Ireland’s Balance Sheet Recession

Id be interested to see how much of the household incresase is deleveraging and how much is savings due to skepticism of future growth. Likewise for business, although they’re not as levered as households so prob growth skepticism – not unreasonably. This would suggest banks are being truthful struggling to meet SME lending target?

If we’re in debt-deflation then the real debt burden gets larger except it’s externally financed so financial repression won’t work. As we’re already at the Keynesian lower bound is it pretty much game over?

To expand on that, Koo was on newsnight a few weeks ago when he said that following Japan’s balance sheet recession, attitudes to debt fundamentally changed. You couldnt throw money at the Japanese. This allowed the state to lever up its balance sheet to 230% GDP because the aging Japs had lots of domestic savings in state banks which could be tapped.

A similar attitude shift happened in the 1930s – people become allergic to debt. A survey should be done to see if that has happened here. If it has we’re up the creek. If not, it’s not clear that investments by businesses with a ten year horizon can yield a return higher than their finance cost. A two year ZIRP teaser loan is likely to require refinancing at a higher rate – it was the ultra low rates wot got us the present malinvestment. Aging western economies are facing structurally lower growth rates, better to invest in emerging ones.

@ Gregory Connor

True, but Ireland is not just any old SOE. We a have a dual economy, with a very opaque, financialised, foreign-controlled, export sector. The under-researched elephant in the economic room.

We are also in a programme of assistance, which entails a formal loss of control over macro-economic policy. Sovereignty was already constrained by the power of internal rent seekers and stakeholders, and, as Paul Hunt is always telling us, that nexus is massively entrenched and resistant to reform.

We sure do have the balance sheet problem, but it seems the troika don’t really want to know. I suppose the take home message from Koo’s paper is that we have a long delflationary grind ahead of us one way or another.

Doug Noland has a useful take on how we got ourselves into this pickle.

http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10610

The dotted red line is supposedto be in postive territory. In a normally fiunctioning arket economy the househod sector’s role is that of a net saver. Via the medium of well-run banks who can assess and price risk properly this surplus is supposed to be recycled to the corporate sector which used the savings to fund investment.

If these two have their savings/borrowings in broad balance, then (assuming there is no major imbalance with the rest of the world) the government sector will also be in balance.

As the chart shows, the corporate sector is not performing its allotted role and has not for some time. It is this which is causing the government’s huge borrowings.

Government cannot encourage the corporate sector to resume borrowing and investment by cutting its own spending- this simply encourages greater corporate savings, and a downward spiral is created.

@Jon Corcoran on the role of cheap credit in the run up to the European component of the Global Financial Crisis

This statement is untrue. The ultra low rates were available in France ,Germany Italy ,Holland etc. They didn’t have property bubbles. <…> The malinvestment was a function of reckless Irish banks who misallocated resources,had very poor risk management procedures,incentivised lending with large bonuses and no regulation.

While a spot of self flagellation and national shame is always fun (Padraig Pearse caused the bank guarantee, doncha know?) the story of banking in Ireland is of a piece of with the general behaviour of banks in the West in the run up to the current Global Financial Crisis.

So while Scotland did not have a property bubble RBS’s “due dilligence of the imagination” on ABN Ambro is as bad as any behaviour in the Irish banking sector (oddly they do not get to make the Dutch pay for their error) and Deutsche Bank’s five billion Euro Las Vegas loss was a result of a reckless bet on reckless betting.

You will find no disagreement on the insanity of upwards only rent reviews but the Irish state now finds itself, thanks to both NAMA and the ECB”s policy of protecting the financial sector, actively involved in property speculation. We are leeching off ourselves to feed the financial sector.

It is the way of committed laisez faire capitalist to always blame the failures on bad players rather than a bad game but the lack of any serious initiative on a banking resolution framework in Europe gives the lie to Ireland being a uniquely bad example of the subversion of state policy by private financial interests.

@ michael burke

The blue line reflects the overall corporate sector. A dis-aggregation into financial corporations and non-financial corporations would show that the non-financial corporate sector was a net borrower for six of the eight years shown in the graph.

The corporate surplus shown is driven almost entirely by the financial sector. Also note that a large part of the increase in the corporate sector financial surplus for 2009 is as a result of the €4 billion capital transfer made to Anglo Irish Bank in May of that year. If Koo has extended the graph into 2010 we would have seen the huge impact of the Promissory Notes on the figures.

In 2010 the corporate sector had a surplus of 27% of GDP! Both financials (24% of GDP) and non-financials (3% of GDP) ran a surplus in 2010 though.

@John Corcoran,

You make a very valid point, but the problem facing the Government is that, if it were to establish a sensible commercial leasing regime, NAMA could disappear under water much more rapidly and much much deeply than it is likely to – and many other loans not under the NAMA unbrella could ship as much water just as quickly. It confronts a similar problem when contemplating the introduction of a more civilised and economcially sensible personal bankruptcy regime.

Let’s close our eyes, pretend it isn’t happening and hope for the best.

@Shay,

Indeed. The rest of the world should repent of its folly and not only that but it should relieve Ireland of the burden of remedying its own peculiar and extreme folly while Ireland does the least possible to heal itself economically.

That’ll show ’em.

Unfortunately, I think you’ll find that repentance for folly will be addressed purely on national terms and that any solidarity that might be extended to the more egregious sinners will be forthcoming only when they demonstrate some genuine resolve to mend their ways – and that means all of their errant ways. Ireland falls so far short of this marker that it would be laughable if it were not so serious.

@Seamus Coffey,

I suspect part of what is being demonstrated in the diagram – and particularly with your update to included 2010 – is the ‘dog in the manger’ attitude of the state. It’s reducing its activity and expenditure in many areas where the private sector, subject to appropriate regulation, could operate efficiently and profitably, but has neither the wit nor ability to make it happen. It is also determined to keep the costs of doing business high in the various sheltered sectors to protect various influential vested interests. And, in those areas, such as the energy semi-states, where it is contemplating reducing its equity investment, it is doing so in the most cack-handed manner conceivable.

So Spain did not have a property bubble? The German savings glut flowed to the highest yielding opportunities in the eurozone, regardless of its laws.

Many thanks Stephen for the Richard Koo article. For a non-economist such as myself, it was very readable and enlightening. The wife accuses me of being a doom and gloom merchant – she does not trouble herself with irisheconomy and article like that. She’s probably better off.

The small open economy argument ain’t what she used to be. We have been a member of the biggest trading bloc in the world since 1973. We are in it primarily because of the protection from unfair trading practices that it afforded. We have our feet firmly planted on a level playing field on equeal footing with Greater Manchester in the UK or Massachusetts in the USA. (‘Tis all about 1932 and the decimation (import duties abroad) of the Irish economy at that time.).

Our present predicament is largely due to the electorate applauding incompetence, fraud and corruption and even worse rewarding it by re-electing the Head Waiter and waiters so as the gravy train could continue to coast.

@ John Corcoran

I agree with you except for the word “organised”. In Ireland consensus is reached by fumbling, bumbling and stumbling along the ould bog road until arriving at the destination known as “now we can all have our fair share complete with a bone or two to throw to the electorate”. A lot of learned men have pondered the question “Why do the Irish people do so well abroad and so poorly at home.? Foreigners like to blame the rain, cloud cover, wind and the cold. Most Irish abroad blame cute hoorism and all that connotes. In America the Irish were noted for practicing corrupt politics, it was not until Kennedy was elected that our reputation improved. If we could only find a caped crusader domestically that would save us from ourselves.

Every now and then I ask myself why are all the incompetents who contributed to our downfall still in office and being paid handsomely. The answer is that’s Ireland for you Mickey boy, business as usual.

@ issac: Koo is to be taken carefully. He has valid points. But nowhere in any of his writings have I encountered a clear exposition of his economic Model-in-Use. This is a common failing with economists, even those on this (very fine!) blog.

My guess is that their economic Model-in-Use (belief system; reference frame, or whatever) is Permagrowth: an annual, incrementing aggregate expansion of economic activity. It is most regrettable that economists do not clearly state what their economic paradigm actually is. It is as if they considered that the global economy was somehow infinite – it will keep going on ‘growing’ for a very long time. That economic activity was somehow or other immune from the Second Thermodynamic Law. They are in for a most disageeable suprise in the not too distant future.

The problem is not money (aka: credit), but access to a reliable and relatively inexpensive source of energy (liquid fossil fuel). This sort of energy is not in good shape, and the prognosis is not good either.

The nett energy (fossil fuels) available to western economies (EU, US, UK) has flat-lined (as of 2005) and shows no sign of a significant uplift. Producers have increased their own domestic use. Chindia is using more. The amount of new discoveries is less than the annual decline in existing reserves. Its a real predicament. If we [Irl] are unable to access a reliable, and relativel inexpensive liquid fossil fuel energy source, our aggregate economic activity will regress, and is most unlikely to ‘recover’.

Back to Koo. He warns about imposing ‘fiscal austerity’ when individuals and firms are attempting to correct their weak financial positions, especially when a major asset class (property in our case) is declining, and will continue to decline for at least the next five years. This is what our legislators are doing. Its a disaster in the making. They seem to expect that ‘growth’ will resume in a few years time and this will bring an auto-correct to our economic and financial situation. I hope they are correct, but the fundamentals (increasing debt load, decreasing incomes, energy costs slowly incrementing, global trading partners in poor economic shape) are firmly against them.

The only reliable solution to our current economic predicament was to have forced all insolvent banks to liquidate. Very nasty shock: Forty Foot on a frosty winter morning. The alternative would be to shackle yourself to a bare rock at low tide and stand there as the tide comes in and slowly submerges you. In the former situation you at least can swin to the ladder and clamber out. In the latter, you drown!

Brian

Read: John K Galbraith (anything you can lay your hands on).

@Frank Galton on Ireland’s good fortune in not being made pay for Depfa as well as Anglo.

Fair enough regarding the Dutch but under the same principle — caveat emptor — the Germans didn’t make us pay (at least not directly) for the pile o’shite that Hypo got when it bought the Irish regulated and supervised Depfa.

I meant to use the word “oddly” ironically – I remain mystified that buyer beware does not appear to apply to certain classes of financial instruments in the same way it does to the companies that issue them. Mistakes were most definitely made in propping up the banks rather than bank resolution, but then winding up banks appears to have been made un-European at some point.

As for the staggeringly large Hypo bailout/buyout I am quite sure that Merkel would have made us pay some of it directly if she could have. She does what is best for Germany after all.

I’m not really sure if any of this is news? Seasoned Japan watchers have seen this story before.

What is odd to me is that Koo’s remedies – state borrow and spend – have not come in for more criticism. They may have eased the deleveraging process, but the bluntness of them must surely give pause? debt:GDP of 200+% is not something that can easily be wished away even if the BoJ is the issuer of Yen.

It seems to me inefficient to issue debt with a coupon (however low) only to later print it having had net deflation or at least no inflation during that time. In constant currency terms, Japan has had huge deflation against the dollar recently.

So would Japan be in a better position if the BoJ had bought sovereign debt and not looked for coupon or interest? i.e. printed it. We’ll probably never know, but we’d want to come up with some answers if Europe as a whole is facing japanning…

By changing tax breaks on pensions Ireland could bring a lot of capital back. Allied to this, there’d be a need for proper unitized funds, e.g.

1) Various property funds (for rental yield)
2) SME investment funds

Yes,obviously pension funds should be diversified (e.g. mostly not in Ireland), but so much else is gone wrong – that tempting back this money may be in the zone of the least worst option

Oh, come on, guys, please. Japan is Japan. Let’s foucs on what’s in front of our noses. We have a Government whose primary requirement is to ensure enactment of the dictates of the Troika. But it retains considerable discretion as to how these dictates may be crafted in a form for enactment. We have the Troika seeking to conceal internal conflicts among its members and distilling the ‘comventional wisdom’ in a manner that might satisfy the major EU powers.

This would be bad enough, but we have the major faction in government with a major policy programme (that was worked out in advance of the election) in conflict with the minor faction (that didn’t put the policy effort in) on the interpretation of this ‘cut and paste’ Programme for Government devised in the context of the Troika’s ‘not-so-clever’ demands.

Both factions have their own special interests to protect and advance and both have their own ‘household gods’ (aka ideological baggage) before whom some genuflection is required.

So we end up with the worst of both worlds. The ‘stupid’ parts of the Troika’s programme are implemented with vigour and enthusiasm; and the ‘sensible’ parts are whittled down to nothingness.

Why anyone should be surprised – and, even more to the point, put effort in to advancing sensible solutions – is beyond me. There is no forum where sensible ideas might be tested and modified and the best advanced to impact on policy formularion. Policy-decisions are amde behind closed doors and promulgated as faits accompli. All the rest is shouting the odds after the event to no effect.

I lived in Japan during the 1990s. If no one told you, you would have been hard put to realise there was a recession taking place. Unemployment was low, however there was a definite lack of good job opportunities for young people. Many graduates found themselves working in low paid part-time employment. Some of them seemed happy enough with this state of affairs. There wasn’t any large scale emigration, probably due to the language barrier. The major problem confronting Japan then and now seems to be the demographic problem – how to pay for the increasing number of pensioners.

@ Paul Hunt

‘Why anyone should be surprised – and, even more to the point, put effort in to advancing sensible solutions – is beyond me. There is no forum where sensible ideas might be tested and modified and the best advanced to impact on policy formulation.’

“ It is necessary to work, if not from inclination, at least from despair. Everything considered, work is less boring than amusing oneself. ”—

Charles Baudelaire

@ Brian Woods

the all at once soluiton is better for the overall economy, but really bad for the current insiders. instead, shackle others to a bare rick at low tide, tell them its for the best and that the tide is not likely to be high. And while you do all this, you have your insider friends move the goodies you nabbed in the good times to higher ground. easy decision for the insider, even if it is toxic for the economy overall.

on the BoI story it amazes me that they worry about an international new entrant when the could license a new irish owned bank, free from past bad decisions and able to lend modestly to small business and homeowners. of course that would never do, because offering choice to the consumer and the capacity to rejeuvenate would spell the end of everything.

All over the world since the Florentine Medicis’ (14th century) banks have hungered for sound collateral and assiduously pursued it.

In downturns banks have always been nervous about the quality of borrowers. In crashes such as the present one banks become paralysed. It does not surprise me nor should it surprise anyone on this blog that Irish banks are not lending. The same can be said for the USA and all the PIIGS. Banks have money to lend, most businesses have cash to invest, alas opportunity is lacking.

When there is a glimmer of recovery on the horizon one or two large foreign banks might set up a branch in Dublin to get a foot in the door and ride the recovery. They would confine themselves to commercial accounts with particular emphasis on the MNCs’ they service in the home market.

NAMA hovers like an albatross over the property market thus delaying recovery by a decade. Our business/commercial/property law is positively medieval and will remain that way. All the professional silos are solid as a rock. Neither the willingness or ability exists to address the more obvious problems. Ireland is the land of no surprises, what was good enough for our forefathers with rifles on the sports field barricades in 1922 should be good enough for us now.

Does anyone see a razor sharp focus on ramping up exports of goods and services. Do we see a razor sharp focus on protecting the oligarchs, the entitled, the overpaid. The present level of emigration at 70,000 is up to the average for the decade that includes the famine. Progress Irish style.

@ MH: “In downturns banks have always been nervous about the quality of borrowers.”

That was in Ye Olde Dayes, when banks were operated by risk averse, prudent folk. If they had known about DNA profiling then – they would surely have used it! Anyhow, the penalty for imprudent lending was bankruptcy. The real thing, not some half-arsed ‘bail-out’ coupled with creative accounting to camoflage the risk in a ‘off-balance sheet’ Scamola.

“In crashes such as the present one banks become paralysed.”

The banks, or the putative borrower? I fancy the latter. If you observe the banker being protected, coddled and fed copious amounts of other people’s money. Whereas you will lose your business, home, etc. You’d be scared sh*tless!

@ clintideal and Bklyn_rntr: Thanks!

For all you occidentials: Nippon IS different! Big time!

Brian.

@PH: “… but their implementation has encountered little political or official opposition.”

Yes, and where might I lay the ‘blame’ for this? The Media. They will get their underwear ino a twist, and will flog an issue, day-after-day – when and if, it suits them. They do not lack intellect or understanding. Just unmotivated. Suppose, the Min of Propaganda decided that we only needed all-Irish radio and TVs. This would save 50% of costs, would’nt it? 8) Maybe not! But it would be a ‘good’ start.

Best wishes for the New Year. We’ll be back!!!

Brian.

@ Stephen,
Forgive my coming so late to this!

I’m trying to figure out the adding-up constraints here. Net private and public saving sum to the current account surplus. Are current account surpluses necessarily bad?

But what does the purple “rest of the world” line mean exactly? It presumably means that these do not all sum to the current account surplus, but to some other component or dimension of the balance of payments.

If you could put a name on this, it might help us think about it further.