Monday, 6 September 2010

Compare and contrast

Michael Burke: The yield on Irish 10-year government debt climbed to 5.7% by close of trading on Friday. This is shown in the chart here. This is back close to the high of 5.85% last seen before the multilateral €750bn bailout of European banks last seen in May. That bailout had the effect of temporarily pushing yields sharply lower- interest on Irish 10yr debt fell then by nearly a 1% as the immediate risk of debt default seemed to have been averted. The resurgence in interest rate costs implies the perceived risk of default has risen once more, back towards its peak.

The yield spread over Germany has widened to 350bps (or 3.5%). Other Euro Area borrowers who can still access the markets have also seen their yields rise and spreads widen; Italy (140bps over Germany), Spain (170bps), and Portugal (330bps). But none has quite the yield premium over Germany of Irish government debt. Only Greece, which cannot borrow in the market, has a higher 10yr yield premium (920bps).

These interest rates ultimately reflect the likely costs of sovereign borrowing in the market. As such, irrespective of any action by the credit ratigs' agencies, they are determined by the average market perception of the creditworthiness of the borrower.

A Wall Street Journal article earlier this year commending the government's austerity policies received much attention. It relied heavily on the fact that Spanish short-term yields were higher than Ireland's, although this is more an indicator of immediate default risk than ultimate creditworthiness. But Irish 2yr yields have since risen sharply and, despite a modest recent retreat, now stand at 3.25%. By comparison, 2yr yields in Spain are currently 2%. This indicates that both Ireland's creditworthiness is seen as lower and its risk of default is higher than that of Spain.

Supporters of the austerity policy have persistently claimed that there is no alternative; to do otherwise would cause yields to rise intolerably higher and increase the risk of being shut out of financial markets altogether. But it is the austerity policy, combined with repeated bank bailouts, that have created just such a situation. The policy has clearly failed, not least because tax revenues have not revived.

By contrast, in countries such as France, the budget deficit has fallen because tax receipts have revived by €60bn in the latest 3 months compared to a year ago. This reflects the prior stimulus measures the government had adopted. A similar pattern is evident in all the countries that adopted stimulus measures, as tax revenues have revived. In Germany, combined Laender and Federal tax revenues are up 2.1% in 2010 to data compared to the same months in 2009, which the Finance Ministry attributes to the prior government spending programme. Of course, all these government now have 10yr yields below 3% - fraction of Irish yields.

The mantra of the second-rate bookkeeper, that 'we can't afford a stimulus package' is the opposite of reality. The proof (negative in Ireland's case) arises from those countries that did adopt these measures; growth has resumed, taxes revived, yields lowered and the deficit has not widened with stimulus measures, it has narrowed.


antoin O Lachtnain said...

What are your criteria for choosing Spain, Germany and France to make comparisons with Ireland? On the face of it, Ireland is a small, open economy, whilst those countries are exactly the opposite. Additionally, these countries all have significant natural resources to fall back on.

What sort of stimulus do you have in mind?

Michael Burke said...


the criteria on bonds aren't my choice- German yields are the benchmark against which all European bond markts are measured. The WSJ, and others have chosen Spain in order, they think, to highlight the greater market approval of Ireland's austerity policies. France is my own doing- because the data are easy to obtain as French fiscal reporting is superior to many. (But I don't think either France or Germany in particular could be described as 'closed' economies; ie the opposite of 'open').

I have sometimes used Belgium as the near comparator for Ireland, as it is the next most 'open' economy in the Euro Area. The contrast with this economy on bond yields and fiscal policy is at least as striking. But, for whatever reason, many here find that comparison objectionable.

The appropriate investment programme would be based on a combination of economic requirements (eg. infrastructure, transport, R&D, education, healthcare, chilcare etc.) as well as the most effective in terms of bang for buck, or Euro, ie the size of the investment multiplier. Happily, these two overlap to a large degree.

Some discussion of the appropriate areas is in the TASC publication, Stimuating Recovery, which can be found here

Chris said...

I think we need to analyse what people mean when they use the term 'open'.

They cannot mean internal trade barriers because membership of the EU requires that all member-states respect free movement rights between member-states. By that definition, France, Germany and Spain must be 'open'. Yet, often Ireland is defined as 'open' in contrast to these countries.

Perhaps there is another definition or other considerations that people are using, but I think this needs to be made clear. Otherwise, this debate will get nowhere.

Michael Burke said...


'Open' is a fequently misused term, with connotations of an open wallet, open vault or open chicken coop.

'Openness' is measured as the proportion of the economy devoted to external trade, both imports and exports. In that sense, this economy is very open, with a very high proportion of both.

This last point is frequently overlooked by opponents of government spending, who argue that any increase will just 'leak' out of the economy via increased imports, ignoring entirely that this economy exports much more than it imports and that the overwhelming bulk of those imports are inputs for re-export.

The overwhelming bulk of goods and services consumed in Ireland are produced here. One key exception is vehicles, where bizarrely the government did provide a stimulus (cutting VRT).

Mack said...

Michael, all of this presupposes that it is fiscal policy rather than the banks that is dragging Ireland down. Whatever the long term difference in scale may turn out to be, surely the upfront costs of the bank bailouts are much higher today?

There seems to a be consensus emerging round these parts that the part of the Irish economy represented by the excess in GDP over GNP is illusory.

Where is debt-to-GNP going to wind up? 150%? Or higher?

Incidentally ,how are our consumers, in debt up to their eyeballs, *ever* going to be bale to spend when the government stimulus stops?

Would it make more sense to make the prevention of the socialistion of private debt a higher priority?

Antoin O Lachtnain said...

Your stimulus package could easily be put in place using tax breaks and indeed that has being done, maybe to an excessive extent. (Tasc, for instance, recently called for on childcare facilities to be cut and the funds diverted to sustain social welfare payments.) For public spending, what transport projects of any size would you propose that would give a significant multiplier and also have a business case at the current interest rates?

Germany is a less open economy, in the sense that it is big enough to make a lot of its own stuff. More importantly for our purposes, Germany can grow without external trade. (The classic example of a non-open economy is Argentina, which tied itself with a currency-peg which was unable to flex with the massive internal growth in the economy resulting in an eventual crisis.)

Ireland, on the other hand, cannot grow like this. Because of its small size and fundamental dependence on imported energy, and commodities Ireland must export to grow. For sure, there was some scope for internal growth. But our internal boom completely and utterly exhausted and over-exploited that internal scope.

Mack is right of course, the increased bond yield has relatively little to do with our yearly repayment capability and a whole lot more to do with how much it looks like we are actually going to end up owing.

Michael Burke said...


I agree with you, the banks are dragging the country down, and Irish bond prices show it. The yield on the Irish 10yr bonds climbed to over 6% yesterday.

This is a specifically Irish question, as Italy was lower at 3.8%, Spain unchanged at just over 4%, Germany a little lower at 2.25%.

This is all about the governemnt's imminent decision on Anglo- bond investors may not be the smartest in the world but they're not dummies either, if you keep handing over sums that represent big chunks of GNP to bailout your mates, they'll stop lending to you.

However, I don't think the fiscal crisis can be attributed to the bank bailout, as many here wish to believe (thereby absolving fiscal policy).

In fact, in Europe as a whole the bank bailouts seem to have no correlation at all to the crisis. Italy spent nothing on bailing out banks, Spain 5% of GDP, Portugal 3%(compared to Ireland's 232%- and counting).

see a good article and the details here

The next biggest bailout after Ireland's was our old bugbear Belgium, followed by the Netherlands, both of which retain the 'approval' of the bond markets.

Right now, there is an increased risk attached to Irish government debt because the markets fear Anglo will be abiled out again.

Michael Burke said...


I think there is a misunderstanding. Tax breaks do not provide the requisite boost because they have lower multipliers, as private agents fearful of their incomes save rather than spend. Ths is confirmed in the most autoritative research from the IMF et al, IMF, The Effects of Fiscal Stimulus in Structural Models, IMF WP/10/73, which argues for government investment, and against tax breaks.

As for the claim that Germany can grow without trade, that will come as news to both German exporters and statisticians. German imports are equivalent to 40% of GDP and exports 50% of GDP. The entirety of record Q2 growth was due to the external sector.

And no sensible person in Germany argued against stimulus measures because imports are 40% of GDP.

Chris said...

Thanks for the above, Michael. Your post was really helpful.