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.