Strange days indeed

We’re living through very strange times. Times when it’s a good thing that only 46 per cent of the Austrian electorate voted for a neo-Nazi to become their president. Thankfully he lost, but only marginally.

Times when fairly sensible constitutional reforms to improve the stability of Italy’s governance system get rejected and immediately throw the Italian banking system, with its €360 billion-worth of non-performing loans, into crisis.

Times when the European Central Bank (ECB) boss Mario Draghi’s decision to only buy the pittance of €60 billion of bonds per month instead of €80 billion in a ‘trimming’ exercise causes the markets to have a conniption.

Times when the 2017 French presidential election will be framed as a contest between Marine Le Pen of the Front Nationale, a hard-right ultra nationalist candidate, and François Fillon, a hard-right neoconservative candidate. Whoever the Socialists choose will be decimated, thanks to François Hollande’s tenure in the Elysée Palace.

Times when Angela Merkel, who allowed more than one million refugees into Germany in under two years to save their lives, needs to kowtow to interests in her own party to stay in power, and starts ranting about appropriate burka policies in supposedly liberal Germany.

Times when a racist, misogynist, lying, nativist demagogue like US president-elect Donald Trump can appoint climate change deniers to the US Environmental Protection Agency and union-busting burger magnates to the Department of Labor, even as the unemployment rate in the US falls to its lowest level since 2006.

Trump will preside over the first US economy since World War II where the average person born in the 1980s has less than a 50 per cent chance of earning the same or more as their parents. Think about that and apply it to your own situation.

Do you expect to earn more than your parents? For most people in Ireland, I think the answer would still be yes. What would it mean for your life, and your expectations for your children, if you didn’t expect to earn more than your parents did?

The ECB last week forecast global economic activity to continue to strengthen, although remaining below its pre-crisis pace. It’s important to stress just how sluggish the international economy is. A recent study on global growth by the ECB found the growth of imports since 2012 has been half of what it was between 1980 and 2008.

We are living through the longest period of below-trend growth in almost half a century, for both advanced and developing economies. One reason for this below-trend growth is the sputtering Chinese economy, which since the 1990s was hoovering up imports of every commodity and service imaginable as it grew.

There’s a problem: prices in China have fallen every year since 2012. No boom here. As China switches slowly from investment-led growth to consumption-led growth, because it has a middle class now, commodity exporters outside China have seen demand for their stuff hit the floor.

Mario Draghi, president of the European Central Bank, addresses the media in Frankfurt last week Picture: Getty

This collapse in demand has geopolitical implications. Countries like Venezuela and Nigeria are deeply dependent on just a few commodities to export. Without buoyant demand for oil, gas, copper and coal, they get mired in recessions and depressions. These recessions have real human consequences, as we in Ireland know.

Venezuela, for example, is currently going through a crisis which makes Ireland’s troika bailout look like a chat over coffee slices in the Shelbourne Hotel. People are unable to find work, food, or shelter, the government is in crisis, and inflation is out of control. Consumer prices in the country have increased 180 per cent year-on-year, and piracy has returned as a real problem.

Another reason for the collapse of global trade is the European Union. Since 2008, austerity and poor crisis management meant that demand for goods and services has been much lower than it should have been. If demand is low, then employment will be low. As we know, long spells of unemployment cause social, economic, and political problems.

Domestic demand in the eurozone was around 1 per cent lower in the second quarter of 2016 than it had been in the first quarter of 2008. The US economy from 2008 to 2016 managed to increase demand by about 23 per cent – which explains why president-elect Donald Trump inherits an economy with low unemployment.

In the eurozone from 2008 to 2016 we managed to increase demand by just 7 per cent. We should have been able to do better. But we didn’t, and the result is mass unemployment and mass youth unemployment in Greece (50 per cent), Spain (48 per cent), and Italy (40 per cent).

Which brings me back to Italy, and its shuddering banking system. Banks are basically balance sheet management systems. We should remember that for a bank, its assets, the things it owns, are its loans and the bonds and cash it holds. The bank’s liabilities, the things it owes, are its deposits and the bonds it has issued to balance the books. A very large bank’s balance sheet is highly sensitive to the economy it operates in.

Say the bank has one mortgage and one deposit. If the price of the house linked to the mortgage falls, the value of the bank’s balance sheet goes down. Even worse, if the person paying the mortgage loses their job and has to default, then the bank has to eat into its equity — the difference between its assets and its liabilities — to cover the losses. If it can’t do that, the bank will need a bailout from the taxpayer or to be wound up.

The Italian banks are stuffed full of non-performing loans. Estimates range from €300 billion to €400 billion.

The era of globalisation we have enjoyed since the 1970s may well be ending

The largest immediate problem is the third-largest bank, Monte dei Paschi di Siena (MDS). It requires €5 billion in recapitalisation funds from the private sector and probably some funds from the European Stability Mechanism, sooner rather than later.

Whatever problems MDS has internally, it shares the same underlying macroeconomic problem with all of Italy’s banks. Without sustained economic growth, loans will continue to either default or scrape by. You can’t heal the balance sheets of a banking system unless the economy is getting stronger. Which it won’t do without significant reforms. The best chance for those reforms went out the window along with Matteo Renzi’s political career.

Italy’s banks are too big to fail, for a few reasons. Size-wise, the banks are about one fifth of Italy’s GDP. They are highly connected, so letting one get into trouble damages other, potentially healthy banks. The ‘bondholders’ of the banks aren’t the typical large international institutional investor. They are ordinary Italian citizens who now own something like €200 billion-worth of bank bonds. Defaulting on them would be like the Irish government defaulting on Prize Bonds.

The likelihood is that European cash will be found to help the injured banks limp along, but this just delays the inevitable. Meanwhile, other tensions increase.

It is fascinating to note that Renzi is the 41st prime minister of Italy since 1946, and the fifth since 2008.

Italy is the only eurozone country whose GDP has not recovered after the crisis. Youth unemployment and Europe’s migration crisis have hit it hard. Yet the amount of net public investment in its crumbling infrastructure has been either zero or slightly negative for decades.

It is not surprising, then, that the world values survey finds the share of the population who “believe it is a good thing to have a strong leader without elections or parliament” is rising.

Faced with either institutional paralysis and democratically elected politicians simply ‘ruling a void’, to use the political scientist Peter Mair’s notable phrase, the average person says no thanks.

Either people disengage politically, or when asked, people use their vote to bring in a strongman character who makes unobtainable populist promises to take power, which, results in corrupting the system further. The model here is not Donald Trump but Silvio Berlusconi, the architect of many of Italy’s current woes.

The era of globalisation we have enjoyed since the 1970s may well be coming to an end. As we’ve talked about in this column many times, economic policy failure always ends up becoming a political problem in the end. So the failure to cope adequately with the global financial crisis of 2008 created many of the problems we have today. Ireland is not insulated from, or immune to, these problems, and a return to re-nationalisation driven by these large forces would hurt us all the more.

Strange times indeed.

Will robots eat your job? @ryanavent's snapshot of a global economy in flux

Review of 'The Wealth of Humans', By Ryan Avent, Penguin, €19

Will robots eat your job? Will your kids have higher standards of living than you, in an age where there are too many workers and too much savings, when technological change makes the jobs many people do obsolete? When their citizens see their jobs disappearing due to international competition or technological change, how will politicians react? Will we see an increase in globalisation or a series of Brexits to re-nationalise the global economy?

Ryan Avent’s new book The Wealth of Humans takes us through the arguments around the digital revolution, the development of the world economy and the very notion of work and wealth in a new post-scarcity age.

Continue reading "Will robots eat your job? @ryanavent's snapshot of a global economy in flux"

A witty history of crisis in the Square Mile

Catastrophes need causality. We even call earthquakes acts of God. There’s something about us that needs to find the whys and the hows of the bad things that happen to us. This is common sense, as we’d like to avoid another catastrophe, if we can.

When it comes to financial catastrophes, it turns out we can’t avoid them, and we can’t quite figure out what causes them. Crash Bang Wallop is the latest in a series of books looking at the recent financial crisis through the lens of history. In this case, the subject under review is the history of the Square Mile of the City of London.

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Letter to NY Times

Sir, I read with interest Prof. Hans-Werner Sinn’s assertion (“Why Greece Should Leave theEurozone”, July 24, 2015) that Ireland’s austerity effectively ended in 2010. As an Irish citizen and an economist I can tell you it didn’t. Dr. Sinn says the bubble burst in 2006, it was 2007. Dr. Sinn says no fiscal rescue was available—there was, but it wasn’t enough. Irish debt relative to GDP went from about 35% in 2006 to about 124% in 2013. Dr. Sinn says Irish wages fell drastically. Not so. According to Ireland’s Earnings, Hours and Employment Costs Survey, private sector wages fell by about 4% while public sector wages fell by about 3% over the crissis. Not nothing, but hardly a drop justifying the term ‘drastic’. What actually happened was employers reduced their wage bills by reducing employment and average hours worked per employee. This is important because what is really going on in the Irish economy is a Keynesian adjustment in quantity of labour and not a neoclassical wage-rate adjustment, implying the ‘cure’ for Ireland’s problems was not so much a supply-side set of ‘reforms’ but a (an?) increase in demand, first from the rest of the world thanks to Ireland’s remarkable openness as an economy, and then from a demand response following the end of austerity in 2013--not 2010. The Greek economy is nowhere near as open as the Irish economy, and, as measured by the cyclically adjusted structural balance, has already endured more than double the amount of austerity than Ireland. The Irish story isn’t a price adjustment, it’s a quantity adjustment. Dr. Sinn gets the most important part of his diagnosis wrong. His prescription is likely to kill the Greek patient. I’m not calling him a quack but if it walks like a duck, etc.

Published in the NYT on the 11th of August.