The Next Debt Blowup Post author By Philip Lane Post date December 1, 2009 The lead story on the NYT website asks where the next debt blowup may take place: you can read the article here. Categories In Banking Crisis, Fiscal Policy Tags debt default 52 Comments on The Next Debt Blowup ← New Bank Guarantee Scheme → Lessons from the floods 52 replies on “The Next Debt Blowup” Where will the next debt blow-up be? The flood of sell order for AIB this morning at €1.51 might be a good clue. So far, they are managing to hold the line above the €1.50 mark. Who do you think the buyers holding that line are? As Ross Perot used to say when he was running for US President “when you hear a giant sucking sound folks, that’s your tax dollars.” Isn’t this the consequence of the widespread respectability in the Keynsian multiplier fairy-tale that has taken root (against) amongst economists and finance ministries around the world? I’m not an economist but I’ve never understood why governments’ spending of borrowed money to ‘stimulate’ the economy – based on the multiplier theory – was anything other than a pyramid scheme. If this crisis buries Keynes idea about this (and in fairness to Keynes he probably would have changed his mind once he saw the facts of government deficit economics) once and for all then at least some good will have been done. It can be frustrating reading economists (some on this site) airily talking about levels of taxation and effects of government measures as any of it will make any difference.. Take note. Rogoff sees the danger of sovereign deault being at its greatest in two years time. He thinks that at that stage (implicit) guarantor nations will stop assisting spendthrift nations. A lot of sovereign debt will be up for renewal around that time. We fall squarely into that category with two year bonds at large, the EU/ECB moving towards withdrawing extraordinary support quicker than elsewhere and domestic political opposition to cuts (“debt intolerance” as Rogoff calls it). Yet another article making reference to debt to GDP for Ireland in a cross-country context, without the long (and by now boring) debate over Ireland’s special chasm between GDP and GNP: I have heard some people defend the use of GDP to compare Irish public indebtedness to other countries, despite the gaping chasm between GDP and GNP, on the basis that GDP is taxed too. My back-of-envelope thoughts on this: 2008 tax on GDP-GNP = (184-156)*.125 = €3.3bn 2008 tax burden on GNP = (€50bn-€3.3bn)/€156bn = 29% Adjustment factor on GDP-GNP = 29/12.5 = 2.32 Denominator for debt comparison purposes = GNP + (GDP-GNP)/2.32 = 168.4 Debt to “G(irish)P” ratio = 90.6% Well ahead of the rest of the eurozone. Newsflash for Paul MacDonnell: Capitalism is a pyramid scheme. @ Cearbhall “The flood of sell order for AIB this morning at €1.51 might be a good clue. Who do you think the buyers holding that line are?” What flood? Who are you suggesting the buyers are?? Trading in the Irish banks has been busier than average, but not significantly so. There’s a growing tendancy on this site to take a suggestion or an opinion and dress it us as a fact. Stop it please. @ Eoin Chech this mornings charts and then if you have any contacts check who the buyers are. By the way the €1.50 line has just been breached. You might convey to your banker friends Eoin that there is a saying on Wall Street “never try to muscle the market, because it’s you against the world and your going to lose.” Why isn’t the insistence on using GNP instead of GDP simply a proxy for an insistence that the scandalously low corporate tax rate must remain inviolate? Karl Whelan suggests that the proper denominator in Ireland remains GDP for the simple reason that GDP is all subject to taxation by the Irish government. And it is. It’s just not taxed much. Is there any reason why 12.5% is the sacrosanct number when it is at least 5 percentage points lower than the lowest top rate in any other European state, less than a third of the top rate in Germany, Japan, the US, and Canada and a fraction of the top rate in Spain, France, Belgium, New Zealand, Italy, Luxembourg, the UK, Australia, the Netherlands, Mexico, Greece, Norway, Sweden, Denmark, Korea, Portugal, Finland, Austria, Czech Republic (and I could go on)? In short, we’re to believe that Ireland spends huge amounts on its public services and has crushing debt (as a percentage of GNP) even though it doesn’t spend huge amounts on its public services and doesn’t have crushing debt (as a percentage of GDP). And we are to believe this only because we’re not supposed to point out that we don’t tax GDP-GNP at anything like the rate that we could or that simple fairness would dictate. Irelands Banks borrowed far more than they or we were worth. They borrowed from other Banks, I believe these to be mostly German Banks, hence the German/EU bailout of our Banks. It is an indirect way of bailing out bigger more systemic Banks. The NYT piece states that the Big Boys will look after the little boys up to a point. In Irelands case Germany will look after our Banks ( not us ) until their Banks are safe or until they can not afford to because of more pressing problems at home. Does this mean we will be allowed bankrupt ourselves before we are allowed default on German Banks or since it is really German money bailing out German Banks have we already defaulted just not publicly. Posted elsewhere butt it is also relevant to this thread. Greek bond spread is again tightening much faster than the Irish bond spread and they are very close again. Greece tightened another 15bps today to 167bps, while the Irish spread has tightened by 2bps to 165bps. @Ernie Ball The profit gap between GNP and GDP in Ireland isn’t real. Profits are moved here artificially by transfer prices and other such measures. The only reason they are moved here is because the tax rate is 12.5%. If the rate increased then much of the gap would disappear as the profits would just be moved elsewhere to be taxed. @ DE i got Greece at 183bps at the moment, low today more like 176bps, so not much movement. @ Cearbhall “the €1.50 line” is this some line in the sand we should be watching? Again, who are you suggesting is buying? At least have the balls to back up an incredibly vague assertion with a somewhat less vague explanation please. As i said, if there was a “flood” of sell orders, why is the volume of trades only about average? @Eoin Are you looking at the bond spreads or the CDS market? Greece 10 Year Bond @ 486bps http://www.bloomberg.com/apps/quote?T=quote.wm&ticker=GGGB10YR:IND And opened this morning at 500bps @ DE sorry CDS. Ireland @ 160, Greece @ 182. The bonds have moved by a good bit more for Greece. @Dreaded_Estate If the corporate tax rate were moved to 17%, where exactly would the profits be moved? Who are we competing with? @Eoin I would imagine that the CDS market is a little more illiquid than the bond market. Have you any access to the volumes traded today in the CDS market? In the cash market the Greece vs Irish gap is down to 3.5bps. @ Eoin Sentiment can move markets, consequently price points are important. For example $1,000 on the gold price which was last reached at the end of 2003. But when that old high was taken out on Oct. 5th the price has since raced ahead to this morning’s high of almost $1,200, an increase of 20% in 8 weeks. The significance of €1.50 on the AIB price is clearly illustrated in price activity since that point was ‘breached’ at 11am. On 3 occasions since it has tried and failed to break through on the upside and failed each time, at the €1.50 mark. ‘Support on the way down, is resistance on the way up’. On the AIB price, from a purely technical viewpoint the €1.445 figure of Nov. 3rd is more important as a support level, beyond that the next support is at €1.25 from July 10th. Regarding the non-disclosure of the other information, it has nothing to do with the size of any part of my anatomy just simply, no more freebies. @Ernie Ball I would imagine that it would move to places such as Bermuda, the Isle of Man or somewhere the tax rate is virtually nil. There is no way real economic activity behind these profits it is just accounting moving them from one country to another. If there was no movement of some of the profits elsewhere increasing the corporation tax to 17% would raise at most €1.5bn But the reality is that there would be a loss of profits to other countries and we would be lucky to raise €1bn. We would also make it more difficult to attract new MNC from setting up here. Other countries may have higher tax rates but they also have much lower costs. If we make our corporation taxes higher MNC might just decide to setup or move elsewhere. @ DE no, all the CDS stuff is off market, and we dont do much of it ourselves. However, that said, while it can often be quite illiquid, apparently there’s a huge amount of two way stuff going on today in Greece and Dubai, Greece on profit taking from the big run up over the last two weeks and Dubai on people realising that ultimately Dubai itself isnt in trouble, just some particular assets it owns. as of now on reuters Greek ten year over bund 167, irish at 165…. five year over bund 103 and 140 @Eoin A movement of nearly 33bps in the last 2 days is far more than profit taking in my mind Eoin. Do you not think it is significant that Ireland has only tightened by 5bps over the same period? @Ernie Ball The 12.5% corporate tax rate is compensation for the fact that outside of the 1st world compounds of multi-nationals Ireland is a public sector riven, uncompetitive, guild socialist, corrupt economic slum. These are foreign enterprises invited here to provide work for (usually) unskilled natives by Cargo Cultist governments.They are here BECAUSE the rate is low. They are not, in the main, part of the Irish economy. They use Ireland as a low-tax platform. They have the economies of scale (well until recently) to cope with the overpriced services and their grateful employees pay all the direct and indirect taxes. It’s a dysfunctional system. In my view Ireland should have one rate of tax – say 15%. It should be a flat tax of 15% on income. 15% on VAT and 15% corporate. Flat all the way. No allowances no exceptions no specific incentives. ..and no opportunities for clever economists to figure out – using this or that research – how to ‘nudge’ behaviour by tweaking it here or there and play God. …because markets are infallible. We’ve just had an object lesson in this, Paul. Try to keep up. @ DE if you look at the graph of the move in Greek debt today, the move is almost completely between 8.30am and 10.30am, and its flatlined since. Its the same withh the Irish bonds. Basically a load of buyers came in first thing this morning on the back of the Dubai news. With most other bonds fairly flat on the day, and Irish stuff slightly better, whats your alternative explanation? @Eoin I think the 8.30am to 10.30 am is more due to when liquidity is in the markets. In the days after the Dubai crisis the Irish and Greek spreads widened significantly but the Greek spread went out much further. Since the panic has abated risk spreads has started to tighten on all assets. But Ireland hasn’t benefited from that tightening as much as other risks and I think we are pushing out to our previous outlier status again. @ Brian Lucey “as of now on reuters Greek ten year over bund 167, irish at 165…. five year over bund 103 and 140” Just to clarify, thats five year over bund 103 (Irish) and 140 (greek), and not the other way around (though the Greek one is slightly longer maturity which explains some of the difference). On the cash market the Greek 5year spread has tightened by 20bps while the Irish spread has come in by 8bps. @Dreaded Estate If Bermuda and the Isle of Man have tax rates which are virtually nil and if we’re just talking about companies free to shift their profits to any country they like, why would any corporation choose Ireland? @ DE Greece is benefitting from two dynamics – itself (ie the EU aint gonna let it go bust) and Dubai (general risk appetite). The story last week was – Greece and Dubai, are they gonna default/need to be bailed out? The story this week – Greece and Dubai, actually its not as bad as it looks, just need to be careful. Its a reminder that the financial crisis is still present is certain assets/locations, but you’d go mad if you made medium terms judgement calls on a day-to-day basis. The focus next week, for instance, is obviously gonna turn to the Irish budget. It’ll be far more important in terms of how the sentiment for Ireland looks as we head into 2010. @Eoin You seem to be missing my point Eoin. Yes Greece is benefiting from everything you have said, my point is that Ireland isn’t. Why do you think this is? @ Ernie because Obama has already said they view certain jurisdictions as borderline tax evaders (Bermuda) and others as simply tax convenient/friendly (Ireland). Not sure how the US feel about the Isle of Man, but a few Bermuda based corporations have relocated to Ireland in recent months (Covenian/Accenture). Because we’re in the EU, it seems to keep the US authorities happy enough. @ DE no im getting your point, i just think you’re over emphasising a one day movement that leaves nominal Greek bond yields still higher than nominal Irish ones, and Ireland is quite clearly benefitting fromt he news, just not as much, but then again it didnt lose out as much either. Im saying its profit taking, you’re implying its a big shift in sentiment against Ireland, despite the fact that Irish yields are lower as well. Its either really really good news for Greece, profit taking after a huge 1 month move up for Greece, or perhaps profit taking on any Ireland vs Greece trades that were put on in recent weeks. Maybe its just short covering and general illiquidity. Hard to paint it as a “bad news for Ireland” day when our bond yields are much lower as well. In the Eurozone, Greece are the outperformers today, but who are the second best performers? Ireland. @Eoin I was more talking about the 3 day relative moves of 33bps for Greece and 5bps for Ireland. one day even one week moves are not terribly important (unless your a quick turnabout trader). The next week is crucial for us – the talks today and the budget. The more fudge is produced the more our bonds will drift out. @Eoin So, let me see if I have this straight: We have to have a beggar-thy-neighbour corporate tax rate because, if we didn’t, the American multinationals would all go to cheaper jurisdictions except that they can’t go to cheaper jurisdictions because the American government takes a dim view of those jurisdictions and all the ones they don’t take a dim view have higher corporate tax rates than we do. So why is it again that we can’t increase our corporate tax rate? @ Ernie what im saying is that its not cost-free for them to remain in Bermuda, much like its not cost free for them to set up shop here (they’re still irritating the Feds somewhat). The point is its less costly reputation-wise to set up here vs Bermuda, and they still get a tangible benefit (c.5% or so) when compared to setting up in the US or UK. As such, its worth it for them overall. If the benefit was 1-2%, it probably wouldn’t be. Its a pretty basic concept of pro’s vs con’s. @ Ernie sorry, the tangible benefit of c.5% would be vs the lower tier of corporation tax rates existing in the main EU countries. @All I think the share price of AIB stopped mattering long ago. AIB is as worthless as the value of “regulated by the financial regulator”. FF allowed them to offend repeatedly since the early 80s. Now they have gone broke for a second time in 25 years. They are almost cartoonishly evil. Expect their next adverts to feature Dick Dastardly (small business pigeon catcher) and Wily E. Coyote (small business road runner catcher). They will be receiving a gratuity for their efforts – but nothing like the billions we are giving AIB through NAMA. All together now: De de de de de do, de de de de de do do do do …. @Ernie Let us not forget that the domestic Irish SME sector also pays tax at 12.5%. What do you think would happen to these firms if their corporate tax burden went up by a third? MAybe its a moot point as many are no longer making profits. 1 December 2009 15:21 – AIB has said it is suspending coupon payments on part of its corporate debt under European Commission rules. A consequence of the move is that that AIB can not pay interest on the Government’s €3.5 billion. ??????????????? @ Cearbhall O Dalaigh Is that now official. Was a statement made this afternoon? @ Cearbhall already dealt with here http://www.irisheconomy.ie/index.php/2009/11/30/new-bank-guarantee-scheme/#comments They’re almost certain to actually pay the govt dividend, as the EU has confirmed it has an “open mind” on the matter. @Eoin Wouldn’t it be better for the state if these coupon payments weren’t made? @Ernie Ball – ‘…because markets are infallible. We’ve just had an object lesson in this’ Ernie, this is a non sequitur. Object lesson in what? What question are you answering? What is it I’m not keeping up with? You said Capitalism is a pyramid scheme. What does this mean? Paul @Eoin, would that be an as open a mind as Sepp Blatter has on Ireland being the 33rd nation in the world cup. These instruments were meant to be core tier 1 i.e. loss bearing in certain circumstance. Here is such a circumstance. @Ernie Ball I’m of the view that we should not treat foreign enterprises (mobile or not) any differently from any other enterprise. The Government and EU agrees. Hence we have a 12.5% corporate tax rate. Now you seem to think that we can raise more money from them by taxing them more. Why does the Irish government need to raise more money? Perhaps it needs to raise less. The working classes, consumers and general populus vulgus agree with me on this. Hence they shop in Newry. Now you have posited a higher tax rate on these MNCs to raise more money. And it’s been objected that this might cause them to move away. I kind of agree that we could raise their tax to 15% but only if we reduce all other tax to 15%. The government doesn’t need much of the money it raises. This is clear when you consider the simple and obvious fact that, 1. given the most efficient business processes, 2. use of technology, 3. integration of activity across sectors, 4. privatisation opportunities and 5. removal of privileges granted to public sector workers in a way that is driven by union coercion / extortion and not markets, – public sector employment could be cut by about 75% and spending by about 80%. I’m talking MNC top-level, productivity stuff here. Otherwise it’s a feudal swamp awaiting the Enlightenment of market forces and Consumer sovereignty. Well….If I may paraphrase Mr N Chamberlain, Mr Cowan tonight told us “i have in my hand an agreement”. Depending on whether the ps payroll is 260 reckonable days or 365 we are saving 3.8 or 5.8 % of pay via 14 days furlough. Which doesnt really help now does it? So the next debt blowup being here is incrementally greater than when there was hope we had a government as opposed to the bearded borg running us. My two cents on the issues here: Greek vs Ireland spreads: Best to look at the moves since June. Ireland 10yr was trading at 70bps approx over Greece. Large ECB LTRO (plenty of liquidity), better risk appetite – Ireland trades 30bps through Greece. Most rational traders would take profit here (looking ahead toward year end liquidty etc). Trades back towards flat. Volatility recently in spreads probably reflects lack of interest from traders in these markets given the time of year coupled with rumours that china will buy 30-90bio of greek debt, dubai jitters, concerns about stock market valuations etc. Wouldn’t try pin it on fundamentals – difficult to fit a story to the moves. Similar moves in Irish – bund spreads – 100bps tighter. Risk reward given reasons outlined above would favour taking this off – hence it trades wider. I am not aware of any stark revelation that the market didn’t know of already that would fundamentally drive this move wider (equally hard to explain the move from june based on the fundamental view that – has Ireland’s position improved so much relative to Germany in the last few months). Corporate Tax I think we should have 0% Corporate Tax. Europe don’t want it because they know what the likely effect is on a multinational’s (who is looking at Europe) decision process. The Gov forecast it will raise 3.5bio to 4bio over the next 3yrs. Given their record – probably going to come in lower. From Minsky’s Stabilizing an Unstable Economy – 0% reduces the incentive to load up a balance sheet with debt because interest payments are deducted before arriving at taxable profit – definitely an incentive worth thinking about in Ireland. It reduces the incentive for executives to lose the plot on advertising and marketing (everything that falls under this umbrella) which also reduces taxable profit. Ensure that the company pays out majority of profits ala reits (who cares if its abroad or not) so as to avoid people using the corporate status as means of avoiding paying income tax. I am sure there are more. Can anyone tell me negatives? Can anyone tell me that it definitely won’t create employment almost immediately (it can be implanted immediately – unlike trying to reduce min. wage, power costs, strength of the euro etc) – it certainly might save some jobs as it puts less of a burden on business? Putting people on training courses doesn’t help them pay mortgages. Yes protected banks will pay levys in the future for the state’s protection and can abolish tax incentives – let the cash flow to the most productive resources/investments – we have enough hotels. I would certainly wager the 4bio that it will attract investment. We have taken far greater risk recently. And finally, yes it is beggar thy neighbor but as the last few months and years have shown it’s a dog eat dog world. No one giving out to the boe, fed snb etc. Can’t think of another way to try tip the scales back slightly in our favour. Would definitely favour a carbon tax. But the key is removing as much as possible any impediments to doing business here. Would love to hear your views. @Brian Lucey: “So the next debt blowup being here is incrementally greater than when there was hope we had a government as opposed to the bearded borg running us.” Enough of this beardism. You’re just jealous. bjg An issue I would like to raise is the growth impact of the fiscal consolidation. Ireland is following a strong pro-cyclical policy (which for me is the right thing to do at the current situation); however, what does this mean to growth in the short-run and long-run? Fiscal consolidation is recommended, though we should not be completely silent about the growth impact. Is the growth dampening so important? How Ricardian is the environment? http://globaleconomicanalysis.blogspot.com/2009/12/gold-and-silver-soar-as-bank-of-japan.html Japan is still bubbling public debt to stimulate a declining economy. Ireland has more growth potential than Japan. DG. Comments are closed.