Irish bond spreads

Full text of Lombard Street Research mentioned above:

Ireland can easily see off the euro-bullies

WE SUGGEST: Large government bond spread is a buying opportunity
SUMMARY: Ireland can absorb any losses in its financial system, and a major recession, and remain enviably richer than Britain, Germany and France, with good long-term growth prospects. In the worst economic and financial scenario its net government debt will be far lower. Commentariat hysteria is a buying opportunity.

A lot of attention has been paid to Irish financial and economic problems recently. The north-central Europe free-riders on other countries’ domestic demand are smug about the temporary difficulties of the more dynamic spender economies. (The crash in German and Benelux GDPs following that of their exports may soon make them wring their hands, though, dependent as they are for exports, and therefore output and income, upon deficitcountry borrowing.) Much the same people are determined to punish Ireland for rejecting the latest version of the European Constitution in a referendum. Their hope is that financial stress will force Ireland to seek help from fellow EMU members – read “Germany, France and Benelux” – for which the condition will be another referendum pronto, the assumption being that an Irish populace cowed by strong recession will cave in and approve it.

In reality, Ireland has “nothing to fear except fear itself”. Its income far exceeds European norms, as our chart shows. It is a small, service-based economy with a substantial migrant element in the labour force, mostly from CEE members of the EU. Prime Minister Cowen recently said real GDP would fall 10% over three years. My colleagues praised him for not covering up, unlike most politicians. But perhaps he did. Maybe, Irish real GDP will fall 15-20%. If so, many of the migrant workers will go home, per capita income will fall by less, and remain enviably ahead of Britain, Germany and France. Much the same happened in 1975 in Switzerland, when real GDP plunged and unemployment rose from under 100 to about 30,000, a minimal 1% of its labour force. In a small flexible service economy, with a small public sector, incomes can much more readily be lowered than in large, bureaucratic economies like most European countries. And the basic Irish long-term growth potential remains intact: ready access to relatively unlimited labour, capital and land.

And the financial problem? Ireland has virtually no net government debt. Its broad money supply is about 130% of GDP. Suppose the financial sector needs to be recapitalised at 20% of this balance sheet (an extreme assumption). Then Irish gross debt might rise by 26% of GDP, reaching the British level and remaining somewhat lower than Germany and
France. Its net debt would rise by less, depending on the actual losses emerging, and would remain well below most other countries’, including all the major Europeans. Meanwhile, the widening of government bond spreads against German bunds must be seen against the falling absolute level of the latter. Current Irish 10-year yields are an affordable 5½%.
Ireland certainly stored up trouble for itself by adopting the euro and making itself vulnerable to the drop in sterling that has actually happened. The case for currency linkage to a major neighbour is understandable for a small economy, but the logical link is to Ireland’s largest trading partner, the UK, or its second largest, the US. But other countries should envy Ireland its problems, and the EMU panjandrums should switch their attention to the economic disaster that is developing amongst the Mediterranean members of EMU.

Charles Dumas