Still Relying on Outsider’s Eyes
Writing in the Irish Independent today Brendan Keenan seemed to have an epiphany regarding Ireland’s deflation problem. He, like most Irish newspaper economic commentators considers the deflationary effects of the strategy to reduce spending, including public sector pay and pension provision as unimportant. In order to achieve this revelation, however, all he had to do was look through the eyes of someone who wasn’t examining the Irish economy while wearing ideological blinkers.
“The prominent British economics journalist I met last week was fascinated, not by the budget deficit we obsess about, but the deflation, which gets much less attention.
So I looked again at the published figures with a new eye, and, right enough, they are something to behold.”
Keenan’s moment of enlightenment allows him to expand on the recent CSO figures which show a 7.4% drop in real GDP compared with the same period in 2008, which drops to a nominal value of 10.4% when the fall in prices is taken into account. Looking at the contraction in terms of GDP or GNP he argues, the fall is either 10% in the case of former or 15% for the latter. Either one ‘suggest an economy in a state of collapse’.
However….
“… that is not quite the case, as financial markets have begun to acknowledge to some extent in recent months. It is not just that things have stabilised since last autumn. Even more curious is that such deflation has been welcomed in much Irish commentary on the economy.”
And so with “much Irish commentary on the economy” we are back to seeing things with Irish eyes, and a deflationary problem which is usually ignored by those who have an interest in doing so. What they are trying to avoid, of course, is to look at the situation in structural terms, one which describe how capital and political power go hand in hand to protect what they have.
So when Ex-IMF economist Simon Johnson, in May 2009 Atlantic article “The Quiet Coup“, said the following about the close connections between business elites and government in the economies that the IMF have to support, many people here took it as description of how things work in Ireland:
“The powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit-and, most of the time, genteel-oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon-correctly, in most cases-that their political connections will allow them to push onto the government any substantial problems that arise.”
Of course, one of Ireland’s archtypical “masters of their mini-universe” is, or was, Seanie FitzPatrick. But while his much anticipated ‘dawn’ arrest this morning illustrates the lengths the government is prepared to go to try and distance themselves from the characterization that Johnson makes, it doesn’t change the nature of that relationship. The fact that the same structural problems that precipitated the crisis are intact can be seen in the governments strategy of ‘resolving’ the banking crisis.
It’s kind of fun then that today in his Baseline Scenario blog Simon Johnson is casting his fresh non-Irish eye over the Irish government’s response to its financial crisis and pouring cold water on the idea that Ireland’s strategy is totally hot right now, at least from the point of view of the financial markets (although the EU commission would like it to be totally hotter).
Johnson warns unequivocally that Ireland is not a model for how Greece, or any other economy should behave.
“Ireland’s perceived “success” is partly due to its draconian fiscal cuts. The government has cut take home pay of public sector workers by roughly 20% since 2008 through lower wages, higher taxes, and increased pension payments. As the head of the National Treasury Management Agency John Corrigan proudly advised the Greeks (and everyone else): “You have to talk the talk and walk the walk”.
So is Ireland truly a model for Greece and other potential problems in Europe and elsewhere? Definitely not - but it does provide a cautionary tale regarding what could go wrong for all of us.”
Commenting on the government’s plan to converted the liabilities of private banks, amounting to potentially 80% of GDP in terms of bad debt, into debts of the Irish taxpayers he said that Ireland’s very low national debt before the crisis hid the “off-balance sheet liability”: basically, the “three huge banks that were seriously out of control.”
However, in resolving the problem with the banks the government chose an option that suited the cadre of masters of their mini-universes more than any one else.
As Johnson puts it:
“Ireland had more prudent choices. They could have avoided taking on private bank debts by forcing the creditors of these banks to share the burden - and this is now what some sensible voices within the main opposition party have called for. However, a strong lobby of real estate developers, the investors who bought the bank bonds, and politicians with links to the failed developments (and their bankers), have managed to ensure that taxpayers rather than creditors will pay. The government plan is - with good reason -highly unpopular, but the coalition of interests in its favor it strong enough to ensure that it will proceed.
Investors may wish to remain pleased today with Ireland, but Ireland’s “austerity” - reflecting an unwillingness to make creditors pay for their past mistakes - hardly seems a good lesson for Greece, the eurozone, or anyone else.”
My emphasis.
In his article today Brendan Keenan’s epiphany unfortunately fizzled out before he got to the end. One can only stand to look at a situation with someone else’s eyes for so long, I guess. Commenting on the disagreements between French Finance Minister Christine Lagarde and Germany’s Gerhard Schaeuble he concludes that there is not “much reward in being a flexible region of a monetary union if the union in question not only has no fiscal transfers, but little growth prospects either”.
Not much reward indeed, considering that notions of flexibility and that other canard ‘competitiveness‘ are chimeras, the mythical nature of which most Irish economic commentators simply fail to see (even if it is slowly dawning on Keenan that to make these adjustments will make little difference).
He lists the only ‘options’ open to the Irish economy as leaving the euro or following the current strategy of deflation:
“Leaving the single currency is not a practical proposition for a country with large debts, large government deficits and a balance of payments gap.
Managing the economy to maintain competitiveness against a basket of our trading currencies is only a little less impractical, but may at least be possible.”
Of course, we don’t need to rely on those looking at our economy from the outside to see what is going on even if people like Keenan do. And even when they do, they still don’t see it.
Discussion
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Comment by: CrisisMaven
Mar 18th 2010 at 21:03
This “fear of deflation” is largely nonsensical. Deflation does not keep people from spending – they always spend what’s necessary. And money NOT “spent” is then saved which means it is credit to someone who invests it for capital goods etc. thus it is again being spent, only not for consumption. Money never lies completely idle to any extent whether there’s inflation, deflation, stability or a solar eclipse. For deflation to seriously happen, not only the current extreme credit expansion by the central banks and states (through “quantitative easing”, stimulus packages, monetising and then spending national debt etc.) but also the money that was released into the economy PRIOR to the collapse would have to be “mopped up” again. This is nowhere to be seen nor would it be technically possible (confiscation aside) so we will rather see inflation than deflation.
Comment by: Hugh Green
Mar 19th 2010 at 12:03
Deflation does not keep people from spending – they always spend what’s necessary.
Necessary for what, precisely?
Comment by: Pope Epopt
Mar 19th 2010 at 17:03
Another gem from Johnson makes a vital point:
That we will be paying for banks’ private debts with cuts in public services - is a concept can’t be nailed to many times into FF/Green/ignorant journalistic heads too forcibly and too often. OK forget the FFers, but perhaps the others are amenable to reason.
Discussion over at irisheconomy.ie is interesting. Even within in the self-imposed dubious constraint of ’saving capitalism’, the bank guarantee could have been much more selective and banks could have been allowed to fail.
Finally, as Greg points out in that forum:
Comment by: CrisisMaven
Mar 19th 2010 at 20:03
Hi Hugh Green - people will still buy bread. Have they ever starved to death because bread could have been gotten cheaper tomorrow and they day after and so on? Who has not bought computers because, there’s no denying it, they steadily become cheaper? If a sales rep. needs a car is he going to wait till all customers have bought elsewhere or will he rather visit them while he can? Prices fluctuate and people know that. If they can wait to buy they sometimes wait. But never will falling prices bring a market to a standstill - there’s no historic precedent. And the Great Depression was so great because (amongst other things) politicians wrecked the division of labour by applying tariffs so that what was left in buying power went to states coffers etc. Here is my take on the matter: http://crisismaven.wordpress.com/2010/03/18/economic-fallacy-iii-looming-deflation/
Comment by: Mchael Burke
Mar 20th 2010 at 18:03
Deflation is a disaster for demand in two ways:
The prospect of price falls leads to the postponement of all purchases other than necessities. That applies to business as well as individuals so demand falls and investment plummets.
The reality of price falls increases the real level of all debts, for all sectors, individuals, companies and government. What the advocates of deflation here have failed to figure out is that the debt and the deficit wil actually worsen. The source of government revenue is taxtion. If all incomes have been deflated, so too wil the tax revenue from it, yet the level of debt will remain the same. An increased proportion of income (GDP) will therefore be required to service it; the real debt burden will have risen. The same pplies to the highly-indebted personal and corporate sectors.
The ‘policy’ would be laughable if it werent so deadly serious.
Comment by: CrisisMaven
Mar 21st 2010 at 01:03
Michael Burke: “prospect of price falls leads to the postponement of all purchases other than necessities” - that has NEVER been proven historically. AND it is not borne out by theory: Let’s see if “deflation” in the sense of FALLING prices tends to make people postpone their buying decisions (and hence bring the economy to a standstill). I flatly deny it, there seems not only to be no historic proof, with the exception of allegations, such as “had the Fed not let deflation happen, THEN the Great Depression could have been averted” etc. – that’s not proof, as we have no access to the “parallel universe” where just that countermeasure was taken to find out if the allegetion were true. But we have access to anecdotal evidence to the contrary: the computer industry has not deterred anyone from buying their product by constantly lowering prices AND even raising quality and functionality with each new model. Well, these are even TWO incentives to wait … forever (the same goes for automobiles – buyers should again wait forever since they can only become better!). But it never happened, in fact computer and related sales as a rule have always increased year over year. Of course some theorists will always argue why the computer industry is different from the yacht industry or bread manufacturing. That’s an easy escape route that defies any scientific reasoning, let the moon be of cheese. However, the exact same “theorists” lump yachts, bread, cheese and computers together in their macro-economic “aggregates” – they can’t have it both ways though. Similarly, in a housing market downturn, people keep buying all the time and if there is a certain reluctance it can more easily be attributed to general scarcity of credit and people feeling insecure rather than them waiting for “the best deal ever”. But there is another psychological moment at play: if you know Dutch auctions, where the auctioner doesn’t bid UP the price but begins with the highest price and every second goes down at a predefined interval until a hand goes up and the deal is closed, this is anecdotal “proof” that especially in an environment where prices fall people are tempted to buy at the EARLIEST possible moment before someone else takes advantage of the perceivedly low price! So price “deflation”, if anything, spurs sales! If bidders formed a cartel to wait as a crowd, granted, that could let prices fall forever. Instead they are independent competitors not knowing each others’ next moves! But you know what: IF prices were falling all the time, but sellers were convinced they would eventually rise again, the danger would come from the exact opposite faction: SELLERs would then be loth to sell, not buyers to buy! Equally, if the argument about “deflationary procrastination” held any water and if we do not resort to polylogism and e.g. racial differentiation arguing sellers are a different breed of people than buyers (anyhow, every seller in one market is a net buyer in another!) then if “DEflation” makes people wait to buy, INflation must make sellers wait to sell, as they’d be better off “selling tomorrow” rather than now! Either way an economy would grind to a complete halt while when prices are stable people would just sit on their hands to wait for future price moves in their predilected direction. All this is ivory tower pseudo-economics. Since under a stable money regime which was the rule under the gold standard, price “deflation” was an economic law since productivity gains would always, all other things being equal, drive down prices, and as people thrived under such circumstances I have yet to see unrefutable proof of how stable money bases with ensuing falling goods prices (as a tendency) would harm an economy rather than benefit it while money inflation always is harmful and even the worst inflators at the helm of central banks wouldn’t dispute it. So this “fear of deflation” is just a ruse by central banks to keep inflating the money supply. Deflation does not keep people from spending – they always spend what’s necessary to carry on in life. If money is NOT “spent” on consumption but saved it becomes credit to someone who invests it in capital goods etc. Thus it is again being spent this time to e.g. build a future factory. That saved money never lies completely idle (supposing it is not stuffed under a mattress). And the recent defaults have even had an INflationary effect since the money extended as credit is still with those who received it in payments; only if the debtors had NOT defaulted would the credit eventually be retired. See How Bank Robbers cause Inflation.
Comment by: Mchael Burke
Mar 21st 2010 at 19:03
CrisisMaven
The attempt to use Dutch auctions to negate the idea that falling prices lead to postponement of purchases is entirely false. Of course most auctions are conducted in the traditional manner, ie highest/last bidder wins. But even in a Dutch auction, everyone postpones the purchase at the higher prices, until just one buyer comes forward at the lower price. All the rest are still waiting for prices to fall.
Similarly, the anecdote about computer prices is also misplaced. Most potential puchasers are priced out of the market at the initial, higher prices. A far greater number of purcasers enter the market a the lower prices.
In hyperinflation, workers bought necessities at midday in order the ovecome the later price rises during the day. In deflation, workers postpone all but necessities (sometimes even then) as the value of their incomes (and savings) will rise over time. If the loaf of bread is going to be cheaper tomorow, if I can I will buy it tomorrow, not today.
The further point, that in a defatinary environment the existing level of debt will increase for all those with debts, individuals, corporates and government is also correct.
This has been the experience in Japan, and will be the experience in Ireland if the advocates of ‘competitive deflation’ have their wway.
Comment by: CrisisMaven
Mar 22nd 2010 at 10:03
Michael, you fail to address why sellers sell in spite of inflation. If you don’*t want to resort to polylogism then this refutes the argument that buyers don’t buy facing “de”flation.
Comment by: Mchael Burke
Mar 25th 2010 at 21:03
that’s easy crisismaven.
Sellers sell under inflation because they not only have profits, but super-profits, as the cost of their inputs was much lower than prevailing maket prices. And they can do it all again, as prices rise.
Bit like the housing bubble, which ought to be familiar.