Monthly Archives: December 2011

Seanad : babies and bathwater

As we leave 2011 one of the government promises which they announced as part of their election appears to be still on track. They do appear to be intent on getting rid of the upper house of the Irish Parliament, Seanad Eireann
I’m not at all confident that is this a good idea.  Most people would say that the majority, of senators over the years have been anonymous, insignificant, and ineffective. This is unfair, as there are many good hardworking Senators, but the reality is that the perception lingers and many Senators remain anonymous to the people throughout their career.

The Irish upper house is elected in a curious manner. Of the 60 senators 11 are appointed directly by the Taoiseach, the Prime Minister. This was designed by the architect of the 1937 Constitution to ensure that the upper house would always have an inbuilt government majority. One of the only reasons to have an upper house is of course it can, in principle, hold the lower house to account. Being neutered from the start was hardly a good idea…
Of remaining senators six are elected, but on a very restricted franchise. Despite the fact that for decades and has been an opportunity to widen this franchise has not been done. The remainder is elected in a series of panels, basically ensuring
that the grip of the political parties remains intact. Details on the electoral process contained on its official website, here. The membership of the panels is in effect in the gift of sitting parliamentarians. A good description of how panels are constructed as contained in the citizen’s information advice
site, here

The existence of the Seanad is very deeply entwined In the Irish Constitution. Eliminating it therefore is a complex task. Ex-Atty Gen and also ex-Minister for Justice, Michael McDowell, has suggested that would in fact be easier to draft a whole new constitution than trying to amend the present one to reflect a vote to abolish the Seanad. I think he’s right, but there is no doubt there is widespread public disgust at how the shadows over the years has been, at least perceived, to be a dumping ground for ex-politicians, a training ground for wannabe politicians, and in general has resulted in the population of the upper house being for the most part either discredited, one proved, or anonymous. The reality is that when people think of high-profile solicitors for the most part the people they would name would be the University Sens. These are people who are elected, as I say, on a very restricted franchise. But at least they do have to face a wide constituency. In the last election there were 53,000 voters eligible to vote for the three senators on the University of Dublin panel.

Here follows, purely as an intellectual exercise, a set of reforms that might if implemented might result in a more user focused and effective upper house.

  1.  Let’s broaden out the electoral base. Since the seventh amendment in 1979 the provision has existed for the government, by law, to extend out the franchise from university seats beyond the existing universities. We need to go further than this, and make election to the Seanad by universal suffrage. I do not agree with the idea of seats in the parliament for persons not resident in the country. And yes, by this I include persons resident in Northern Ireland. I do believe however that we should have elections to the upper house for which anybody, regardless of citizenship, who is resident in this country for tax purposes may vote. I see no reason why, for example, a Polish or German national resident here for the last decade and tax compliant, cannot vote or indeed stand for election to the upper house.
  2.  Let’s have terms. Is jealous of 60 people there is no reason why we shouldn’t have a fixed term for Senate of say five years. The presence of these senators tied to the electoral calendar of the lower house. Let’s liberate it, let it be independent, but let’s have it like United States Senate, where one fifth of the members are up for election every year. Along with universal suffrage this would ensure that the upper house without is a continual “ thermometer” regarding political opinion in the state.
  3.  Let’s change the method of election. As I’ve stated we should of course of universal suffrage. One of the objections that people have raised when I have suggested the idea of the rolling electoral process such as in point to be that this would result in the vast expense and continual electioneering. There’s no reason why we have to continue to do things the way we have done. Electronic voting in Ireland has had a bad name since the absolute fiasco of the e-voting machines. There’s no reason why we shouldn’t experiment with, for example, voting online. In effect, and this is where tying the voting register to the tax register would come in useful, would ask the revenue to issue to each voter/taxpayer and alphanumeric multi- character code. They already do this if you want to use revenue online system. Recall that to have 12 senators elected each year then we need to have three or four constituencies, roughly approximating to the provinces perhaps. This is simply so that in retaining the single transferable proportional representation vote system we do not end up with vast and overwhelming election ballots. Each taxpayer now having received their unique code, the block of codes for each constituency should then be given over to an absolutely independent electoral commission. It would be be essential that there be no way in which an individual called would be tied by anybody to an individual taxpayer/vote. Information Commissioner should be tasked with overseeing this. The code which each taxpayer now possesses would be required as a one-time only login on a voting website. I’m sure there are huge technical challenges, but if Amazon and eBay can run sophisticated online electronic commerce there is no reason why we should be able to do this.
  4.  Let’s change what the Senate does. One of the problems at the moment as it is not clear what the Senate actually does. Yes, it debates legislation. But the government has an inbuilt majority and therefore the house cannot act as an effective block or oversight. Yes, with certain exceptions, senators can initiate bills. As we have seen in the recent example of Sen Sean Barrett, even when the government are in total agreement with the thrust of the bill, individual Senate proposals from non-government source will never get beyond a polite pat on the head. The government in its election promises made much about cleaning up the win which appointments are made to state bodies. Let’s give the Senate a role in this. All senior appointments to all state boards, all senior appointments in the civil service, all senior appointments to the army and police, the heads of all universities etc., should be required to go before a Senate committee. A majority vote of said committee would be required in order for the person to be appointed. Let’s have the Senate question people as their fitness for office. Let’s let the public see what the views, attitudes, ideas, and proposals are, of the most senior echelons of state apparatus before we find ourselves paying for them.
  5.  Lets make senators part of the government. At present, with some exceptions, Cabinet posts are open to senators. And yet, despite the government having the ability to point persons of merit from outside the party political process and then appoint them to senior cabinet positions, the last such senator to be appointed to a senior Cabinet office was that of Sen Jim Dooge over 30 years ago. My proposal above suggests that we abolish the ability of the Taoiseach to appoint people. The universal suffrage, on a rolling basis, should give a Senate, which is representative of the views of the people. Let’s incorporate those views into the Cabinet, by requiring that at least two Cabinet posts be held by Sens.

I’m sure there are other, no doubt better, proposals which people could make which would make the Seanad work more effectively. Let’s try proposals, let’s see if we can make the system work better. If having done our best to improve and reform the Seanad it’s still not working, then we should by all means consider getting rid of it. But getting rid of the Seanad, without having tried to reform at first, strikes me as a classic case of throwing the baby out with the bathwater

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Down the Memory Hole: why we should give more priority to economic and financial history

A few months ago I found myself teaching third-year students for about one hour on the historical experience of stocks and bonds in relation to the risk/return characteristics. I’m sure most people who have taught finance will have come across these phenomena, where one finds oneself referring to a for the students historical but in ones own case very pertinent event, in my case the 1987 crash, and looking up realizing that this is so far beyond the life abd professional experience of the students that you may as well be talking about the reforms of the Roman bureaucracy by the Emperor Titus.

We know that people generally speaking tend to engage in what financial economists call “hyperbolic discounting”, which applies both to the past as well as the future, resulting in a shorter term perception, giving greater weight, greater than would be appropriate given the distribution of outcomes, to more recent events. This also manifests itself in a number of other financial and behavioral biases. The bottom line is that there is always a tendency for people to consider that this time really is something new. And of course, this flies in the face of what we know from history. Probably the best book on economics and finance over last couple of years has been the book by Reinhard / Rogoff ” this time is different”, credit should know, it’s almost certainly not. In my view this book should be compulsory reading for anybody who thinks about being involved in financial and economic markets at any level. In my case the 1987 crash was memorable, of course as a major event in finance, and also because on that Monday I started work on the Central bank of Ireland.

This memory, and the realization that for many students, and don’t forget them in a couple of years these students will be the ones that will be managing your money, and knowledge of financial, business, or even economic history, is lacking. Earlier this year a study was undertaken by the St Paul’s Institute, which looked at the economic and financial historical knowledge of London finance professionals. The full study, available here, is a fascinating read about the attitudes of finance professionals in the city of London around the areas of ethics and integrity. What was reported widely, see for example an interesting report here, was a city professionals exhibited a profound lack of knowledge around the economic and financial history of the own profession. Quoting from the London Independent

In an indication that memories fade fast within the banking sector, less than a third of employees were able to pin point 1980 and 1991/92 as the last two dates major recessions took place in the UK. In contrast, more than three-quarters of respondents correctly answered that the post-credit crunch recession began in 2008.

Equally, almost seven in 10 people had no idea that this year is the 25th anniversary of the “Big Bang”, the major deregulation of Britain’s banking industry that allowed London to become the financial capital of the world – and an inevitable epicentre of the ongoing economic turmoil.

To me this is profoundly worrying. The words of George Orwell are very apt: he who controls the past controls the future. And it’s not just me that worried…the CFA Institute, the professional body that certifies and regulates the “front office” portfolio and institutional managers, is reported today in in the financial Times as also being concerned. The report is behind the financial Times registration barrier, registration is free, and provides limited access to a number of articles per month. Nonetheless, some quotes from it are illustrative.

CFA UK, which represents 9,000 investment professionals, argues that the study of financial history should form a major part of all compulsory education for retail and wholesale investment professionals. “Financial amnesia disarms individuals, the market and the regulator,” the body said. “It causes risk to be mispriced, bubbles to develop and crises to break.”

The education requirements for investment professionals in the UK do not oblige them to have “any understanding of financial history”, added Will Goodhart, chief executive of CFA UK. While the UK’s Financial Services Authority sets the framework for the Investment Management Certificate, the country’s most widely recognised qualification for investment professionals, CFA UK sets the questions. Mr Goodhart suggested that about 15 per cent of the syllabus focus on financial history.

The British CFA programme should be reformed to include “a practical history of financial markets, designed to remind us about the effects of liquidity, psychology and regulatory failure”, the report said.

It also advised the boards of financial institutions to undertake an annual “amnesia check”. “It would be reassuring to know that once a year the board of a financial services firm had reminded itself that this time it is not different,” Mr Goodhart said. The

The CFA Institute have a relationship with the number, about 100, universities where they provide input into Masters level degrees in finance The idea here is that the Masters in finance cover much of the ground of the professional qualifications of the CFA Institute, although no exemptions are given, and that they therefore provide both an academically rigorous as well as industry focused experience for students. Trinity College Dublin and University College Dublin are the only two such universities in Ireland which have courses so aligned. The MSc in finance in Trinity College, and the MBS in finance in UCD are the relevant courses. It’s instructive to note that examining the syllabi for these courses there appears to be no opportunity for students to study financial history. I should note that the initial design of the MSc in finance and Trinity College was mine, and therefore I should take some responsibility for not having included as an optional module, ab initio, a module on financial and economic history. In my defense I can note that there was a proposal the following year have such a module, but it was not felt that there would be sufficient numbers of students interested to warrant offering the course. And, the sad fact is, that this is probably the case. Students who have never been exposed to history are not likely to have an inherent appreciation of the importance of history.

What about other courses? I am the external examiner for the Masters in financial economics at University College Cork, and it is an excellent course of course, but it does not have a module on financial history. The University of Limerick offer a wonderful degree at Masters level in computational finance, the Masters In finance and capital markets in Dublin city University has been on the go for a number of decades and again provides excellent training, and there is a recently developed masters in financial engineering at NUIM. None of these, insofar as I can see from examining the course lists online, offer students a module in financial history.

it doesn’t seem to be any better in economics. The TCD masters in economics does not appear to have a module available on financial or economic history; nor does the largest masters in economics degree course, that run by UCD. This also seems to be the case in NUIM, and in Cork.

What about MBA degrees? If our financial and economic professionals were not been trained in a manner, which incorporates as a formal module and understanding of history perhaps, business masters of the universe are so being taught? Again from my knowledge there is no such module on the MBA Trinity , nor on the MBA offered in UCD, despite it being the only MBA in Ireland which is “triple accredited” and the only MBA in Ireland ranked in the Financial Times rankings. In fact the only mention of history on the UCD MBA site appears to be in the promotional brochure outlining the history of Dublin.

I haven’t looked at the situation in UK, USA. That would be an interesting master’s thesis, for a student to examine attitudes and approaches to the incorporation of financial and economic history into graduate professional training programs. But I am pretty certain that situation which I have described here in Ireland is representative of the vast majority of courses. The teaching of economic and financial history has never been a core strength, particularly in Ireland, of business schools. Even within economics departments economic history, still less the history of economic thought, has tended to be a very minority sport. Ireland in recent years has been blessed in having exceptionally talented economic historians, such as Kevin O’Rourke in TCD, and Morgan Kelly and Cormac O’Grada in UCD . Kevin has now left Trinity College, has taken a professorship at All Souls College Oxford; Cormac has retired; Morgan showed in his analysis of the economic crisis the benefits which a good grounding in historical concepts can provide.

The reality is that as people move and retire they are unlikely to be replaced, certainly not the same levels, and given that it takes decades of dedicated skill to achieve the levels of knowledge then certainly not at the same level, ab initio, in terms of intellectual firepower. Yet, who can doubt that a greater knowledge of history would be useful? Who can doubt that were people, particularly those entrusted with our financial and economic well-being, more aware of the cycles of the economy and of the markets, that they would be at least better armed in relation to realizing that this time is not different, and that by observing and learning from the past we can at least not be excused the knowledge that “we never knew this could happen”. Of course, there are no smart green nano bots, no patents, and very few high-tech spin-offs that come from providing economic and financial history courses. And therefore, given the dreadful trudge towards turning universities into some form of annex to an ill-defined “Smart economy” we will continue to churn out highly technically skilled economic and financial graduates whose only exposure to economic and financial history has come about through individual course leaders dropping nuggets of information into their courses, or for the select few more so motivated, from their own autodidactic endeavors. And that is one way to ensure that we have a dumb economy and one that is doomed to prove Santayana right : Those who cannot remember the past are condemned to repeat it.

What will 2012 bring us on the economic front?

This post is an expanded and hyperlinked version of an opinion piece published n the Irish Examiner, 24 December 2011

http://www.examiner.ie/business/another-full-blown-euro-crisis-looms-in-2012-178197.html

This has been a pretty horrific economic year, with the European economy stumbling from crisis to chaos and back again, with the change of driver at the wheel of the irish economy but with no discernible deviation from the pre-existing path, with the United States proving even less politically capable than Ireland of achieving economic consensus, and with emerging doubts about the long-term capacity of China to continue its growth path.

So what then will 2012 bring? Is absolutely true that “forecasting is very difficult, especially about the future”, I think it is better to subscribe to the words of the great French mathematician and political philosopher, Henri Poincare, who stated, “”It is far better to foresee even without certainty than not to foresee at all”. Poincare famously left open a conjecture in topology which took decades to solve and was not impressed by the use of overly mathematical concepts in economics. Let us hope that the problems to be solved in economics now do not take as long, and that those who solve them do not end up as disillusioned as Perleman did on solving the Poincare Conjecture.

The outlook for the world economy leaving 2011 is considerably less rosy than it was upon entering it. Predictions for the OECD economies, the largest economies in the world, at for growth in GDP to be less than 2%, with growth in world trade to be less than 5%, both significantly below the 2011 figures. The IMF, with a broader perspective, sees global economic growth somewhat higher, but it is interesting to note that for the most part economies will see lower growth rates in 2012 than 2011, which in most cases was lower again that in 2010, and the outlook is that economies will struggle to reach growth rates in the early years of this decade equal to that of the early years of the previous decade. The world economic engine has slowed. From the context of a country such as Ireland, which is heavily dependent upon the benign international environment, this is not good news. There are a host of downside risk factors which could be identified, instability in the Middle East particularly around Iran, growing signs of a rapid deflation in the Chinese property bubble (with all of the consequences which we are all too familiar with), geopolitical dangers posed by instability in North Korea, and of course the ever present danger of sovereign defaults. 2012 will, I fear, see a further deterioration in global economic conditions. Until the Chinese property bubble is deflated safely, and the US economy with its myriad problems is under the control of a detoxified political system one should bet on the downside.

The chinese issue in particular is one that is worth watching. Nomura published a quite downbeat analysis of China in November. As part of their global economic research analysis they have constructed a China Stress Index, and this plus their other analyses give them a 1/3 chance of a chinese hard landing (defined as growth of less than 5% ) by 2014, predicated on a number of stresses that will be all too familiar to observers of the Irish crash : over investment fuelled by a credit boom, an inappropriate fixed exchange rate, crony capitalism, falling credit standards, and the slowing of the demographic dividend. It will be interesting to see if the Chinese government fare any better in handling these than did the Cowan government. For the Irish diaspora a chinese hard landing would impact severely on Australia, where China is now its third largest export market.

In a European context, where much of our destiny is being laid out, we have seen the most appalling year. The people of Europe have been spectacularly ill served by their political masters. Dithering and insouchant lasitude seem to have replaced action and analysis, with the dyad of Merkel and Sarkozy using the opportunity to strengthe their own relationship, buttress tehir political flanks against domestic enemies, and in the process let the markets take the political leadership which they should, as the leaders of the largest countries in Europe, be giving. Then we have the odious and priapic antics of Silvio and the political gaucheness of Cameron to complete the quartet of political mice. Summit after summit has come and gone with the large grey tusked mammal of sovereign debt being studiously ignored.

Much criticism has been, but correctly, directed at the European Central bank, including from myself. It is however vital to remember that at least the European Central bank has been doing something. We may not have always agreed with it but it has had, reasonably, consistent and from its prospective logical economic reasons for doing that which it has done or not done. Very late in the day the European Central bank has thrown, if not a wall then a few hod loads of bricks, at the sovereign debt markets via a three-year loan facility. It is particularly galling from the perspective of an Irish economic viewpoint that this has taken until now.

Back in July we were told that there was no prospect of such a facility. Much of the subtext around the debate in relation to whether or not we should or should not “ burn the bondholders” was predicated on an unspoken threat that if we were to do so then as Irish banks were dependent on very short-term rolling over liquidity from the ECB going against the wishes of the ECB might result in the cutting off this liquidity, killing the Irish economy stone dead in. If we were ever unclear about our relative unimportance compared to economies such as Italy, the recent about turn by the ECB on the provision of a medium-term liquidity instrument when that country got into trouble should make it abundantly clear. We are truly at the kindness of strangers

However, we should not think that this liquidity is the solution. It is a solution, to a liquidity crisis, but Europe, in particular the peripheral countries, faces a twin crisis of stagnant growth and excessive government (and private) debt. This liquidity will allow banks, although not in any way compelled them, to purchase government bonds, driving down the interest rates, and therefore in theory allowing these countries more rapid re-entry to the international bond markets. It will do nothing, in fact may even be perverse, in relation to enhancing country’s economic growth prospects and certainly will not reduce overall debt levels. 2012 needs to see significant concentrated action at the European level around these two issues.

These issues are recognize as being paramount: the annual growth survey places eduction, training and labour market activation measures at the heart of the required strategy. Absent this labour conditions will worsen, and growth forecasts (see graphic for the EU commission forecasts) will be relentlessly ratcheted down

At the heart of the German problem in Europe is their assumption, whether stated are not, that everybody must be in surplus. On all aggregates. Always. This is the economics of the swabian housewife, a neo mercantilist view that exports are the bee all and end all. This is impossibility in a globalized economy. For those of us of a certain age the eponymous housewife is redolent of the lincolnshire shopkeeper so beloved by Mrs Thatcher. For some economies being surplus others must be in deficit. German imbalances are as much a problem for europe as are Irish or Italian. see here for a discussion of the german imbalances , here for a discussion of why German growth needs to move more towards domestic (import and consumer led) than international perspectives, here for a discussion of why this would be good for germany as well as for other countries , here for a discussion of how the german export competitiveness has acted to drive down german wages further fueling export competitiveness. See here for a discussion on german Imbalances in the context of intra bank claims) The imposition of an austerity compact will in and of itself not solve Europe’s problems but may solve the domestic political concerns of Dr. Merkel. The compact may not survive domestic political scrutiny in other countries, and I suspect that we will be back in full-blown Euro crisis mode and in the first half of 2012.

As it is for Europe so too is it for Ireland. We face into 2012 in the dreary realization that “the beatings will continue until morale improves”. Much of the fiscal consolidation to date has been achieved by snipping at the margins, and in particular by the deferment of planned capital expenditure. And yet we will borrow to €21 billion in 2012… the simply cannot go on. From 2012 onwards it is clear that if the government is to actually achieve even its own modest 3% deficit targets entire program areas will have to be shutdown and significant tax increases will have to be put in place. Ideally increases in tax should come about organically as result of a robust and growing economy.

We are in the terrible position that faced with a weak economy the government perceives no choice other than to increase the tax rates in the hope of increasing tax levels, leaving nothing aside to bolster growth. They are in a red queens race, where they have to run faster (increase tax rates) to stand still ( keep tax levels in nominal terms up). This is the logic that has in the face of collapsing retail sales (yes, even though the november figures came in ok there is still a massive crisis here led to an increase in the level of sales tax. Expect to see more of this.

The most pressing problem the Irish economy faces is the re-emergence of persistent long-term unemployment, and this in the face of tens of thousands emigrating.

As of november 2011 we have 18k males and just under 9k females under the age of 25 who have been unemployed for more than one year. There is very strong evidence that long period of unemployment when youger have a severe effect, reducing lifelong employment prospects, greatly increasing the probability of future unemployment, and generally scarring prospects. Therefore labour market measures should ideally be targeted to these disproportionally one might argue…but of course the young dont vote as much as the older, and when they do they do with their feet. We see a massive outflow of our children, and all the skype chats and cheap-ish flights in the world do not make up for the renewal of what has been our biggest industry, fresh Irish youth on the hoof. At least this time they are more educated and more globalised than the previous generations….

We cannot export our way out of this problem, if only for the reason noted above with world economic growth is slowing. In any case the structure of Irish exports is such that they will not provide job traction. Finally, a very large part of Irish exports (up to 60% of total and closer to 90% of the trade balance) is dependent upon pharmaceutical products that are now coming “ Off patent”. Some estimates are that up to 80% of patent drugs switch to generic within the first year of these drugs coming off patent. Whether the Irish Pharmaceutical industry can effectively negotiate safely down this patent cliff remains open question but apart from the thousands of jobs at risk the potential damage

In any case, 2012 sees the beginning of the 10 years of government cash being borrowed and funneled into the black hole of the Irish bank resolution Corporation, aka Anglo Irish bank. Every year for the next 10 years the Irish taxpayer will borrow €3.1 billion, and rather than use this for targeted job initiatives, to assist in the Roll out of an ultra-high-speed broadband, to incentivize science education, to provide credit and export backup for indigenous SMEs, or even to deliver social services, this will instead be given to a dead bank. There is a growing consensus that while we might in theory get some of this money back upon the eventual windup of Anglo it represents a serious drag on the ongoing financial capacity of the Irish state. An agreement from Europe that takes this fiscal Monkey off the back of the economy should be an absolute prerequisite for the government even entering into contemplation of a referendum on the fiscal compact. Without such an agreement then the fiscal compact will not, should not, survive contact with the Irish population, facing into the 2012 where austerity will really finally began to bite. So, a lot done more to do and no corner left unturned…

No simple solutions to our economic woes


This post is an expanded version of an opinion piece in the Irish Examiner published Saturday 17th December.
http://www.examiner.ie/business/nobodys-paving-the-road-for-return-to-growth-177533.html

So another European summit has ground to an inconclusive conclusion. It is still not clear whether or not the decision by David Cameron to walk out was due to a principled stand on behalf of the one square mile of the UK that is the city of London or whether it was that he found himself tactically outmaneuvered and beat a retreat. In any case a Weakened United Kingdom is not good news for a country which exports 16% of its exports to the UK. There is a strong sense reading the communiqué that it is highly aspirational, and designed along the lines of : we must do something, this is a thing.

In terms of these aspirations what we appear to have on on the table is a promise of neither a fiscal nor a transfer union but an austerity union. We are all to adhere to even stricter guidelines than were in the Stability and Growth Pact, in relation to government spending. In fact, if we take the proposal for a 0.5% budget deficit, and put in any reasonable levels of growth, a long-term Irish debt to GDP ratio of 20% would be implied. As has been pointed out by a number of commentators (see Karl Whelan here and Com McCarthy here ) this is likely to take a very long time, and in any case would result in the perverse situation of too low a level of long-term government bonds, which among other things would have implications for the ability of insurance and pension companies to hedge their long-term liabilities.

It is noteworthy that the issue of fiscal responsibility is one that is significantly greater than that of mere rules. In the Seanad Senator Sean Barrett tabled a bill this week on Fiscal Responsibility which was generally welcomed by the Government (they wont accept the bill of course). More information on that bill can be found here and see the response by Brian Hayes TD here which gives a good outline of the sort of issues comprehensive fiscal responsibility involves.

It is not clear, despite the existence of a proposal to have advance warning systems, if the compact now proposed had been in place that it would have materially slowed the descent into sovereign debt crisis. In any case, the stability and growth pact was breached repeatedly by France and Germany without compunction.

Neither did the summit solve the vexed issue of whether or not the European Central bank will in fact be an effective lender of last resort. While there is a proposal to have a medium-term liquidity function, highly desirable in the Irish context of banks being dependent for over €100 billion worth of liquidity from the ECB (albeit a large but unknown proportion of this being IFSC banks) the system seems to be resorting to ever more convoluted mechanisms by which the ECB can in effect but not in fact purchase bonds of member states. As I have stated previously this is a policy of treating the problem as one of liquidity when it is more likely one of solvency.

More starkly the summit does not address the issue of growth. Successive predictions for euro area growth issued over the last year have relentlessly ratcheted down expectations. The OECD prediction for 2012 for the Eurozone are for an anemic 0.6% growth in GDP, absent any significant shock.

In the context of this we should then examine the Irish budget. Although there is a perception abroad that we have had significant austerity, and certainly people are beginning to feel the pinch, when one examines the actual figures, as Seamus Coffey from University College Cork has done, it’s very clear that the actual level of money that has been taken out the economy is significantly less than the “€21 billion” figure much bandied around. The reality is that we have only just begun the process of adjusting for the difference between government expenditure and revenue. This may seem startling after four years of continued “austerity” budgets but the reality is that even on the basis of the government’s own figures we are still likely to run a deficit of 8.6% of GDP, over 10% of GNP. It’s worth remembering that in the initial November 2010 four-year plan deficit for 2012 was to be 7% of GDP, which slipped to 7.5% in the 2010 budget and slid further to 8.6% by April of this year. And of course this 8.6% is contingent on what may now seem to be a reasonably optimistic growth prospect. The ESRI predicted GDP growth in 2012 of .9%, Department of Finance 1.3%, or 1.6% depending on which document you read, and the Commission 1%. All suggest that the domestic economy will remain stagnant at very best. The Commission were as late as summer 2011 suggesting a real GDP growth rate of 1.9%, which they had consistently done since 2010. Clearly a corner has been turned in forecasts.

The budget therefore, set against the context of a dysfunctional European Union, facing into stormy international growth waters in 2012, is unlikely to significantly affect the dynamics of the Irish government debt. Much of the adjustment to date has been on the basis of capital projects, in particular by the cancellation of projected capital projects, in other words equating not spending planned money with Actually making savings. The largest items and current expenditure are social protection at 40% of government expenditure Health at 27% and education at 17%. Cuts in these are politically sensitive and socially difficult.

There is a meme in Irish political discourse that somehow or other we can solve our budgetary problems by simply cutting public sector pay and social protection. On its own projections the government will next year run a current budget deficit of €13.1 billion, and will borrow €8.4 billion for capital expenditure, a total borrowing requirement of over €21 billion. This gap cannot be closed by changes in any one sector on its own. It will take a mixture of increased tax take, reduced expenditure, and must especially economic growth.

if we were to cut public sector pay by 20%, whether across-the-board or by targeted cuts, this would result in a gross saving of .2* €18.6 billion, €3.7 billion in gross terms. The average public sector wage is €47,000, but of course there are fewer people in total earning That than there are public sector workers. More probably the median public sector worker earns closer to €35,000. Based on 2009 revenue data this would imply that their average 22%. This would imply that a cut of 20% in public sector wages in gross terms would yield net savings of the order of €3 billion, but of course that ignores the billions of Euro of lost VAT, excise, etc, not to mention the second-order effects of reduced economic growth resulting in reduced tax take overall. Cutting public sector wages is not a panacea.

Nor is cutting social protection. The largest part of the social protection budget is the €4.3b spent on income supports, some €2.7b of which is the dole. Cutting this by 20% will yield €540m, at a pretty high social cost. Contributory old age and widows pensions, paid for over a lifetime through PRSI, amount for some €5b, and the ghost of Ernest Blyth hangs heavy over any cut there, but again a cut of 20% will yield €1b, dare any government so do.

The government is in a massive hole, and there are no simple solutions, although simplistic solutions abound. A return to growth is a sine qua non for our salvation and neither the budget nor the eu summit promise same.

Referenda, Promissory Notes and Anglo

So  it seems that there is going to have to be a new referendum, in order to put in place the treaty changes to underpin the Franco German proposal to end the Eurozone crisis. The proposals have an element which involves golden rules, so-called, on national budgets. And this would seem to involve a referendum.

Before the government even  moves a writ to proceed to a referendum it must in my view receive an ironclad guarantee that the Anglo-Irish bank promissory notes, which from March 31, 2012 will cost the  taxpayer  3.1 billion Euro per annum, will instead be paid by someone other than the Irish taxpayer.

Between January 1 2012 when we repay an un-guaranteed bond of The Bank Formally Known As Anglo and 31 March 2012 when we pay the first installment of a decade long commitment to TBFKAA in the form of 3.1b from the Promissory Note  we will in effect take out of the taxpayer an amount greater than the adjustment in this budget.  Every March 31 to 2023 we will pay 3.1b. And then we will pay 7.6b over the remaining 8 years to 2031. There are two excellent posts on the notes by Karl Whelan here and here

Now, it might be arguable that we should in fact radically accelerate the needed closing of the gap between spending and income. In that context, there would be few who would argue that if we HAVE to take 4b plus out of the economy the best way is to close the gap, not to pay the creditors of TBFKAA.

So, for me the calculus is simple. IF the government can get a deal that involves the notes being taken off the irish taxpayer, then they should go to move the writ for a referendum. If not, then no deal means no deal surely.

The Euro : moving on or just staying in a death spiral

This week saw a number of developments in the ongoing Eurozone crisis, none of them particularly good news for the currency. The published opinion piece was sent to the Irish Examiner before the coordinated Merkel-Sarkozy announcements on the need for fiscal union, but that is such a large issue as to deserve a post of its own. This post appeared as http://www.examiner.ie/business/addiction-to-cheap-and-easy-credit-must-end-175922.html.

First, and quite startling, we saw the emergence of negative yield rates on german short-term bonds. This in effect means that investors will now pay to hold (sure and safe) german bonds rather than lend to other risky assets. This says something not terribly good about how investors see the prospect of the eurozone. There has indeed been a generalized and widespread flight to safety with yields being bid down on swedish, UK and Swiss bonds also.

We saw the Italian yield curve invert, where investors seek a higher rate on short-term loans to Italy than they seek for longer term loans. Such an inversion preceded the bailouts of the existing programme countries, and is generally taken as being a fairly decent predictor of an economic slump looming. More generally as discussed in this short but excellent Seeking Alpha piece it is a general feature of distressed credit that short end yields will be greater than longer end, due to the same discount (haircut) being applied across the maturity spectrum and as a consequence the measured yield on the short end rising.

Third, we saw a coordinated can kicking, whereby the central banks of the world, persisting in the assumption that this is a liquidity as opposed to a solvency issue, injected massive amounts of cheap money into the world economy. Of course, the money is cheap dollar finance, as opposed to euro finance, but as the advert states ‘every little helps’. It is true that italy, spain and france all are still raising small amounts on the bond markets, albeit at increased costs. This perhaps reflects less a desire by markets to lend to them and more a demand from banks for assets, relatively cheap (recall that as interest rates rise the value of bonds falls) compared to german assets, to swap or repo at the ECB for liquidity.  This in turn gave rise to (so far unsubstantiated) rumors that a large (french) bank was in liquidity problems.  The ever reliable FT Alphaville has a series of posts on this issue which are well worth a read : see here, here and especially here where El Arian, the CIO of PIMCO and the man who in most ways personifies the bond markets, gives a cautious, muted and less than glowing analysis of this..

Finally we saw the publication of an exceptionally gloomy outlook from the ESRI and an even gloomier one from the OECD. In passing it is quite extraordinary that the ESRI charge several hundred euro for their Quarterly Economic Commentary. Why on earth that is the case beats me….

The approach taken by the central banks is treating a symptom. The drying up of liquidity in the markets is a symptom of real concerns about the longer-term prospects of these countries repaying their debts. European banks, sovereigns, companies and consumers are heavily indebted. Banks have to ‘deleverage’, shrink their balance sheets, and in doing so are, even if this is something the Bank of England doesnt want to see,  forcing the deleveraging of nonfinancial companies and individuals.  Similarity states need to reduce their debt levels.

Italy has a debt/gdp ratio of 118% , france 83%, spain  a lowly 62% and even Germany is at 84%. Recall that the oft-noted Reinhardt-Rogoff threshold for distress is 80% and we see that even in the core of Europe we have problems.  Italy is already paying over 5% of GDP in interest payments, Greece over 6% and Ireland close to 4%. Europe as a whole is extremely indebted and this will inhibit growth hugely

These burdens will continue to grow. In the ESRI analysis the sustainability of the debt burden, its stabilization, depends crucially on the economy achieving growth of between 2.5% and 4.5% in the 2012-5 period, set against projected flat lining for this year and next. And yet, growth in Europe in general and Ireland in particular is predicated on sustained export growth. While it is clear that we have been spared the trade and protectionism wars of the 1930’s it is also evident that any export growth will involve exports to Asia and BRICS, nations where we have at best muted penetration. An excellent presentation on this was made by Kevin O’Rourke, one of the highest profile economists in the world, a world leader in his field who left at the start of this academic year to move from TCD to Oxford.

Europe is in many ways like a heroin addict. We have become addicted to cheap, easy credit. Credit is an absolute essential part of the modern economy, as are natural opiates an essential part of the body. Overreliance however causes problems. The really hard task for European politicians is how to wean the sectors off cheap easy credit without a collapse. In that context liquidity is similar to methadone – it can act as bridging element while a longer term solution is generated. The longer solution must involve three elements: growth, which is especially important for Iberian countries with their dangerously high levels of youth unemployment; modern administration which means in the case of Greece and Italy that tax compliance is enforced; a proper fiscal union which is not simply ceding to an unelected and unresponsive central power the ability to raise debt and disburse but which involves automatic stabilizers.

In the USA a major automatic stabilizer is internal migration. If there is a recession in Kansas people move elsewhere. Ireland has experience of this, via mass migration, and it is neither a likely nor desirable nor feasible solution for Europe as a whole. Thus any fiscal union needs to be culturally bounded by the diverse political cultures of Europe, be democratically controlled, and be effective. It is very debatable if that can be created by 9th December this month’s final final drop dead deadline.

What will not work is a hodgepodge of measures designed to remove the immediate liquidity crisis without dealing with the longterm solvency; a series of measures that move democracy even further at a remove from the technocratic governments we have seen installed; a one (german) size fits all policy on fiscal austerity; nor a policy that treats symptoms not causes. Europe needs to move from credit led to economic led growth, and any policy that does not deliver same will not work. More to the point, discipline for its own sake is simply masochistic.

Europe is, as Goldmans put in this excellent graphic in a ‘death spiral’. Someone needs to break it and soon.  Pouring more cash into the system will not work.