoid the Japanese style of decades-long bailouts. Japan has gone from the strongest fiscal position of any country in the world, in the 1980s, to a heavily-indebted mess today. Things just keep getting worse over there because they refuse to allow their bad players to fail.

Well, to be honest, I haven't looked closely at Japan in, geeze, five or six years. So things could be changing over there. I haven't been paying attention. But I do know they're deeply indebted, and just can't seem to really get their economy restarted, and haven't been able to for more than twenty years. If they'd just let the bad players go, taken their lumps and started rebuilding from the smoking wreckage, they'd be the powerhouse of the world again. As is, despite the amazing quality of their exports, they're still a terrible mess. Spain desperately needs to avoid that outcome, and it sounds like the EU isn't going to let them.

Malor wrote:

Shadout: I think the primary difference there is that the Asian Tigers grew by private debt issuance, rather than public. Once the debt was realized as bad, and cleared the system, the economies resumed growth.

Public debt, however, can't be reneged on without terrible consequences, so the situations are very different.

What Shadout is referring to I guess, Malor, and I was alluding too is the infrastructure and expertise that we have built up in the the sectors that created our "Tiger". Take just today, Bioware have opened up shop in Galway, for example. If we can get our collective asses together we could find ourselves back on strong growth figures very soon, a prospect the markets and many analysts actually agree with. Our problem is we had a government expenditure based on an irregular tax source (taxing the buying and selling of property). Once the economy dived we basically got hit by a double wammy. We need to fix our property tax, introduce water rates, increase retirement age, get off foreign oil and reform our the government services by reducing the size with efficiencies and bringing it up to date. Thankfully there is huge appetite for all these actions as the majority of the population has lived through at least one severe recession. Some of these reforms are already well under way.

Spain was in a similar situation to us altougth is not quite as bad seeing at they actually had a functioning financial regulator. Its true to say Spain ran a surplus but it was based on windfall taxes and not sustained ones like us. When the tide went out they got hit like us. Thankfully Zaparteo has been made see sense and his cutting his cloth to suit his measure.. Even Italy are getting in on the act. The long and short of it is the Growth and Stability Pact is going to get enforced for the short to medium term. I would like to see a mechanism that gives it teeth. No government can hold its head high in all of this and perhaps a peer-review of budgets wouldn't hurt in the long term.

Either way, the German or Chinese habit of saving money needs to be engrained into a lot of people. Its going to hurt, goman, myself and Malor are under no doubt it will but kicking it further down the road is not going to fix this problem. I've lived through that option during the '80s and it was a disaster resulting in emigration so severe that the population contracted over a series of censuses. I'm glad that the Germans are stopping the rest of us print our way out of this mess. We'll thank them for it in due course and perhaps somewhere Robert Schuman will smile wryly at that prospect.

Bill Gross says

Tougher sovereign budgets, Gross said, lead to lower growth in the short-run, with government worker layoffs, pay cuts, reduced pension benefits and ultimately, a drag on consumption.

"Recession becomes the fait accompli, and the deficit/GDP ratio moves ever higher because of skyrocketing risk premiums and a plunging GDP denominator. In many cases, therefore, it may not be possible for a country to escape a debt crisis by reducing deficits!" Gross wrote.

There are some countries that can use increased debt levels to help spur enough growth to repay debt.

"But those countries are few - the United States among perhaps a handful that have that privilege, and investors, including PIMCO, have strong doubts about U.S. fiscal deficits leading to strong future growth rates," he wrote.

http://www.reuters.com/article/idUSN...

Isn't that what I have been saying?

All the talk about Ireland made me curious to read more about the economy. I didn't consider the scale we're talking about here until I looked at the numbers. Four and a half million people with GDP the size of Maryland's. Very small. Why is what happens there of a concern to everyone?

Well a couple of reasons but the main is the potential for sovereign default. The thinking goes if one of the lesser PIIGS default the cost of borrowing will increase to the point that the larger ones will as well. At that point the euro collapses and Europe would be devastated. Even the openly hostile (to the EU and the euro) Tories have stated that a successful euro is vital to those outside the eurozone as well as in.

Funkenpants wrote:

All the talk about Ireland made me curious to read more about the economy. I didn't consider the scale we're talking about here until I looked at the numbers. Four and a half million people with GDP the size of Maryland's. Very small. Why is what happens there of a concern to everyone?

This doesn't lower my concerns about Ireland so much as it increases my concerns about the US. Many of the states are close to bankruptcy, and I fully expect there to be a serious Cash flow shortage before the end of the year for many states. The dominoes that fall from that situation do not end well in my head.

Edit: Another way to look at it is to break up the US into states, and rank the states against other world economies. When you talk about California, Illinois, etc looking at bankruptcy, a ripple effect across the US and into the world would take place similar to what we are talking about with Ireland.

Edit Edit: I'm reasonably sure of what will happen, and I'm growing increasingly sure of the time frame. I still just don't know what the safest course of action will be. I suppose it's a moot point, with world tensions going the way they are along with all of this.

Jolly Bill wrote:

This doesn't lower my concerns about Ireland so much as it increases my concerns about the US. Many of the states are close to bankruptcy, and I fully expect there to be a serious Cash flow shortage before the end of the year for many states.

We may have an advantage versus a place like Ireland in that our tax rates are currently very low compared to the rest of the industrialized nations. We don't have VAT, we tax capital gains at a low rate, etc., so we have room for a tax hike if necessary (even if it's not optimal in a recession) as part of a restructuring. We don't hear about this much in the media because the media is conditioned to play up the idea that taxes here are ridiculously high.

Ireland seems to me to be in a tougher position because a major engine of their growth is based around low corporate taxes that attract multinationals looking for a tax haven in Europe. They can't tax that economic activity like we can (and do) here, so the rest of the society will have to pony up the costs to cover the multinational's share.

Taxes are a poor source of revenue during times of recession. One idea is that states should charter their own bank and require all local and state agencies put their deposits there. Check clearing could be done interest/fee free. This would save millions of dollars. Also this bank could extend credit to small businesses, students, and other agencies and be another source of revenue.

Oh wait it has already been done before.

http://en.wikipedia.org/wiki/Bank_of...

From the economist who coined the term "quantitative easing" comes the solution. The state bank solution above works with it like a glove. "It is about productivity stupid"

Richard Werner - Understanding and Forecasting the Credit Cycle—Why the Mainstream Paradigm in Economics and Finance Collapsed

http://www.qfinance.com/macroeconomi...

How to Fix the Banking System and Ensure Employment
What should be done to end the current crisis and avoid large-scale unemployment? Just like the Japanese government in the early 1990s, governments have responded by increasing fiscal expenditure, funded by borrowing, and central banks have responded by lowering interest rates. Neither will help. The privately owned creators of the bulk of the money supply are battening down the hatches; in their increased risk aversion they will reduce credit creation. Just as their excessive credit creation affects us all, so does their reduction of credit. For economic growth, as traditionally measured, credit creation is necessary. This is why the current policies will not help. Fiscal policy on its own does not create credit. By borrowing more, national debt is increased, but the money for the fiscal stimulation is the same money that is removed from the economy through bond issuance. Thus fiscal policy, if not backed by credit creation, will crowd out private demand dollar by dollar. And lower interest rates will not help—even if they drop to zero—if the quantity of credit does not increase. This is why Japan will soon be in the twentieth year of recession after its own credit bubble burst in 1990. (My predictions and recommendations to this effect over the past twenty years have been met with stony silence or outright rejection by policy makers.)

The solution is simple: fiscal stimulation, in the form of purchases of nonperforming assets from banks, and public purchases of bank equity, should be funded either by the issuance of government money (such as Kennedy’s 1963 “United States Notes,” to give a graphic example), or, failing that, undertaken directly by the central banks, for their own account. In both cases, national debt and interest liabilities will not increase, but credit creation will. Growth will not collapse. This also makes sense from a moral hazard perspective. The tax payer is not responsible for the current mess, the central banks are—so let them pay.

In countries, where central banks are not cooperative with governments, credit creation can still be jump-started by stopping the issuance of government bonds and instead funding the public sector borrowing requirement through direct borrowing from the commercial banks (a policy I first proposed in 1996). All of the above proposals I termed ‘quantitative easing’ in my publications, such as articles for the Nikkei in 1995 and 1996. When the Bank of Japan adopted my terminology (which has now conquered the world), it unfortunately chose to use my label, but not the actual policies: it focused on expanding banks’ reserves, which I had already explained would not help.

Read it all to get the full understanding of what he is talking about.

[...]in the short-run[....]

I would have bolded that, but you did it for me. You can't run a country on a year-to-year basis. Issuing debt is almost always better in the short run. You feel much, much better. Until it's time to pay it back. If your borrowing created substantial new wealth generation that isn't dependent on continuing borrowing to prosper, then you're ahead, sometimes substantially. That's what debt is good for. But if you borrowed for revenue-neutral (can't think of any examples off the top of my head, but they must certainly exist) or wealth-destructive ends (wars and welfare come to mind), you're in much worse shape than you were before.

Government borrowing is very rarely directly wealth-creative. Governments don't build factories, they build roads. Infrastructure is generally about the best that government does. This can make it possible for new wealth generation to occur, even to the point of being revenue-positive after accounting for the debt repayment. But most Western countries are built out to the point that additional infrastructure doesn't add that much economic value, rarely enough to liquidate the debt. And it's almost always better to just pay for things instead of borrowing for them. You always, always pay more for something if you borrow.

Every time the government issues debt, that's services it can no longer provide, emergencies it can no longer cope with. Every debt issuance restricts what the government can do.

You can't just think about short-run pain. Economies and countries need to last a long time. As Axon says, kicking the can down the road just leads to more problems, not fewer.

Axon wrote:

Either way, the German or Chinese habit of saving money needs to be engrained into a lot of people. Its going to hurt, goman, myself and Malor are under no doubt it will but kicking it further down the road is not going to fix this problem. I've lived through that option during the '80s and it was a disaster resulting in emigration so severe that the population contracted over a series of censuses. I'm glad that the Germans are stopping the rest of us print our way out of this mess. We'll thank them for it in due course and perhaps somewhere Robert Schuman will smile wryly at that prospect.

Goman is on record as saying that governments should just print money to take anything they want out of the economy, so I don't think you should include him in the "fiscal prudence" camp.

My prediction: even though Germany may be saving your butts, you will never thank them for it. Fiscal discipline is always terribly unpopular, even when it works. Under a good, solid, well-run government, barring external influences, you get slow and steady growth, without crashes and without constant crises. Things mostly work, and keep working, but everyone always expects that.

You don't get thanked for preventing crashes. You only get thanked if you take "aggressive steps to contain the problem", even though your stupid policies caused an unnecessary crash in the first place.

Malor wrote:

Goman is on record as saying that governments should just print money to take anything they want out of the economy, so I don't think you should include him in the "fiscal prudence" camp.

My prediction: even though Germany may be saving your butts, you will never thank them for it. Fiscal discipline is always terribly unpopular, even when it works. Under a good, solid, well-run government, barring external influences, you get slow and steady growth, without crashes and without constant crises. Things mostly work, and keep working, but everyone always expects that.

You don't get thanked for preventing crashes. You only get thanked if you take "aggressive steps to contain the problem", even though your stupid policies caused the problem in the first place.

I have always said printing money, ie no-interest credit, for productive purposes will work. They are not taking anything from the economy but adding to the economy. Printing money adds.

However, printing money for consumption is inflationary.

Printing money adds.

All printing money adds is paper. It doesn't add houses, or cars, or boats, or new energy facilities. It might stimulate the economy to build some of those things, but much of it will built in error because of the artificial demand. As soon as the money printing stops, those sections of the economy will be destroyed. And if the money printing doesn't stop, the real wealth of the economy gradually gets taken away from the productive people making it, and given to the recipients of the money. Those people, by definition, are taking wealth from the economy and handing out paper in exchange.

If that goes on long enough, and it always has to accelerate because of the increasing instability in the economy, you end up in hyperinflation.

How the heck do you think Zimbabwe happened, anyway?