Economics News : 19 Nov

November 19, 2010

Dream of things that never were,
nor ever will be.

John. Kennedy, Speech in Dublin 1963. Was he addressing the EU’s Commissioners? His track record was as bad as theirs!

Appearances are sometimes deceptive.
What’s happened to Ireland? Has its economy really changed so much? Was it a powerful tiger one moment and a pusillanimous mouse the next? Or is it just our perceptions of the country that have altered? Were they overstated previously? Are they understated now?

Perceptions often misleading.
None of us knows. It’ll be several years before a dispassionate assessment of the fundamentals is possible. But it has to be acknowledged that economists are as susceptible to sentiment (post hoc rationalisation) as investors. They set their expectations of the future by reference to their perceptions of the past. That’s sensible enough in normal circumstances. But it can lead to escalating error in periods of excess credit.

Was Ireland’s virtuosity . . .
Was Ireland then just a consequence of bubble psychology? Its economics prowess mis-analysed as a result of heady asset valuations and overwhelming capital flows? When the dust has settled, will the message be that nothing much changed in the last fifteen years? That yesterday’s euphoria wasn’t justified but that today’s despair is? Will our image of the country be returned to its status quo ante?

. . . just an illusion?
Possibly. Similar transformations have occurred to other countries. Analysts are not unemotional: always looking for the next superstar, they’re rather too easily persuaded they’ve found it. There’s a reluctance to acknowledge how rarely paragons occur.

Can the country deliver only when . . .
Brazil, for instance, has been touted as the next big thing for more than a hundred years. And, from time to time, on the back of temporarily favourable circumstances, it does have a good run. But the country’s never managed to sustain its spurts. Instead, it’s always regressed.

. . . circumstances are exceptionally favourable?
Is Ireland another Brazil? Time will tell. But there’s no doubting that the country was swamped with funds when membership of the euro coincided with globally easy credit. Nor that its economy was flattered by the receipt of huge EU grants. Nor that the Finance Ministry’s decision to cut corporation tax to 12½%, the lowest rate in Europe, was instrumental in attracting to the country the headquarters of large numbers of multi-nationals.

Nobody knows.
For a while, therefore, the country found itself in a virtuous circle. Economics activity and asset values and capital flows reinforcing each other. Even its Rugby became sublime!

But sentiment has reversed.
But was there anything substantive going on underneath the froth? What were the USP’s that’d survive the temporarily favourable circumstances? Gradually, in the years following the Fed’s credit squeeze, investors became first less optimistic, and then pessimistic. The good times, they said, were a mirage; all smoke and mirrors.

Everybody (Osborne only excepted) . . .
Now, a vicious circle is operating. All news is negative and all analysis pessimistic. Ireland can’t afford to stay in the euro, it is said. Its 10 year bonds are yielding 8¼% and its inflation rate is minus 1¼%! No country can bear that combination, least of all one in which GDP is collapsing.

. . . is gloomy.
Nor will it be able to maintain its low corporation tax rate. It may gradually lose its HQ trophies, therefore. That’ll put more pressure on GDP, on sentiment, and on the fiscal balance. Out of the EMS, Ireland’s borrowing costs will gradually subside, but they’ll do so only gradually. For years to come, possibly for decades, they’ll be higher than those in competitor countries.

Most of Europe is in a mess.
It’s presumed that something similar will happen to Greece. Probably also to Portugal and Spain. But will the process stop there? What about Eastern Europe? What about Italy and France and Belgium?

Heads ought to roll.
And what will be the fate of those who were the source of all this woe? What will happen to the half-baked Commissioners who proposed Monetary Union in advance of Political Union? Will they be censured? Or sacked? Or allowed to cause more mischief?

Elsewhere in the world . . .
Meanwhile, outside Europe, there’ve been some interesting economics developments. The US has been making reasonably good real progress. China has reported fairly steep increases in inflation. And India (another Ireland?) seems to have hit the buffers.

. . . the US may be quickening, the PRC overheating, and India stalling.
The message from the first is that, in dull economics circumstances, devaluation yields short term benefits. It’s one that Ireland and Greece would do well to take on board. The message from the second is that the yuan is going to be allowed to rise sharply. It’ll be a corollary of the containment of price pressures. That from the third is not at all encouraging. If interest rates are to be raised to cap inflation, there’s a danger that real activity will shudder to a halt!

But valuations up.
Asset markets to continue to rise: money easy; inflation low; and corporate profits resilient.


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