Everybody in Ireland, individuals, companies, banks and the government, are engaging in deleveraging these days, tightening their belts to pay off the debts we collectively accumulated during the boom.
Deleveraging is the opposite of leveraging. When using leverage, you borrow money in the hope of obtaining greater returns, faster, by taking on more risk (a pendulum effect). The issue is that leverage also exacerbates losses when things go pear-shaped. Deleveraging has the opposite impact – it brings down risk. When you pay off your loans or borrow less, the impact of the ups and downs is more mute.
Having to choose between paying off debt and spending your way out of the recession
This is fine in theory, but it only begs the question: to deleverage you need money. Where will it come from? Out of current spending. A mortgage holder wants to pay down their mortgage, but that has become progressively more difficult, since they have less money with which to do so if their wages and benefits have been cut.
By borrowing, I take the money from the future and I move it into today, but by paying down debt I take the money from today and I send it into yesterday.
The Irish government is engaged in a serious procedure of deleveraging, as examplified in the 2013 Budget. To the wider public, the most obvious manifestations of this deleveraging are austerity measures, taxation increases and expenditure cuts.
Now Keynesian economics recommends that you spend your way out of a recession: if everybody spends more, businesses will earn more money and can hire more people, thereby creating a Multiplier Effect which should herald the end of the recession.
To a lot of people, the government is doing the complete opposite of what it should be doing. It should be investing in stimulus, in capital projects that have higher value, it should be investing in creating more jobs and employing people in a more labour-intensive way.
Instead, the government is cutting spending, and it seems that, at a time when unemployment is 14% and consumer spending is low and projected to get lower, what they’re doing is taking more money out of people’s pockets. Which doesn’t sound like a great idea. For the government, the issue is that it doesn’t have an awful lot of money and is already spending more than it has, creating a deficit. The only ways to reduce this deficit are to increase taxes and decrease spending.
The thing is that we don’t spend (or save) according to our existing circumstances, but according to our expectations of the future. During the boom, we spent more than we had because we anticipated a payrise and behaved accordingly with a negative spending ratio.
Now, we anticipate further harsh budgets and difficult employment conditions, and our savings ratio is at 14% of disposable income (a significant rise from the 11% of money after bills last year).
Nobody bailed Ireland out but Ireland itself
During 2007, our debt/GDP ratio was a very manageable 25%. This turned sharply around when a widening deficit required us to borrow to maintain the funding of the state, when a rise in our government bond yield mandated us to pay a higher interest rate on those borrowings, and the recapitalization of the banks left us a promissory note as its legacy.
I think it’s important to differentiate our experience in bailing out banks with that of other countries. We underwrote the banks and dealt with them as an Irish problem. By the time other European financial institutions got into trouble, the European Union and Zone architecture was taking a European view of the issue.
When Ireland bailed out the banks it was a lone country. Greece was bailed out in May 2010, but even then nobody was talking about Portugal, and Italy and Spain weren’t on the agenda. Nobody thought France would lose its AAA rating.
At the time, Ireland was this small country, representing roughly 1% of the GDP and geography of Europe. Ireland’s problems were perceived as internal problems which ran the risk of becoming a poisonous contagion, so would the Irish just go and sort it out please.
So we had to bail out our banks as an individual country whereas other countries, when their turn came, had a European solution to what had come to be perceived as a Europe-wide problem. We had to take on that debt as an independent state, even though we could never have honoured the bank guarantee if push had come to shove: the guarantee represented €440bn; our GDP was about €150bn at the time. And our tax take was around €30bn. We had to do it to provide a modicum of certainty to the banks, since nobody else was going to provide that guarantee.
With a little help from our friends?
Now when the government is deleveraging and paying off that debt, when it is paying back a €3bn promissory note every year, it is not spending that money in the economy. That money is spent to pay back IBRC, formerly Anglo Irish Bank, which amounts to pouring promised, expensive money into a dead bank. Talk about sending the money into yesterday.
To try and solve this, many are asking for this debt to be restructured, into oblivion even: we could be repaying a small amount every year for the next 100 years, and inflation would eventually reduce the real value of that repayment to the point where it would be painless.
While Ireland had to bail itself out, by the time problems came on with Spain and Italy, the perspective on the matter had become European. The ECB recently said they would use unlimited bond-buying in order to stem the acceleration of bond yields to new heights. Compare this with summer 2010, when everybody frowned at Irish bond yields going through the roof and Irish bonds being downgraded to junk status.
Rather than dealing with this on a country-by-country basis, as Ireland had to do, we are dealing with this at a European level at this stage. There is talk of a banking union and a fiscal union and a political union, when there was none before.
I don’t think that we should be asking to be let off on this one, but rather that we deserve a massive reward for stemming a problem that would have infected European banks and economies and portfolios. I understand the moral hazard issues with other countries, but I don’t think they had to deal with the “economic loneliness” that we had to.
Our small nation’s problems would have highlighted the insolvency cracks throughout the continent and may have put extreme pressure on the euro to survive, never mind hold its value at the time.
We literally bought very expensive time for the Eurozone crisis in September 2008 and that is why I firmly believe that we really do deserve a multilateral banking debt restructuring at this point for the good of the economic, social, commercial and political future of the nation.
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