Achieving Devaluation Inside EMU

There is a fascinating press release from SIPTU (the largest union) today: you can read it here.  The key segments of the press release are:

“Speaking after the meeting, the Union’s General President Jack O’Connor said, “The assault under way is about correcting the problem in the public finances without the wealthy contributing a single cent. It is equally about achieving the adjustment, which would normally be brought about through a currency devaluation, by driving down wages across the private sector as well.”

and

“While a devaluation would affect all sectors of society, cutting pay achieves the same results exclusively at the expense of workers.”

For a member of a monetary union, the analogue of currency devaluation is to engineer a reduction in the general price level relative to the price levels of trading partners (measured in the same currency). This indeed involves a reduction in the inflation-adjusted level of wages across the economy. In relation to the owners of firms, the impact on margins is ambiguous and depends on the structure of each industry. Firms that are exporters and are price takers on world should see an improvement in profitability, as should firms that produce goods and services that are close substitutes with imports. In contrast, firms in ‘nontraded’ sectors may well experience a decline in profitability, especially if these firms use imported inputs.

These considerations are basically similar whether the real devaluation takes the form of a currency devaluation or a decline in the general level of domestic wages and (domestically-influenced) prices.

The major problems with the current situation are:

(i) the national pay agreement is not supporting the attainment of real devaluation. Since the pay increases are still being implemented by ESB, Bank of Ireland and others, the goal of a ‘uniform’ movement in wages across the economy is being inhibited.  It would be better to cancel the existing agreement (the macroeconomic conditions now are far worse than when the deal was reached in September 2008).

(ii)  Wage adjustment is best accompanied by policies to promote competition among firms and, in regulated sectors, to ensure monopoly power is not abused.

(ii) while it is obvious that the overall fiscal adjustment package will require substantial tax increases (including a higher tax take from high income groups), the delay in announcing this component of the deal raises perceptions of unfairness, in addition to increasing uncertainty about the expected level of post-tax incomes for all groups in society. The government could do more in terms of explaining the likely nature of tax increases over the coming years (at least in broad terms). While the Commission on Taxation may have ideas in terms of expanding the tax base, much of the adjustment will be in terms of income taxes and (possibly) VAT.  The general strategy regarding these components could be communicated more quickly.

Toxic Assets and Recapitalisation

Last night’s RTE news was full of breathless commentary from Brussels and Montrose to the effect that governments needed to do more than just re-capitalise the banks.  From Brussels, Sean Whelan excitedly talked about “toxic assets” and how it was going to be necessary to “buy the toxic assets at a steep discount, leaving the banks to continue with the viable parts of their business.  Simply re-capitalising the banks isn’t seen as enough.”  Back in Montrose, David Murphy authoritatively informed us that “In terms of doing something else in addition to re-capitalisation, they have an option of setting up a bad bank or, for instance, insuring the banks against the some of the bad loans that are coming down the track.  But it’s pretty clear that the re-capitalisation on its own won’t be enough.   And if they do something that isn’t enough, the markets won’t like it one little bit and Ireland will be punished for that.”

Despite the confident tones in which this expert analysis was delivered, as far as I can see it doesn’t make any sense. 

There is no logical distinction between the issue of undercapitalisation and the problems created by so-called toxic assets.    Banks could get rid of all their toxic assets in an instant if they just wrote them down to zero.  But then they would be undercapitalised—and that’s the problem with toxic assets.  What appears to be going on is that the various re-capitalisation programs around the world have not managed to offset the likely losses from bad loans.  However, this is a problem with the size of the re-capitalisation programs, not their nature.  There is no logical argument for now augmenting these programs with a scheme to systematically overpay for impaired assets.  (Sean Whelan may think the proposal is for buying assets “at a steep discount” but that discount is relative to what they were originally worth, not what they are worth now.)

What appears to be going on is that neither banks or governments want to inject more government equity capital because going any further than we are now requires effectively admitting that the banks need to be nationalised.  Government concerns about nationalising banks are well-founded but it seems that, in many cases, we are well beyond that point.  If the banks can’t find private equity to re-capitalise them and government is willing to do so, then that’s where we should end up.

As a final point, it’s worth noting that despite the constant commentary about toxic assets and all the problems created by the evils of structured finance (CDO-squared and all that), this stuff is essentially irrelevant to the Irish banks.  Their toxic assets are largely plain old loans to bankrupt developers and rocket science isn’t required to come up with a guess at the size of the loan losses.  As Colm McCarthy has joked “We didn’t import any toxic assets, we grew our own.”

As usual, I have the sneaking feeling that I’m missing something.  Perhaps our team of commenting pundits can explain to me what I’ve got wrong.

Linkages between Ireland and the International Economy

While domestic factors are clearly important in explaining Ireland’s current predicament, it is also true that the deep global recession has compounded the economic difficulties.  A new ESRI research study by Jean Goggin and Iulia Siedschlag provides empirical evidence on the transmission to Ireland of international business cycle shocks: the study is here.

More bad publicity

This article in the Guardian is going to infuriate British readers — not that they have any particular right to be infuriated, while British territories continue to operate as tax havens.

None of this is sustainable in the long run, and we need to start planning for the long run now.

It gets worse

It was always obvious that the crisis would put global economic multilateralism under pressure. But today’s roundup from Eurointelligence makes grim reading. Incredibly, the crisis seems to be threatening economic openness within the European Union itself, as a result of President Sarkozy’s comments on French car companies operating in eastern Europe.

I don’t believe that the future of the European project will depend on what happens in a couple of peripheral economies of marginal significance. Rather, it will depend on the answer to two fundamental questions. How much do the Germans really want the Single Currency? And how much do the French really want the Single Market?

While I remain optimistic, we are only a year into this crisis. By the time we are through with it, the answer could yet turn out to be: ‘not enough’.