The problem with the bailout of Ireland is that the EU and the IMF are effectively saying to the markets – You are wrong. The markets have concluded that Ireland is a risky bet, and will only lend to the government at rates that would make the cost of servicing debt unbearable. So the EU and the IMF, and good old Blighty and Sweden, go to the markets to borrow money at a lower interest rate and then lend it back to Ireland at a slightly higher rate. So, in theory, the UK, along with all the other creditors, makes a profit.
It is just that if it is that good a deal, why don’t the markets go out and do the same?
So, George Osborne says: “Don’t worry, we will get our money back.” But if making money was that easy, we would all be doing it. Those of us with a good enough credit status could trundle down to the bank, top up our mortgage at one or two per cent interest, and lend the money to Ireland at five per cent. We don’t do that, for the same reason the markets don’t do that, or at least do something similar. Unlike Goodtime George, we have a gut instinct which is telling us that we can by no means be sure Ireland will indeed be able to repay its loan.
But Georgy Boy, along with his fellow finance ministers, can do one thing we can’t do. If Ireland gets into trouble again, and horror of horror struggles once again to repay its debts, then the UK government, along with the rest of the motley crew, can lend it more money.
Of course, it is a technique that a certain late Charles Ponzi, or indeed a certain Mr Bernard Madoff, would be all too familiar with, but what are the alternatives?
If they let Ireland go, many of our banks will follow, including no doubt RBS, and for that matter so perhaps will go one of our biggest export markets. Go down the drain, that is.
So, don’t be fooled into thinking the latest money being handed out to Ireland is a prudent safe bet. It’s a desperate act, implemented only because George and Christine (Lagarde) and Wolfgang (Schauble) are terrified of the alternative.
They see the bailout as the lesser of two evils.
But are they really right?
The big fear of course is not so much that the contagion will spread to Portugal; the EU can just about cope ad infinitum with lending money to Ireland, Greece and Portugal to pay off the money it lent previously. But if Spain gets caught up in it all, well now, that would be a different matter entirely.
So, how likely is this?
Today we are peeking beneath the surface, to try and work out exactly how serious the problems with the euro are. So we are taking a look at debt levels, that’s both government and household; house prices; and indeed unit labour costs; across the Eurozone’s more troubled countries and comparing with the UK and Germany.
So how bad is it? And might the UK go the way of Ireland too, eventually?
First off, let’s look at government debt.
According to the latest data from Eurostat, total government debt and the annual deficit at the end of 2009 in the Eurozone and for the UK, as a percentage of respective GDP, can be summarised as follows:
|Government debtas % of GDP||% Deficit|
In other words, by the end of last year, both Germany and France had higher government debt than Spain, Portugal, Ireland and indeed the UK. Greece, on the other hand, was a basket case even then.
The worry of course relates to the level of borrowing that occurred in 2009, and any ongoing borrowing. But earlier this year Ireland slammed on the brakes, and was making good progress. But Ireland’s problem is its banks, and the government’s problems can be dated back to when it agreed to provide a 100 per cent guarantee for Irish bank debts.
So this begs the question, why are its banks in so much debt?
And this takes us into new territory. Now we need to look beyond government debt, to household and company debt.
According to PwC, UK public and private debt combined will hit £10 trillion, or 540 per cent of GDP, by 2015. But that estimate includes our pension liabilities, which in some cases won’t actually be due for a very long time, and in any case, changes in the retirement age or stock market performance could completely transform pension liabilities.
According to a piece in The Economist back in April, Portugal’s household debt is around 100 per cent of GDP. Ireland’s households are thought to be indebted to the tune of about 176 per cent. Spanish household indebtedness is around 90 per cent of GDP, and yet in Greece, households are a frugal lot, apparently, and Greek household debt is around 61 per cent. Household debt in Belgium is lower still, and in fact is less than half Germany’s.
According to the OECD, household debt in 2007 across the G7 was as follows:
|Household debt in 2007across the G7 (% of GDP)|
According to the OECD, indebtedness of enterprises across the G7 in 2007, as a percentage of GDP, was:
|Enterprise debt in 2007across the G7 (% of GDP)|
It’s all very well looking at household and corporate debt, but a more pertinent question relates to the nature of debt. Most would agree that lending in the form of a mortgage is not necessarily a bad thing. You would expect mortgages to be higher in countries where a high percentage of households own their home. And it just so happens that home ownership is especially popular in Spain and the UK, and not at all popular in Germany.
So it’s all very well saying shock horror, UK households are in debt relative to Germany, but if this is explained by the fact that more UK households have mortgages and own their home, this may be a ‘so what’ statistic.
In fact, according to OECD figures, if you remove mortgage debt from the data, then UK households have less debt than those in Canada, Italy and Japan, and only marginally more debt than in households across the other three G7 countries.
So it all seems to boil down to how secure mortgage debt is, and this in turn relates to house prices.
The OECD has produced some good data here.
During the ten-year period from 1996 to 2006, average house price inflation across key countries was as follows:
|Average annual house price inflation from1996 to 2006 (%)|
Data on Greece and Portugal is not available from the OECD, but according to data from Bank of Greece, Greek house price inflation during 2005, 2006 and 2007 was marginally higher than in the UK. Portuguese house price inflation (according to Instituto Nacional de Estatistica de Portugal), on the other hand, was very modest.
Of course, right now, house prices are falling rapidly. From Q1 2008 to Q2 this year, house prices have fallen in Ireland by around 38 per cent; in Spain by about 12 per cent; by 11 per cent in the US; and by just over 8 per cent in the UK and Greece.
So put that together, and what do we get?
Ireland‘s problems relate to falling house prices. For Spain and the US, falling house prices also are a big problem, just not quite as crippling as in Ireland. For Greece, yes, falling house prices is an issue, but it’s the combination of falling house prices and crippling government debt which is proving such a nasty cocktail. Given that Greek household debt is so low, however, one assumes falling house prices is not quite such a serious problem.
This begs the question, how much further have prices to fall?
The OECD has produced data comparing average house prices to average income. And that data shows up a quite scary fact: assuming a long-run average of 100 for each country, this is how it pans out as at the end of 2008:
|Average house prices toaverage income (base 100)|
In Ireland, house prices have fallen quite a bit since then, suggesting they are approaching a sustainable level. In the US, the ratio of price to income should be below the long-run average by now, but it would seem Spain, the UK and Belgium are suffering from a market that is still way too expensive.
And finally, moving away from house prices, there is another factor – competitiveness.
According to data from the ECB, average labour unit costs between 1996 and Q1 2010, across Germany, Ireland, Greece, Spain, Portugal and the UK, have risen as follows:
|Increase in labour unit costsbetween 1996 and end of 2009 (%)|
So what can we conclude? Well, it’s especially sad for countries with large household debt, but which are not called Germany. So, for Portugal, Spain and Ireland, households are in debt, but it appears labour is overpaid. So at once wages must fall, while households repay debt. Not a pleasant combination.
For the UK, we are similarly cursed. But there is one difference. The UK is not in the euro. The UK can regain competitiveness via a falling currency.
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