I agree with Guido…

At least on the immediate question of Ireland.

They should default. 20% of tax revenues going on interest payments is not sustainable. Better to default early than drag it out.

 As David McWilliams argues:

This is our trump card and we must have the courage to play it. The deal is simple. If they don’t do the deal willingly, we need to default and see what happens. And do you know what will happen? They will find a mechanism to take the shares of Irish banks onto their balance sheet. And the crisis will be over, because they will not risk the euro and all that political capital to teach the Irish a lesson.

More on this question at Slugger O’Toole.

 

The New OBR Numbers

I’ve had a quick look at the new OBR forecasts.

My first thought – this is a lot more realistic than the last set of forecasts, although as Robert Chote himself says they will almost certainly be wrong.

The media is so far concentrating (helped no doubt by Tory spin) on two aspects: the revised 2010 numbers and the public sector jobs figure. I’m not sure either is that note worthy.

2010 growth has been revised up but coming November with Q2 and Q3 growth figures both having surprise on the up side already (due, according to the OBR to temporary factors notably construction) this isn’t “new news”. The downgrades to 2011 and 2012 growth are far more significant.

Equally, I don’t find the revising down of public sector job losses especially surprising. What has changed between now and the June budget is the amount of spending cuts coming from welfare – more money cut from that budget means less cut from other public spending and hence fewer job losses.

I expect the OBR forecast of public sector job losses to be reasonably accurate – they are in a better position to forecast than they are anything else and Robert Chote is a very competent economist.

So 330,000 jobs lost in the public sector (on current spending plans) seems a reasonable assumption.

The core message of the OBR is that this will be a slower recovery than those of the 1970s, the 1980s or the 1990s. Even on their numbers unemployment will still be higher in 2015 than it was pre-recession.

The great uncertainty, and where I worry the OBR is too optimistic, is the private jobs market.

They still assume a business investment boom is about the occur and they still bank on a very strong performance by UK exports – but as the Chancellor reminded us last week, we currently export more to Ireland than to Brazil, Russia, India and China combined. We growth prospects in our major trading partners looking weak (and with the ongoing threat of global currency wars and trade battles), we can’t be sure of this. And without strong external demand I don’t see businesses investing in their future capacity.  

No export boom would mean no business investment boom. In the absence of these it is hard to justify their forecast for private sector job creation.

These downgrades have taken the OBR closer to my own (back of the envelope) forecasts made six months ago (for example I estimated 2011 growth at 1.8%, they said 2.3% in June and have now revised down to 2.1%). So we probably set for a sluggish recovery, the only question is how sluggish.

Ireland & the Eurozone: First Thoughts

So, we have a provisional deal in Ireland. And the deal is only provisional; the new government new year will almost certainly re-open the talks.

What does this actually mean? In the (very) short term, some of the pressure is now off Ireland. Although in the medium term this solves nothing – no haircut on bank or government debt makes this unaffordable. The underlying problem is being ignored. By 2014 interest payments will be 20% of Irish tax revenues – there is no way to balance the budget with that kind of headwind. The cuts mean that the medium term prospects for growth look horrible.

The next obvious flash point (financially speaking) is the Budget, followed by the election. I’d be voting Labour myself, although expect Sinn Fein to do surprisingly well.

For the Eurozone as a whole the crisis is far from over. There is some immediate relief in the markets today (to be expected) but I still believe Portugal will be under pressure soon. The market reaction is hardly euphoric. We were told in May that the bailout of Greece was the end point. It bought Ireland six months. I expect Portugal’s period of “calm” to be a lot shorter.

One brighter development is reported in today’s FT – the ECB is looking at extending liquidity support for periphery banks (a necessary but not sufficient step for recovery).

Baseline scenario runs through 4 scenarios for the future of the Eurozone that are well worth a read.

In the end game, we are going to see either restructuring of debts or outright default. The banks needed to be prepared to take this hit. Following the Greek disaster 6 months ago, the EU conducted “stress tests” and decided that “everything was fine” with Eurozone banks. We need to use this breathing space to conduct real stress tests (assuming large losses on periphery exposures) and re-capitalise banks ASAP. We might not get another chance.

The Euro Crisis: How to Stop It

I said on Monday that the bailout of Ireland would not work. I was talking in terms of Ireland itself and the future of its economy. I stand by that.

But I also asked:

what happens after this? Assuming the EU manages to come up with enough cash to keep the economy liquid, what happens next? Do the bond markets now turn on Portugal? And if the EFSF (European Financial Stability Facility) is then used to bailout Lisbon, what if they turn on Spain? The EFSF couldn’t cope with that. What long term planning is being done to come up with a long term, Europe-wide solution? It’s taken a week of leaks and denials to get to this point with Ireland, this bailout has been incredibly badly managed – I doubt much long term planning has been carried out.

It turns out I was right to be worried.

Back in May, the bailing out of Greece was met by an immediate (although now unwound) “relief rally” in Greek bonds, peripherial country spreads and the Euro.

This is not happening now.

Instead we are stepping closer to crisis.

Irish, Portuguese, Spanish, Greek and (very alarmingly) Italian spreads over German bunds are still rising.

Even more alarmingly, looking beyond the spreads – the actual yields on German bunds have headed higher too. As have German CDS spreads (from a low base).

The Irish bailout is now expected to be agreed by Sunday – after inept management for two weeks. But both Labour Party and FG are saying they will want to renegotiate it.

The Irish budget, set for 7th Dec, may not pass.

Either way, Portugal will need support with in days now. And after Portugal and Ireland, there is no cash left in EFSF.

There is an urgent need to stop the crisis before it hits Spain properly.

I’d suggest three immediate steps, I’m not sure that it would work, but I think the chances of success are higher than what is currently “planned”.

 (i)                  The ECB should announce it is prepared to offer as much liquidity support as is needed to periphery banks if deposits continue to flee. An emergency from of QE, but one that might help stem the flight of deposits.

(ii)                We need “proper” stress tests of all euroarea banks (not just the periphery). Not the confidence building exercises of a few months ago, but severe scenarios (taking into account step three below). This should be immediately followed by a full recapitalisation of those banks that fail. Give the banks 20 days or so to try and raise that capital in the private markets, if they can’t then forcibly inject it and be prepared to severely hit (or even wipe out) equity holders.  In an ideal world the EFSF would be used to fund the new equity, creating a string of banks with large stakes held by the Euroland governments in common.

By these two steps the Euroland governments and the ECB can settle liquidity and solvency issues in the banks. It should hopefully lead to banks better equipped to lend to fund a recovery.

Ideally the ECB should fund this through QE rather than placing more pressure on government deficits.

 (iii)               Sovereign restructuring in the periphery with hair cuts around the 20-30% on government bonds. The recapitalised banks should be able to take the strain. Pension funds will be hit (on the other hand, it will lead to less taxation in the medium term, the net effect on pensioners is hard to determine).

This might or might not work. It is a medium term fix. The longer term requires greater rebalancing in the Euroland economies and a reordering of the ECB. But I suspect it is better than relying on austerity.

Ireland: Three Questions and a Red Line

Ireland is finally facing a long awaited reckoning. This comes as no surprise.

Rather than run, once again, through the reasons why this has happened, I thought it might be worth setting out some questions – and a red line on which the UK government in particular should be negotiating.

But first, it is worth dealing with one central point: this bail out will not work. Without strong medium near (and preferably near term) growth, there will be no solution to Ireland’s problems and such growth will not emerge against a back drop of severe fiscal tightening, The medicine prescribed by the Irish government, and urged by the UK, will kill the patient.

Three major questions remain. First, what happens after this? Assuming the EU manages to come up with enough cash to keep the economy liquid, what happens next? Do the bond markets now turn on Portugal? And if the EFSF (European Financial Stability Facility) is then used to bailout Lisbon, what if they turn on Spain? The EFSF couldn’t cope with that. What long term planning is being done to come up with a long term, Europe-wide solution? It’s taken a week of leaks and denials to get to this point with Ireland, this bailout has been incredibly badly managed – I doubt much long term planning has been carried out.

Second, what solution will Europe suggest to the Irish growth problem? Monetary policy is tight (in the context of domestic deflation, real interest rates are high) and fiscal policy is off the table. So, presumably, as with Greece the answer will be “structural reforms” and “liberalisation” to raise productivity and the growth potential.  Someone will have to explain to me how Ireland, the poster-child for liberalisation, can be reformed further. Exactly what “reforms” are about to be inflicted on the ailing economy?

Finally, is the UK going to lend to Ireland bi-laterally? Why? Will UK loans have a different place in the creditor queue in the event of default (which will come)? Will they have different conditions attached?

And lastly, the red line: Irish corporation tax. Maintaining a 12.5% corporation tax rate was always predatory, and in mine opinion not in the Irish national interest anyway. It is now indefensible. It was indefensible to not raise it whilst cutting pensions, benefits, jobs and spending on infrastructure and public services. In the Irish case “they are all in this together except foreign corporations”.

The Celtic Tiger was not build on structural reforms and low taxes, it was build on foundations of sand: negative real interest rates and an asset price boom.  

The pulling in of footloose global companies attracted by the lowest tax rate in the Eurozone not only deprived other states of much needed revenues, it also led to a fundamentally unbalanced Irish economy.

We should not support a bailout that doesn’t involve raising that tax rate.

Some Good Reading on Economics

The blog has been quiet for the past two weeks due to a combination of (real) work, work for my masters (part time, History (a real subject)) and, to be honest, bit of a lack of inspiration.

I’ll try and be better this week.

In the meantime some stuff to keep you all going.

The FT reports today that some bond market analysts believe that the low yield on UK gilts is signal that “that there will be no real growth in the economy in the next few years”.

Here’s an excellent article on CiF about the changing global balance of economic power.

The task is even more daunting than in the years after 1945, for today a number of fiercely independent-minded, aspiring world powers must be herded into the global order. As the main architect of globalisation, which awakened awareness worldwide of the need for global public goods, the US must, even in its weariness, summon its creative resources.

Martin Wolf’s thoughts on the gold standard are well worth a read. Especially in light of today’s call from Robert Zoellick for a return to the “barbarous relic”.

Paul Krugman shares some interesting polling on perceptions of the deficit in the 1990s. Even as Clinton vastily improved the budget position – Republicans still believed it was getting worse!

Finally Brad DeLong outlines some “centrist technocratic” ways to deal with the deficit in the States. There is a lot in here relevant to the UK and worth considering.

Here is the platform for the bipartisan technocrats of the center:

• Ten-Year PAYGO: a 2/3 supermajority in both houses commitment to ten-year PAYGO starting now, and a pledge by every president and presidential candidate that they will veto all bills that do not meet ten-year PAYGO standards. Everything Congress passes must be projected to reduce the outstanding national debt within ten years.
• “Starting now” means starting now: no middle-class tax cut this month or next month without a pay-for within ten years. Taking current law rather than current policy as our baseline and requiring PAYGO for everything gets our 25-year fiscal gap down to 1.2% of GDP (as opposed to 4.8% of GDP) and gets our 50-year fiscal gap down to 0.8% of GDP (as opposed to 6.9% of GDP). Our long-run deficit problem is overwhelmingly due to things that Congress is about to do, not things that Congress has done.
• Carbon tax: a 1.0% of GDP carbon tax is the best policy to provide American businesses with the incentives they need to invent the clean energy technologies of the future. Half of it should be channeled into the Social Security Trust Fund to improve its solvency. Half should be used to help close our remaining operating fiscal gap.
• Pick-your-poison: Additional stand-by tax increases and stand-by spending cuts to close the remaining 0.3% of GDP long-run fiscal gap.
• Private add-on Social Security accounts: At their option, all Americans can add up to 2% of their Social Security wages to a private Social Security account run through the U.S. government’s Thrift Savings Program. Private contributions will be matched two-for-one by the federal government out of carbon tax revenue
• Recovery: when every fired local, state, and federal worker takes a private sector job down as well and when the U.S. government can borrow at today’s absurdly-low terms, it is criminal stupidity not to pull government spending forward into the present and push taxes back into the future (all within the ten-year PAYGO rule, of course). Since the macroeconomic situation is worse now than it was ever projected to get when the first Recovery Act was passed and since the U.S. government can borrow on better terms now than it could at the time of the first Recovery Act, it is time for a second Recovery Act–fifty percent federal government purchases and aid to the states, fifty percent tax cuts–somewhat larger than the first was.
• Certainty: The principal sources of uncertainty in American economics right now are three: we don’t know how the long-run fiscal gap will be closed (but we think it will be), we don’t know how our health-care system will be reformed and transformed (but we know it will be), and we don’t know what our policy toward global warming will be in a generation (but we know that we will have one). The best things the government could do to diminish uncertainty would be to: (1) commit immediately to the full implementation of the version of RomneyCare-plus-cuts-in-Medicare-and-taxes-on-gold-plated-health-plans that was this year’s PPACA, (2) commit immediately to a long-run climate policy in the form of a carbon tax coupled with research incentives for future energy technologies, and (3) commit immediately to a plan to cover the long-term fiscal gap.

Churchill Quotes of the Day

“The Governor shows himself perfectly happy in the spectacle of Britain possessing the finest credit in the world simultaneously with a million and a quarter unemployed”.

“I would rather see Finance less proud and Industry more content”.