Friday, 5 November 2010

2011, 2014, the Bond Markets and Growth

Nat O'Connor: It seems to me that there is some confusion in the way in which international factors on Ireland's deficit are presented to the general public in the media. In particular, the 'requirement' that Ireland's deficit is reduced to three per cent of GDP by 2014 seems to be confused with the issue of whether it may be too expensive for us to borrow from the bond markets early next year. The financial institutions that lend money to countries (i.e. the 'bond markets') do not care whether Ireland reaches three per cent of GDP by 2014, provided we can show evidence of an ability to repay our borrowings. But in terms of providing this evidence, the deadline for satisfying these lenders may well be early 2011, not end-2014.

Those who are offering to lend money to Ireland at the moment (at high rates of nearly eight per cent) are taking a chance on making big money on these loans; balanced against a heightened risk that this or the next Irish Government will decide not to pay back the loan - or only pay back a portion of it. However, they are not crazy. They would not lend to Ireland (except at extortionate, short-term rates) if they thought that it was highly likely that we would default on the loans. So, we are still in a position where some of these large - and coldly calculating - financial institutions think that they can make money. (That is, they are confident that we will pay back the loans, or at least enough years of interest, to make it worth their while taking the risk). Unfortunately, not enough of them are interested in lending to Ireland, hence we would have to borrow at nearly eight per cent from the small pool of risk-takers who are willing to lend.

However, the institutions that might consider lending to Ireland at lower rates are not necessarily the same financial institutions that would lend at higher rates. Some institutions make more conservative lending decisions, while others go for more risky investments. This is an oversimplification, perhaps, as most will have balanced portfolios, but it hopefully illustrates the point that not all participants in the international bond markets are clones.

The more conservative institutions operating in the bond markets want to see more evidence of ability to pay. That is, they want evidence that Ireland has moved into a period of economic growth that can be sustained. And they want evidence that tax revenue is stable. And they certainly want to see public expenditure reduced over time to what the state can afford, based on its revenue. However, as long as there is evidence that the state is on a sustainable path, it doesn't matter whether it is 2014, 2016 or 2020. All that matters is that Ireland is on a stable growth trajectory and can show that it will be able to pay back the money.

Meanwhile, there is another part of the bond market that Ireland must also satisfy. That is those institutions that have already - in better times - lent money to Ireland. (Much of our borrowing is at 3 or 4 per cent interest). Like the conservative financial institutions that will not currently lend to Ireland, those who have already lent to us very urgently want to see evidence of ability to pay! They want to see a credible growth plan, because they are not even benefitting from especially high interest rates on what have become risky loans. Some of these institutions may be the same ones that might lend more money to Ireland in future, but only if presented with evidence of growth.

Finally, there is the EU dimension to all of this. The EU Stability and Growth Pact is a political agreement made between all Eurozone countries. Our Government have pledged to return our deficit to 3 per cent by 2014. This is a political decision. It was perhaps a necessary decision in order to persuade the European Central Bank to assist Ireland by buying some of our bonds, and accepting the IOUs we gave our banks to cash in. But it is only one of the many political compromises we make in Europe all of the time. Much EU business is done by consensus within the Council of Ministers. There is certainly scope for Ireland to gain compromise on this target, with the support of other Eurozone countries who are also in danger of missing the target.

However - and this is where the more immediate bond market question gets mixed up with the EU 2014 question - if we think that our economic strategies are not going to deliver growth, and therefore the international bond markets will not lend to us at a reasonable rate, we have to remain on reasonably good terms with the ECB, so that they will buy our bonds and, ultimately, bail us out with the EU-IMF fund, if the worst comes to pass.

Ironically, the effort to satisfy the EU by aiming for a deficit of 3 per cent by 2014 - in case we need EU help - is likely to make it more likely that we will need to avail of emergency assistance! That is because our sequence of severely contractionary budgets (and a further €6 billion in cuts and taxes planned for December) is shrinking the economy, cutting or even killing growth, and making it less likely that the more risk-averse parts of the bond market will lend to us.

How do we get out of this bind? The answer is simply that we need to deal with 2011 before we deal with 2014. The issue in 2011 is whether Ireland has a credible growth strategy, which will persuade more international lenders to lend us money at a more reasonable rate. The only way that this can be achieved is by a smart combination of tax changes, expenditure changes and measures to foster growth and jobs.

Crucially, Budget 2011 is effectively Ireland's last chance to change direction. The Government has the option of spending sufficient money from the national pensions reserve fund (NPRF) to offset some - or maybe even all - of the contractionary effects of increased taxation and reduced expenditure in 2011. We do still need to lower the deficit by a combination of tax and spending changes. But we also need to boost jobs, boost aggregate demand, and boost economic growth.

At this stage, a number of commentators have made the same observation and a range of bodies have put forward credible options for boosting growth in the economy. Without getting into the pros and cons of the different approaches - and there are profound differences - there are many options that Government could take:

- TASC proposes a €3 billion Economic Recovery Fund in 2011 including a credit guarantee scheme for small businesses and rollout of next generation broadband (which would be labour intensive);

-ICTU calls for a minimum investment of €2 billion per annum, over three years, to be spent on a new water and waste network, retrofitting energy inefficient buildings, educational buildings and broadband (with options to bring in private finance, as well as using NPRF money);

- Fine Gael propose a major state-led investment of €18 billion through their NewERA proposals, funded through selling state assets;

- Labour wants to create a Strategic Investment Bank to invest €2 billion (initially) in SMEs and raise finance for infrastructure;

- Sinn Féin proposes a 3.5 year stimulus, using €7 billion from the NPRF (€2 billion in 2011) to invest in a revised National Development Plan, including remediating the water network, extending and rolling out broadband. Also a 'cash stimulus' through welfare, which would boost aggregate demand in local areas;

- IBEC have stated that only growth will solve the fiscal crisis. They call for limiting cuts to capital investment, reviews to ensure all new government policy and legislative initiatives support employment, a radical overhaul of the public employment service, an ambitious national internship programme and the continued PRSI reduction for employing people who are long-term employed;

- ISME "warns of Government complacency on jobs". They claim that businesses are "handicapped by a reduction in consumer demand exacerbated by exorbitant costs, late payments and a difficulty in accessing bank credit";

There is a broad and growing consensus on the economy. That consensus is on the need to change direction, and focus on jobs and growth.

And this is recognised internationally. Paul Krugman notes the 'experiment' (and here also) that Ireland's austerity resulted in a worse result than Spain's attempts at stimulus. Joseph Stiglitz has claimed that Europe "made a wrong bet with austerity". In particular, Ireland’s struggle to revitalize its economy after the country’s worst recession on record shows the risks of focusing on deficits. "The belief that markets will get new confidence has been shown wrong" by Ireland’s austerity drive, Stiglitz said.

If the Government continues to monomaniacally focus on cuts and taxes, and refuse to present a credible growth strategy, it will bring us much closer to requiring an EU-IMF bailout, allow further collapse in the economy and cause unnecessary hardship for many people.


Nat O`Connor said...

Bloomberg reports a negative bond market reaction to the Government's announcement of €6 billion austerity. More evidence against the current strategy.

We need to change direction.

Paul Hunt said...

I think the NPRF has been ravaged enough and, if this is closed off, most players seem to think they'll magic money from mid-air. It's interesting that the Government is the only player who seems to be seriously contemplating semi-state privatisation. This would be a real game-changer in terms of national debt, efficient and lower cost service provision and providing funds for infrastructure investment.

The CER's proposed decision on DSO revenues to extract an additional €200 million from consumers (on top of already over-priced electricity) over the next 5 years to keep the ESB quiet puts it all in context.

Nat O`Connor said...

It is sensible economics for the state to lead investment during a recession. Hence, far from "ravaging" the reserve fund, TASC and others suggest making good use of our savings in order to launch a growth strategy.

As a point of information, Fine Gael is also actively contemplating semi-state privatisation in their NewERA proposals.

Paul Hunt said...

No problem with the state leading investment during a recession. I've being calling for this for two years. However, my view - and that's all it is - is that it would be better to match any drawdown for infrastructure investment with privatisation receipts.

I considered mentioning FG's contemplations but decided not to in a short post because the bits they are looking to sell are of low value and a lot of restucturing would need to take place before they could be sold. I'm not sure FG has thought it through properly and they seem to be fighting shy of privatisation for fear of spooking Labour in the context of a coalition government.

I still think the gouging the CER is contemplating on behalf of the ESB is reprehensible and indefensible. If the CER were doing it for a private sector company the progressive left would be up in arms. Privatisation is the only way to put a proper valuation on these businesses, shake up the current cosy club and generate real benefits for consumers.

Michael Burke said...


It's noteworthy that in all the talk of 'reform' is now revealed as a synonym for privatisation.

Putting a valuation on these businesses is a circular argument- you only need a valuation if you intend to sell them.

As for 'shaking up the cosy club' and 'benefitting consumers'- all very laudable but entirely irrelevent to the current crisis.

Paul Hunt said...

The problem is that cosy clubs and ripping off citizens who, as final consumers, pay for everything has been the over-riding policy stance for the last 20 years. That's why we are where we are.

It's time for people to get real. In Sep. 2008 the Government had two options: call in the IMF or take emergency economic powers, nationalise the domestic banks and try to do a deal with the bondholders (where they took severe haircuts) or, failing that, impose losses across the board and sell what remained to international banks that had been able to maintain their solvency and liquidity - or were able to shore up their solvency and liquidity quite rapidly after the Lehman bust.

The EU vetoed both options. On the first, while it was fine to have the IMF involved in non-Eurozone members, the IMF in a EZ member was not on. On the second, there was no way Irish bank bond losses were going to be imposed on core EZ country banks and pension funds.

All that was on offer was the ECB shoring up the liquidity of the domestic banking system, but Ireland had to take the heat, eventually, on the bank losses and continuously on its fiscal deficit while the institutional and political EU (I&P EU) struggles to come up with institutional mechanisms that will replicate the IMF in an EZ context - in other words, and EMF.

Ireland has had two years of a combination of limbo and purgatory and another three rougher years loom until 2013 when the I&P EU reckons it will have the necessary changes in the TFEU to establish its EMF. And that will be no redemption, because the ECB will want the money back it has contributed to the re-financing of the bank bond holders.

The only bonus is that the IMF will soon be involved and it can rip in to the cosy clubs and consumer rip-offs that are choking the domestic economy.

Anonymous said...

The EU did not veto alternatives to Sept. 2008. On the contrary, EU members voiced their anger and frustration with the decision taken by Cowen, Lenihan et al.

If you are going to get real, at least get your facts straight.

Paul Hunt said...

Thanks, Anonymous. We don't know - and, perhaps, never will know - what happened in the run-up to that fateful decision. The anger of other EU members was occasioned because they feared the markets might force them to take a similar decision. As I read it, the Government thought it was facing a bank liquidity and not a bank solvency crisis. It didn't see the need to - or felt it could - call in the IMF. And neither the Government not the EU had an institutional mechanism to deal with a bank solvency crisis. Soon after the guarantee was enacted it became clear that it was a bank solvency crisis on top of a liquidity crisis. By then all avenues to restructuring were closed - effectively by the EU - nd all that was on offer was liquidity support form the ECB. And that's all that will be available until the TFEU is amended along the lines Chancellor Merkel desires. And even then I'm not sure how much haircutting will be done.

Anonymous said...

Well, you're speculating, Paul. no harm in that, but spare us the 'get real' line, will you? This isn't the Jeremy Kyle show.

Paul Hunt said...

The 'reality' is what Ireland is facing now. We can talk and speculate about any number of roads not taken in the past. This reality is that we have a government with constitutional legitimacy - barely - and no popular legitimacy which is determined to soldier on in an attempt to secure the survival of the governing factions as political entities. It is prepared to sacrifice the well-being of any number of citizens to achieve this end. And its next objective is to do what it takes to avoid recourse to the EFSF - and its tactics are being determined by the EC. If it fails it can always blame the evil bond vigilantes and this will allow it to save some face. And its last remaining bargaining chip is that the institutional and political EU wants to keep Ireland out of the EFSF as much, if not more, than Ireland wants to stay out of it.

It'll be a damned close run thing.

Anonymous said...

Nice to know that you think that 'reality' begins and ends when you say so.

You are still setting the parameters of what constitutes 'reality' here Paul. Basically, in linear terms, 'reality' is what you way it is, and it is affected and influenced purely by what you way it is.

How convenient.

Paul Hunt said...

This is just my take on the basis of what I see as givens. You're perfectly free to disagree, but it would be better if this were focused on what I see as givens rather than ad hominem.

These, for example, include (1) a government determined to do what it takes to retain power until its constitutional mandate runs out, (2) a corresponding determination to do what it takes - irrespective of the damage to the economy - to keep Ireland out of the EFSF, (3)the lack of an Irish bank resolution process and the almost certainty that if one is to emerge it will emerge only on an EU-wide basis in the context of the EFSF being put on a permanent footing (perhaps by 2013)and (4) the determination of Chancellor Merkel to eventually impose losses on bond investors who invested foolishly in peripheral banks and sovereigns is driving up yields on Irish sovereigns and runs the risk of shutting the NTMA out of the market.

Anonymous said...

what is ad hodinem about pointing out the logical and methodological flaws in your arguments?

you seem to believe that events cause things to happen - that if we dismiss events we can get back to reality and what is really going on.

Yet, human events are shaped by deep social, economic and geographical forces, and these forces need to be understood in order for us to attain a grip on what is happening now, and, indeed, on what took place.

So, I'm not attacking you, paul, although thanks for the strawman.

I am simply pointing out that the methods of analysis you are bringing to the table here border on useless - predicated as they are on a 19th c. idea of 'events' as the cause and outcome of the world we live in - that if we filter the bad events from the good events we will arrive at the right answers.

Well, good luck with that.

Paul Hunt said...

Ah, I think I'm getting it - assuming you're the same Anon (the joys of the blogosphere!). There I was thinking I was addressing the political and economic forces that are bearing down on Ireland's sovereignty and the well being of its citizens, when I should have been focused on the inevitable destruction of capitalism and the equally inevitable triumph of the proletariat. Mea culpa.

Anonymous said...


you've substituted what I said for your own statement, which you then refute!

I hope you don't treat your balance sheets the same way.

It is very interesting, though, that you think that mainstream methodological approaches - approaches accepted across the world and taught in almost every university in the world - are dangerous revolutionary nonsense.