30.3.09

Where is the Irish Economy going? Off a cliff



Last week, it was reported that the Irish economy experienced a 7.5 % contraction in GDP in the last quarter of 2008. The situation has more than likely deteriorated further in the first quarter of 2009.

Government tax receipts have experienced a similar contraction, with the government now expected to only collect €34 billion, a shortfall of €24 billion against the November Budget forecasts.

In response, the government will hold a "mini Budget" on April 6th. This Budget aims to reduce this shortfall by increasing the government's taxation take. Such steps should reduce the level and the cost of Irish government borrowing.

However, by sucking money out of the economy the government will hasten the deterioration of the economy as demand for goods and services will only reduce further, causing businesses to close and create even more unemployment. As a consequence, the economy will become deflationary.

Deflation is a very dangerous economic condition in any country, but especially when her citizens are not only crushed and cumbered with debt but are in severe negative equity on the assets which they borrowed for.

In the early 90's, Japan's economy experienced these very symptoms. Japanese consumers had borrowed and borrowed during the late 80's causing massive increases of commercial and residential property valuations. For example, real estate in Tokyo sold for as much as $139,000 a square foot—more than 350 times as much as property in Manhattan.

When, the bubble burst the value of these properties fell by as much as 87%. In response, Japanese consumers stopped borrowing money from banks. Investing in new businesses or buying new electrical goods fell dramatically. Instead, consumers just paid back debt. The Japanese paid back debt until their liabilities equaled their assets. This process lasted about 10 years.

According to Richard Koo of Nomura, the Japanese experienced "the largest loss of wealth in human history during peace time." Yet, the highest rate of unemployment during this "lost decade" was only 5.5%. This was achieved by the government filling the gap created by the absence of the private sector by borrowing the money that the private was unwilling to borrow.

Yet, in Ireland we are going to the exact opposite. The government will not borrow more money, but instead will introduce a monetary contraction policy, despite the lessons of Japanese.

This is suicide, as the only result will be further reductions of GDP and more and more unemployment.

24.3.09

Monetary Expansion & Monetary Contraction

In the aftermath of the great depression, Mr Hoover wrote a letter to the president elect, Franklin D Roosevelt. In the letter Hoover informed Roosevelt that "it would steady the country greatly if there could be prompt assurance that there will be no tampering or inflation of the currency; that the budget will be unquestionably balanced even if further taxation is necessary; that the government credit will be maintained by refusal to exhaust it in issue of securities"

This policy of Hoover was essentially a rejection of the tools of fiscal and monetary policy that were at his disposal. These tools could of limited and reduced the effects of the Wall Street Crash. As a consequence America sled into a very significant deflationary spiral between 1930-1933.

Ben Bernake, the present chairman of the federal reserve has studied the Great Depression with great depth. One of the main conclusions of his studies, is that this deflationary spiral could of been avoided if the Federal Reserve had not caused a contraction of the money supply. Such a contraction is known as monetary contraction

However, there are some very real dangers of implementing a policy of monetary expansion, the opposite of monetary contraction.

If monetary expansion is two aggressive, this will result in significant inflation. Very strong inflation will destroy people's saving and pension funds, place upward pressure on prices and result in social upheaval. Yet, very strong will inflation would have the positive effect of eroding the real value of debt and liberating the borrower from his repayments. Though such inflation could be seen as a reward for reckless borrowing and raises some questions in relation to moral hazard.

Therefore, a policy of expansionary expansion is as dangerous as a policy of monetary contraction as it can destabilize an economy even further, damage consumer sentiment delay any upturn. Thus, an equilibrium must be found between each policy.

1.3.09

Snow Day!!!!