by Michael Dwyer.
The capacity of Irish policy makers and commentators to self delude and fail to learn from bitter experience is positively Bourbonic. When Morgan Kelly published his now famous piece on the state of Irish banks and the economic winter that would follow on their inevitable collapse he the first and only Cassandra. Others had vague misgivings and generalised anxiety, his vision was clear and precise. He saw Troy’s towers consumed by conflagration. Yet five years and still there is absolutely no sense that anyone in Government or in the commentariat understands or, which is worse, wants to understand what the fundamental flaw that split asunder the Irish economy. It is much easier to invent bogeymen and wicked capitalistic buggaboos that face up to the truth. However blaming developers, bankers, speculators and Fianna Fail though morally satisfying in no way advances our understanding or prevents us from making precisely the same errors again.
From the foundation of the state until 1979 the Irish pound was linked to sterling. We floated for thirteen years until EMU in 1992 and then finally abandoned the Punt for the Euro. Many have argued that we entered at too low a level and that was the start of our downfall. But having been crucified on bank rates of the high teens and twenties the low interest of the EMU and then the Euro seemed to Irish business and home buyers as a very Canaan. Rates set to meet the needs of the European heart, especially Germany, meant that an economy alreqady growing strongly had access masses of cheap and easily available capital. Money was cheap for a long time. Ireland was under capitalized, under invested, lacking in infrastructure, highly productive, competitive, low taxed and low waged. It had historically underperformed and was now engaging in catch up. However once under the capitalised slack had been taken up increases in productivity were needed to maintain further money growth without inflation.
Now one of the real failures of government, and this is not peculiar to ours, is that all the talk about controlling inflation was mono-maniacally obsessed only with CPI and regarded asset inflation as neither a symptom, a warning, or a problem. For many years our CPI was very low and even in the mid naughties when it was seen to be growing above the desired limit it was low compared to the level endured during the seventies and eighties. Somehow we have accepted the notion that the increase in the price of goods, and services and commodities is bad except when it comes to PROPERTY. What is particularly pernicious about property and associated asset inflation is that it draws capital away from productive and creative enterprises. The Irish experience of the last two decades is a case study of how mispriced credit over an extended period will produce irrational investment choices and distort both our sense of risk and time when we make investment decisions.
Once upon a time there was a small investment bank in Dublin called Anglo Irish Bank. It was a perfectly nice and old fashioned house. Then a thrusting young man came along and exploited brilliantly changed market conditions and the flexibility of fractional reserve banking. In fifteen years he would grow the bank to be jointly the second largest bank in Ireland. He was let us not forget lionised in the press and corridors of power. Also remember that it took some years for the two big banks to start on the property ladder. They changed their previously prudential lending practices when non Irish banks appeared on mortgage markets. They, and their shareholders, saw the incredible growth of Anglo and it was perhaps inevitable, nothing else impeding it, that the retail banks ended up copying the Anglo model. What made it worse was the fact that coming late to the party they ended up those last years of the boom being even more risk insensitive than Anglo.
BUT as Morgan Kelly has shown what we had in Ireland was not primarily a property bubble. Not even an asset bubble. It was a credit bubble. Our banks fed the fire of cheap and easy credit with money which they borrowed at emergency rates from German banks full of money but short on customers. Why then are we the only ones to be scolded and punished for reckless banking? Did the German banks not lend in a reckless fashion to shaky banks with a crazy exposure to the possibility of a property crash? With risk comes reward, and also sometimes pain. We shall see if they are enforced to endure any pain. Well as always something occurs, asymmetric shock, collapse of asset values and all that, and the debt begins to unwind. And then chaos.
There was one necessary condition for the credit bubble to occur in Ireland. THAT WAS BANK RATES WHICH WERE NOT CONSISTENT WITH THE STATE OF THE IRISH ECONOMY. Money was too cheap. It suited economies growing at one or two per cent, but not one growing at ten per cent. Without the ability to dampen inflation with appropriate interest rates the government failed to use the fiscal tools it had to manage growth. It also failed to use the regulatory tools it had to control bank lending and to maintain healthy reserves and diversified loan books.
BUT I am not sure in the end if Irish banks had tried to stay out of the market it would not have ended up in the same place. Foreign lenders, regulated outside the sate and competing in the market would have driven lending, and faced the Irish banks with the choice of losing their home market or competing on level terms with these non national banks. The damage might have been mitigated, but there would still have been a horrible crash.
Unlike some of my friends I am also sceptical about the capacity of politicians using only fiscal levers to control this kind of credit expansion. No doubt it could have been handled better, and on the fiscal/budgetary side glaring mistakes were made. However, it is my opinion, only that, when we have an expansion of credit as large as ours over an extended period then a bubble is inevitable. And such an expansion will always occur when money is too cheap. Cheap money confuses, it distorts risk and our sense of return. It discombobulates every thing economic.
I am loathe to say it. I really am. I want there to be a solution. However I think that most of you reading this will have guessed my conclusion. As long as our economy is not in the same business cycle as Germany then we will have to endure bank rates that our not appropriate to this economy. It will always be an accident that what are the right interest rates for Germany will be the right ones for Ireland. I see no reason to believe that we will soon be able to be in cycle. In fact the danger is that next year higher inflationary pressure in Germany will lead to creeping increases in the base rate. At precisely the time we need a loose monetary policy the ECB is going to begin what may have to be a tightening process for a couple of years.
While we have been victims of some very bad government we are also victims of a currency which we cannot control – whose value and price is ditermined in Germany not here. An economy which is counter cyclical with its own currency is in trouble. We are in trouble. We have to find a way out.