Archive for February, 2009

Burj Dubai: The Skyscraper as Economic Nexus & Leading Index

2009, February 22

[Remember all those Irish property expo shows for apartments in Turkey, Eastern Europe… Dubai? All emphases mine]

“The common pattern in these … historical episodes contain… the following features. First, a period of “easy money” leads to a rapid expansion of the economy and a boom in the stock market. In particular, the relatively easy availability of credit fuels a substantial increase in capital expenditures.
Capital expenditures flow in the direction of new technologies which in turn creates new industries and transforms some existing industries in terms of their structure and technology.”

“This is when the world’s tallest buildings are begun.”

“At some point thereafter negative information ignites panicky behavior in financial markets and there is a decline in the relative price of fixed capital goods. Finally, unemployment increases, particularly in capital and technology-intensive industries…”

In the twentieth century the skyscraper has replaced the factory and railroad, just as the information and service sectors have replaced heavy industry and manufacturing as the dominant sectors of the economy.”

The skyscraper is the critical nexus of the administration of modern global capitalism and commerce where decisions are made and transmitted throughout the capitalist system and where traders communicate and exchange information and goods, interconnecting with the telecommunications network. Therefore it should not be surprising that the skyscraper is an important manifestation of the twentieth-century business cycle, just as the canals, railroads, and factories were in previous times.” (Thornton – Ref. 3)


“A DISTINCTIVE FEATURE OF FLUCTUATiONS of both construction and real estate prices over the last 150 years in the United States, Great Britain, and other countries is the regularity of cycles of roughly 20 years… Clarence Long… observed that a decline in building precedes general business declines in major downturns… a phenomenon that has continued to the present day.”

“The United States has had a real estate cycle of roughly 18-year spans, starting as early as 1800, The peaks of the U,S. real estate cycles prior to World War II occurred in 1818, 1836, 1854, 1872, 1890, 1907, and 1925, Cycle bottoms occurred in 1819, 1843, 1858, 1875, 1894, 1908, and 1933… Upward movement in real estate prices persisted in 1819-1836,1860-72,1894-1907, and 1908-1925, Sharply falling real estate prices occurred in 1818-19,1837-1840,1857-59,1873-75,1892-94,1907- 08, and 1929-32… Detailed histories of these cycles are related in Hoyt (1933), Sakolski (1932), Hicks (1961), English and Cardiff (1979), and other works.”

“The congruence of the real estate and business cycles is seen clearly in the Great Depression and preceding 1920s boom. In 1920, the total value of U.S. urban land in cities of over 30,000 was $25 billion. By 1926, urban sites rose to over $50 billion… During 1925, $500 million of northern capital had poured into Florida real estate, where speculation was most extreme… In the fall of 1926, the Florida land boom collapsed. Construction in the cities continued with undiminished ardor during 1927-1928; from 1923 to 1929, the square feet of office space in Chicago almost doubled. So powerful was the 1920s boom and subsequent bust that no new office buildings were erected and no new large hotel was built in Chicago from 1931 to 1950…”

“If the production of capital goods, especially construction, was the key element of the “second derivative” of the 1920s boom, its decline after 1925 would eventually bring the first-derivative growth to a halt. The timing, in the midst of the boom, was right. Hansen (1964, p. 46) calls the drop in construction in 1928 “catastrophic,” and states, “No explanation of the boom of the twenties or the severity and duration of the depression of the thirties is adequate which leaves out of account the great expansion and contraction in building activity.” Hoyt (1970, p. 532) remarked that the increase in the number of foreclosures in 1927 “was a barometer of approaching financial storms…”

Land is essential for all production. In any particular economic region, the quantity of surface sites is fixed… When a boom is underway, the anticipated increase in rent induces speculators to buy land for price appreciation rather than for present use, which causes the current site value to rise above that warranted by present use. Once widespread speculation sets in, land values are carried beyond the point at which enterprises can make a profit after paying for rent or mortgages. The rate of increase of investment slows down, eventually reducing aggregate demand as the slowdown ripples through the economy, increasing unemployment and bringing forth a depression. Thus a fall in demand follows the initial cause, the rising cost of land…”

“Murray Rothbard (1975, p, 86) reports that the money supply of the United States increased by 62 percent during the 1920s boom. The major increases in credit expansion took place in 1922-25, Here again, the money and credit system, this time orchestrated by the new Federal Reserve System, fueled the speculation.”

– (Foldvary – Ref. 1)


“In the overheated speculation of the 1920s, as land prices rose, towers grew steadily taller. Or should the order be: as skyscrapers grew taller, land prices rose? The variables that contributed to real estate cycles were even more complex than this “chicken and egg” conundrum. (Willis 1995, p. 88)”

1818    —         LAND price peak
1819     —        BUST
-24         $    [recession: harvest & bank failures, widespread farm foreclosures]

~~~~~~~~~~~~~~~~

1836     (18)     LAND price peak
1836    —        CONSTRUCTION peak
1837     (18)     BUST
-43         $$$    [“Panic of 1837” American banks stop payment in precious metal – speculation markets greatly affected]

~~~~~~~~~~~~~~~~

1854     (18)     LAND price peak
1856     (20)     CONSTRUCTION peak
1857     (20)     BUST
–60          $    [recession triggered by Ohio Life Insurance & Trust Company bust, European bubble in US railroads]

~~~~~~~~~~~~~~~~

1871     (15)     CONSTRUCTION peak
1872     (18)     LAND price peak
1873     (16)     BUST
-79             $$$    [“Panic of 1873” largest bank in US fails, bursts post-Civil War speculative bubble]
$    [Coinage Act of 1873 demotes silver in favour of gold – effectively cuts credit of Western & rural populations]
-96             $    [“The Long Depression”]
~~~~~~~~
1890     (18)     LAND price peak
1892     (21)     CONSTRUCTION peak
1893     (20)     BUST
–96         $    [recession triggered by failure of US Reading Railroad & withdrawal of European investment]

~~~~~~~~~~~~~~~~

# = NEW RECORD for World’s tallest building.

1907     (17)     LAND price peak
$    [“Panic of 1907”, run on Knickerbocker Trust Company deposits]

# Singer Building    New York     (Completed)

1909     (17)     CONSTRUCTION peak

# Metropolitan Life    New York    (Completed)

# 1913         Woolworth         New York    (Completed)

$    Founding of Federal Reserve System:
“…The Panic of 1907… widely considered to be a key event in the passage of the Federal Reserve Act in 1913…”

1914-18             WWI

1918     (25)        BUST
–21         $    [severe hyperinflation in Europe,
rampant real estate speculation in Germany]
Depression         Jan 1920-Jul ’21

~~~~~~~~~~~~~~~~

Sharp Recession    May 1923-Jul ’24
1925     (18)     LAND price peak
(16)     CONSTRUCTION peak
Mild Recession     Oct 1926-Nov ’27
1929     (11)     BUST
-39         $$$    [stock markets crash worldwide, the Great Depression]
Depression        Aug 1929-Mar ’33

# 1929        40 Wall St         New York     (Completed)

# 1930        Chrysler Building    New York     (Completed)

# 1931        Empire State        New York     (Completed)

Depression        May 1937-Jun ’38
1939-45           WWII

~~~~~~~~~~~~~~~~

1947-91           Cold War
-51                [Marshall Plan]
Sharp Recession    Nov 1948-Oct ’49
Sharp Recession    Jul 1953-May ’54
1956                [Federal-Aid Highway Act – “Dwight D. Eisenhower National System of Interstate & Defense Highways”; construction absorbs more than half the world’s commodities in 1950’s. (Holmes, Ref. 4); The golden age of Suburbia & Los Angeles (designed for cars)]
Sharp Recession    Aug 1957-Apr ’58
Mild Recession    Apr 1960-Feb ’61
~~~~~~~~

1967-72            “An old-fashioned real-estate boom finally developed, especially for apartments, from 1967 to 1972, coinciding with increased inflation. Baby boomers increased the demand for rental housing. Prices of apartment buildings were rising faster than their rents, but ‘investors didn’t care . . . they were buying into the rental property market in order to speculate on future price increases’…
$    The Tax Reform Act of 1969 had made rental property more attractive. Tax shelters used negative cash flow as a tax advantage. Real estate became a favored hedge against increasing inflation, the stock market having topped out. ” (Foldvary)
Mild Recession    Dec 1969-Nov ’70
1972     (47)         CONSTRUCTION peak

# -73         World Trade Center    New York

$$$    Real Estate Investment Trust (REIT) assets grew from $2 billion in 1969 to $20 billion in 1973. Commercial bank mortgage loans increased from $66.7 billion in 1969 to $113.6 billion in 1973…” “Then vacancies began to increase. ‘With catastrophic swiftness, the money machine sputtered to a stop. The financial suptirstructure collapsed; the REIT industry faced bankruptcy’… “Interest rates were also increasing. Many REITs and developers went bankrupt. Apartment units begun dropped from their peak of 1,047,500 in 1972 to 268,300 in 1975…
‘More money may have been lost in the Apartment Crash than in any of the more celebrated crashes.
But it remains an unheralded financial crisis’ … It was the worst recession in the U.S. since the 1930s.” (Foldvary)
Sharp Recession    Nov 1973-Mar ’75
Ben Bernanke (2003): “… the deep 1973–75 recession was caused only in part by increases in oil prices per se. An equally important source of the recession was several years of overexpansionary monetary policy that squandered the Fed’s credibility regarding inflation… ”
1973     (48)      LAND price peak
(44)      BUST

# 1974        Sears Tower        Chicago     (Completed)

US Population growth rate & Wholesale Price Peak (Long-Wave IV): “Baby Boomers”

~~~~~~~~~~~~~~~~

1978     (6)         CONSTRUCTION peak
1979     (6)         LAND price peak
1980     (7)         BUST
Mild Recession    Jan 1980-Jul ’80
Sharp Recession  Jul 1981-Nov ’82
-94        $     [Cheney: “Reagan proved that deficits don’t matter”]
[1,600+ banks insured by FDIC closed or received financial assistance. L. William Seidman, former chairman of both the FDIC and the Resolution Trust Corporation: “The banking problems of the ’80s and ’90s came primarily, but not exclusively, from unsound real estate lending.”]

~~~~~~~~~~~~~~~~

1986     (8)        CONSTRUCTION peak
$    [Tax Reform Act removes many tax shelters for real estate investments.]
-89             [FSLIC closed or otherwise resolved 296 institutions with total assets of $125 billion.]
-95            [number of US federally insured S&L’s in the US declined from 3,234 to 1,645;
primarily due to unsound real estate lending.]
1987             $$$    [Oct 19 Black Friday Stockmarket Crash worldwide]
1989     (10)     LAND price peak
-95             [Resolution Trust Corporation agency resolution of an additional 747 thrift banks.]
1990     (10)     BUST
Mild Recession    Jul 1990-Mar ’91
[Douglas Coupland’s “Generation X” in their 20’s, originally referred to as the “baby bust” generation]
1986-1991      [number of new homes constructed dropped from 1.8 to 1 million; lowest rate since WWII.]

~~~~~~~~~~~~~~~~

1989-91           [End of Cold War: Fall of Berlin Wall, collapse of Soviet Union & Comecon network;
Former Soviet populations and resources now accessible – Fukuyama’s “End of History” & rise of global – IMF enforced – neoliberalism]
[1991-present: Al Gore invents Internet (!); rise of World Wide Web, cybernetic Information Technology networks]
$    [1995–Mar 2000 Dotcom & Information Technology Bubble – Newt Gingrich invents “Information Superhighway” (!), & NAFTA – puts Contract on America]
1993-96          $    [Foreign debt-to-GDP ratios rise from 100% to 167% in the four large ASEAN economies.]

# 1997         Petronas Tower    Kuala Lumpur    (Completed)    “Asian Contagion”/”Asian Flu”

-98         $    [Thai government floats the baht, cuts peg to USD, after exhaustive efforts to support it;
foreign debt-to-GDP ratios beyond 180%; severe financial overextension part real estate driven; Russian Government default on government bonds; Long Term Capital Management loses $4.6 billion in less than four months, almost crashes system]

~~~~~~~~~~~~~~~~

2000             $    [March, Dotcom crash]
2001                 [June 13, Taipei 101  “topped out.”]
# 2004        Taipei 101    Republic of China/Taiwan    (Completed)
[Burj Dubai – Construction start]
2005                [China uses half of world’s cement and 40 percent of world’s steel (Holmes, Ref. 4)]
2006                [China plans to build 14 express highways, six railways and a dozen new seaport facilities before 2010; energy consumption expected to be 69 percent higher in 2010 than in 2002, according to the FEIA; growth rate 5X US, >15X Europe; India invests 3.5% GDP on power plants, roads and other infrastructure, financing “industrial townships” (Holmes, Ref. 4)]
2006     (17)     LAND price peak
2006     (20)     CONSTRUCTION peak
2007             [“subprime mortgage financial crisis”]
2008                [Sep 1: Burj Dubai is tallest structure ever built.]
2008!     (18)    BUST
$$$ [The Crisis of 2008-20??]
2009                [Jan 17: Burj Dubai “tops out” at 818 m – half a mile]
# 2009         Burj Dubai     Dubai     [September-December, estimated completion date!]

# 2012         Shanghai     China     [estimated completion date as of 2005]

“In the overheated speculation of the 1920s, as land prices rose, towers grew steadily taller. Or should the order be: as skyscrapers grew taller, land prices rose?

“The common pattern in these … historical episodes contain… First, a period of “easy money”…

“…the money supply of the United States increased by 62 percent during the 1920s boom. The major increases in credit expansion took place in 1922-25, Here again, the money and credit system, this time orchestrated by the new Federal Reserve System, fueled the speculation.”


[A note on Ireland and the Crisis… if I remember correctly, there were plans by Sean Dunlop to build a skyscraper in D4 not so long ago? How’s that U2 tower going?]

“In a way, Ireland offers a lesson in how not to handle your newfound riches. Alan Ahearne, an economist at the National University of Ireland in Galway, worked for the U.S. Federal Reserve. When he came back to Ireland in 2005, he was unnerved. House prices had rocketed, outpacing incomes and rents [Remember US Apartment Crash of 1973: “worst recession in the U.S. since the 1930s”]. In 2006, the census found more than 250,000 empty properties, in a country with a population of just over four million. Many were investments their owners didn’t bother renting out, so good were the gains from rising prices. “That, to me, was a scary sign,” Mr. Ahearne said.

Ireland’s membership in the euro zone brought benefits, but also hazards. Low interest rates brought a flood of credit, which the Irish put to work buying homes.

The period of low rates was “fine for the German economy, which was very weak at the time, but it wasn’t for the Irish economy, which was very strong,” says Mr. Ahearne. To regain its footing, he says, Ireland will face painful “real devaluation” — falling wages and prices that bring the living standard down.”

http://online.wsj.com/article_email/SB123397193880159399.html

Wall Street Journal, FEBRUARY 7, 2009, Ireland’s Boom Falls Hard in Global Crisis, By CHARLES FORELLE


https://eriugenasnotes.wordpress.com

Other references:
http://www.wikipedia.org
(1) “The Business Cycle: A Georgist-Austrian Synthesis”, Fred Foldvary (Economist, Santa Clara University), American Journal of Economics and Sociology, Vol. 56, No. 4 (October, 1977).
http://www.findarticles.com/p/articles/mi_m0254/is_n4_v56/ai_20381871
http://www.foldvary.net/works/cycle.html
(2) The Concise Encyclopedia of Economics
Recessions
by Geoffrey H. Moore
http://www.econlib.org/library/Enc1/Recessions.html
SOURCE: Based on table A-2 in G. H. Moore, Business Cycles, Inflation and Forecasting, 2nd ed., 1983. Note that the brief and mild recession of 1945 is omitted here.
(3) “Sky Scrapers and Business Cycles”, Mark Thornton,  The Quarterly Journal of Austrian Economics, Vol. 8, No. 1 (Spring 2005), 51-74.
http://www.mises.org/journals/qjae/pdf/qjae8_1_4.pdf
(4) The Rise of the Chinese Consumer
By Frank E. Holmes
July 12, 2006
http://www.kitco.com/ind/Holmes/jul122006.html

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Total Fiat Money (& Credit) Deflation Model – Mish

2009, February 22

Mike “Mish” Shedlock (Sitka Pacific), Global Economic Trend Analysis:

I don’t agree with some of his attitudes – for example: “Fiat Money” is backed not by a physical commodity, but by trust – one of the most precious forms of social capital, foundational to all human relationships and behaviour. “My word is my bond” is not backed by a physical commodity, but by trust – that hardly means it’s not worth anything. The fact that the States of Weimar and Zimbabwe betrayed that pooled trust, is symptomatic of a complete bankruptcy (literal and figurative) of trust and the social contract or order in those states. A kind of bizarro mirror-image is Kim Jing Il’s refusal to let his subjects use “fiat” (or any other) money until recently – a totalitarian, sociopathic Scrooge McDuck’s hoarding of all trust and exchange to himself.

I think that money is a measure, a bit like inches – a meter would still be a meter even if that rod in Paris was not there to physically back it. Money is a relative measure of all other goods that operates more like a daily index or telephone exchange that transmits messages. I can see how the system can be rigged and devalued, but don’t see that it’s value needs to derive from only one physical good.

The attraction I see with gold is that it has no counterparty risk: it’s unforgeable and limited, though fungible, so the social value derives from the trust itself derived from gold always being gold, and being limited as is trust, but also being transferable and dividable.

But I think the following is a really clear and succinct summary of what is happening – something absolutely missing from all the talking heads. He puts into relatively rigorous and logical terms that metaphor of the growing pile of money the banks are storing in case they need to plug those growing “black holes” of collapsing credit. It is also a useful way to navigate all the different definitions of inflation and deflation, and their resultingly different conclusions, I think:

Fiat World Mathematical Model

Fm = Fb + MV(Fc)

Fm = Fiat Money Total
Fb = Fiat Monetary Base
Fc = Fiat Credit, the amount of credit on the balances sheets of institutions in excess of Fb

MV(Fc) is the market value Fc

Inflation is an expansion of Fm
Deflation is a contraction of Fm

If only base money was lent out (no fractional reserve lending), MV(Fc) would equal zero. The equation ensures we do not double count credit in Fm.

MV is a function of time preference and credit sentiment (ie. Belief that one can be paid back). As long as that belief was high, banks were willing to lend.

Because (at the moment) Fc (credit) dwarfs Fb (base money), the system can only hold together as long as there is belief credit can be paid back and as long as there are not defaults. Needless to say, the perceived belief that Fc can be paid back is under attack, both by rising defaults, and by sentiment. That is why MV(Fc) is collapsing.

In other words, the mark to market value of credit is contracting faster than base money is rising.

See also:

“SGS M3 Continuation” – John Williams

2009, February 18

John Williams, Shadow Government Statistics:

http://www.shadowstats.com/alternate_data

SGS M3 Continuation: shadowstats.com

SGS M3 Continuation: shadowstats.com

SGS Consumer Price Index continuation: shadowstats.com

SGS Consumer Price Index continuation: shadowstats.com

SGS GDP continuation: shadowstats.com

SGS GDP continuation: shadowstats.com

SGS alternate employment data

SGS alternate employment data

“M Prime” (M’) – Mike “Mish” Shedlock

2009, February 18

TMS: A Truer Money Supply?

http://globaleconomicanalysis.blogspot.com/2008/07/tms-truer-money-supply.html

M Prime

Using Shostak’s definition and with much charting help from Bart at Now and Futures, I came up with M Prime (M’), arguably what TMS is supposed to be. For more details on the origin of M’, please see Money Supply and Recessions.

M Prime 1968 To Present

M' (M Prime) 1968-2008, with percentage changes

M' (M Prime) 1968-2008, with percentage changes

M’ dips below 2.5% or so are a strong signal of recession.

M Prime vs. TMS

As for measuring inflation or deflation, I do not think any of them will suffice for the simple reason that credit marked to market is plunging and that is the way things need to be looked at. Unfortunately, there is no accurate measure of the plunge in credit because financial institutions are not marking credit to market. Instead much credit is still in SIVs and/or hidden in Level 3 (marked to fantasy) assets.

… That is on top of the distortion I mentioned earlier in that M3 and MZM are expanding because credit lines are being tapped and parked in money market funds.

Judging from collapsing real estate, people walking away from homes, risk aversion sinking in, and banks unwillingness to lend, together with the idea that credit that should be marked to market isn’t, I believe we are in deflation, right here right now. Those focused on M3 or energy and food prices are truly missing the boat. Trillions of dollars of destruction in housing wealth (with much more coming) and another trillion markdown in bank credit coming (on top of what we have already seen) are far more important and far more representative of the state of affairs than is M3, or any other monetary aggregate for that matter.

M' (M Prime) versus TMS, 1968-2008

M' (M Prime) versus TMS, 1968-2008

Is Big Inflation Coming?

…a perfect 15 out of 15 conditions experienced in the great depression are happening today as discussed in Humpty Dumpty On Inflation.

Of course Humpty Dumpty can and does pretend that deflation is specifically about money supply, totally ignoring credit. And those same Humpty Dumpties were amazed by the collapse in commodities and were crushed shorting treasuries because they did not see this coming.

“Actual Money Supply” – Paul Van Eeden

2009, February 18

http://www.paulvaneeden.com/Actual.Money.Supply

PaulVanEeden.com: "Actual Money Supply"
PaulVanEeden.com: “Actual Money Supply”

PaulVanEeden.com: AMS comparison

PaulVanEeden.com: AMS comparison


PaulVanEeden.com: AMS historical

PaulVanEeden.com: AMS historical

“True Money Supply” – Rothbard

2009, February 18

Ludwig von Mises Institute · 518 West Magnolia Avenue · Auburn, Alabama

http://mises.org/content/nofed/chart.aspx?series=TMS 

Series: True Money Supply, MZM Money Stock, M1 Money Stock, M2 Money Stock, M3 Money Stock

" True Money Supply" 09-02-17

" True Money Supply" 09-02-17

The True Money Supply (TMS) was formulated by Murray Rothbard and represents the amount of money in the economy that is available for immediate use in exchange. It has been referred to in the past as the Austrian Money Supply, the Rothbard Money Supply and the True Money Supply. The benefits of TMS over conventional measures calculated by the Federal Reserve are that it counts only immediately available money for exchange and does not double count. MMMF shares are excluded from TMS precisely because they represent equity shares in a portfolio of highly liquid, short-term investments which must be sold in exchange for money before such shares can be redeemed. For a detailed description and explanation of the TMS aggregate, see Salerno (1987) and Shostak (2000). The TMS consists of the following: Currency Component of M1, Total Checkable Deposits, Savings Deposits, U.S. Government Demand Deposits and Note Balances, Demand Deposits Due to Foreign Commercial Banks, and Demand Deposits Due to Foreign Official Institutions.

Ireland can easily see off the Euro-bullies

2009, February 17

1. “France, Germany and Britain still dominate the European Union and want to continue to do so…  “People fear more of this power management””;
2. “Ireland’s membership in the euro zone brought benefits, but also hazards”;
3. “Ireland can easily see off the Euro-bullies… Ireland has “nothing to fear except fear itself””;


(1.)

http://www.nytimes.com/2009/02/14/world/europe/14union.html?_r=1&emc=eta1&pagewanted=all

New York Times
Diplomatic Memo
Impairing Europe, Gibe by Gibe
By STEVEN ERLANGER
February 13, 2009

“France, Germany and Britain still dominate the European Union and want to continue to do so, said Alexandr Vondra, the Czech deputy prime minister for European affairs. “Occasionally they consult others,” he said, “but of course the people of small countries know this, and that’s why there is hesitation about the Lisbon Treaty,” which would create a permanent European president and foreign minister, and which the Irish have rejected and the Czechs have not yet ratified. “People fear more of this power management.””


(2.)

http://online.wsj.com/article_email/SB123397193880159399.html
http://s.wsj.net/public/resources/images/NA-AV770_WIRELA_NS_20090206204858.gif

Wall Street Journal
FEBRUARY 7, 2009
Ireland’s Boom Falls Hard in Global Crisis
As Overheated Property Market Crumbles, Even Guinness Beer Feels the Pain as
Brewery Plans Are Put on Hold
By CHARLES FORELLE

“In a way, Ireland offers a lesson in how not to handle your newfound riches.

Alan Ahearne, an economist at the National University of Ireland in Galway, worked for the U.S. Federal Reserve. When he came back to Ireland in 2005, he was unnerved. House prices had rocketed, outpacing incomes and rents. In 2006, the census found more than 250,000 empty properties, in a country with a population of just over four million. Many were investments their owners didn’t bother renting out, so good were the gains from rising prices. “That, to me, was a scary sign,” Mr. Ahearne said.

Ireland’s membership in the euro zone brought benefits, but also hazards. Low interest rates brought a flood of credit, which the Irish put to work buying homes.

The period of low rates was “fine for the German economy, which was very weak at the time, but it wasn’t for the Irish economy, which was very strong,” says Mr. Ahearne. To regain its footing, he says, Ireland will face painful “real devaluation” — falling wages and prices that bring the living standard down.”


(3.)

Lombard Street Research • Daily Note •
www.lombardstreetresearch.com
Daily Note: 6 February 2009
Ireland can easily see off the euro-bullies

WE SUGGEST: Large government bond spread is a buying opportunity
SUMMARY: Ireland can absorb any losses in its financial system, and a major recession, and remain enviably richer than Britain, Germany and France, with good long-term growth prospects. In the worst economic and financial scenario its net government debt will be far lower. Commentariat hysteria is a buying opportunity.

A lot of attention has been paid to Irish financial and economic problems recently. The north-central Europe free-riders on other countries’ domestic demand are smug about the temporary difficulties of the more dynamic spender economies. (The crash in German and Benelux GDPs following that of their exports may soon make them wring their hands, though, dependent as they are for exports, and therefore output and income, upon deficit country borrowing.) Much the same people are determined to punish Ireland for rejecting the latest version of the European Constitution in a referendum. Their hope is that financial stress will force Ireland to seek help from fellow EMU members – read “Germany, France and Benelux” – for which the condition will be another referendum pronto, the assumption being that an Irish populace cowed by strong recession will cave in and approve it.

Irish debt is low, income high
[…]

In reality, Ireland has “nothing to fear except fear itself”. Its income far exceeds European norms, as our chart shows. It is a small, service-based economy with a substantial migrant element in the labour force, mostly from CEE members of the EU. Prime Minister Cowen recently said real GDP would fall 10% over three years. My colleagues praised him for not covering up, unlike most politicians. But perhaps he did. Maybe, Irish real GDP will fall 15-20%. If so, many of the migrant workers will go home, per capita income will fall by less, and remain enviably ahead of Britain, Germany and France. Much the same happened in 1975 in Switzerland, when real GDP plunged and unemployment rose from under 100 to about 30,000, a minimal 1% of its labour force. In a small flexible service economy, with a small public sector, incomes can much more readily be lowered than in large, bureaucratic economies like most European countries. And the basic Irish long-term growth potential remains intact: ready access to relatively unlimited labour, capital and land.

And the financial problem? Ireland has virtually no net government debt. Its broad money supply is about 130% of GDP. Suppose the financial sector needs to be recapitalised at 20% of this balance sheet (an extreme assumption). Then Irish gross debt might rise by 26% of GDP, reaching the British level and remaining somewhat lower than Germany and France. Its net debt would rise by less, depending on the actual losses emerging, and would remain well below most other countries’, including all the major Europeans. Meanwhile, the widening of government bond spreads against German bunds must be seen against the falling absolute level of the latter. Current Irish 10-year yields are an affordable 51/2%. Ireland certainly stored up trouble for itself by adopting the euro and making itself vulnerable to the drop in sterling that has actually happened. The case for currency linkage to a major neighbour is understandable for a small economy, but the logical link is to Ireland’s largest trading partner, the UK, or its second largest, the US. But other countries should envy Ireland its problems, and the EMU panjandrums should switch their attention to the economic disaster that is developing amongst the Mediterranean members of EMU.

-Charles Dumas