What the Markets are Telling Us (and What our Commentators are Not). The Recession Diaries - May 16th

We are not Spain, we are not Italy, we are not Portugal. Repeat. We are not Spain, we are not Italy, we are not Portugal.

In one sense, that’s correct. In terms of the ‘market’ view of the Irish economy, we’re worse. But don’t expect commentators who have been demanding public spending cuts to point this out; it would undermine their arguments.

Remember at the start of the recession when we were given crash tutorials in the 10-year German Bond spreads? This compares the cost of borrowing with that of prudent Germany. This was the leading index to divine what the markets thought of Government debt and, so, the Irish economy:

• The smaller the spread, the more markets are pleased.
• The larger the spread, the more markets are angry.

The 10-year bond spread was presented as the ultimate portal into the collective mind of the market.

During the Euro crisis, when bond yields were soaring, we were told we were not like the other periphery countries. Our deflationary interventions in 2009 – when billions were ripped out of the economy through spending cuts and tax increases on low-average income earners – had ‘pleased’ the markets. Therefore, while the debt of other countries were under attack, ours was safe.

To make this argument work, though, you have to ignore the 10-year bond spread – the very index that was used to justify deflationary policies in the first place.

Why is this crucial index now being ignored?  Because after all the deflationary measures Fianna Fail imposed, the markets still tore strips off Government debt in the recent crisis. It’s not just that the markets were not pleased; if anything, they were even angrier. Those who demanded deflation don’t want you to know that. Therefore, don’t present the data and hope that people won’t notice.

Let’s correct this. I have taken, from the Financial Times Bond Index, the average spreads of both the periphery countries (Spain, Italy and Portugal) and the ‘core’, or non-periphery countries (all other countries in the EU-15) and compared them with Ireland.  I have excluded Greece since they are not in the market anymore. Let’s see what we find.

First Phase – Entering the Recession

In spring 2008, all countries were bunched together, quite close to German rates. Irish borrowing costs (as measured by the spread) were pretty much the same, on average, as other ‘core’ countries and below the costs of the periphery countries – namely, Spain, Italy and Portugal. No crisis there. However, in a few months, gaps were emerging.

By the end of the year – following the bank guarantee and a panic budget which showed the Government didn’t know what it was doing – borrowing costs were substantially higher than the core countries and higher than even the periphery countries. The markets were getting angry.

Second Phase – the Year of Deflation

Based on these gruesome numbers, the campaign for ‘decisive, courageous action’ (i.e. cut wages, cut welfare, cut services and hit low-average income earners with tax) gathered steam. This ‘tough’ action would please the markets and bring our spreads back into line we were told. So what happened?

Our spreads worsened. They fell even further behind ‘core’ borrowing costs. And they nearly doubled over the periphery countries.

This wasn’t supposed to happen. Our tough action – in contrast to those fiscally profligate countries on the periphery – was supposed to be rewarded by the markets. It wasn’t. Imagine that.

Third Phase – the recent Euro Crisis

In the third week in April of this year, everything started going south. The bail-out of the reckless lending by German and French banks (sorry, the Greek bail-out), the falling Euro, worries over public and private debt – markets were in turmoil; both angry and confused.

Of course, some countries, namely the ‘core’ countries weathered the storm okay; actually, better than okay. Investors sought the safety of the countries whose borrowing costs in most cases actually declined. It was the periphery countries that were next for the chopping block. So, given that the markets were ‘pleased’ (according to commentators who find it difficult to read indexes) with what Ireland had done over the previous year, how did we fare against the periphery countries which the markets were angry at?

Not good. While Portugal came under particular pressure, all the other countries remained well below Irish borrowing costs. Of the four periphery countries, Irish debt came off second worst.

And here’s the shocker. Which country now has the worst spread in the EU-14 (given that Greece is no longer a player)? Ireland. As of Friday, after a week of bounce-back, Irish spreads were higher than Spain and Italy (by a considerable amount) and marginally ahead of even Portugal.

* * *

One could despair of this debate with unsubstantiated assertions, selective use of data, spin, and gullible commentators who repeat the spin for want of a little research. Jimmy Stewart did warn us:

‘This is why financial markets were not 'reassured'. For all the Thatcherite bluster of the bond analysts, who are salesmen, bond investors understand whether they are more, or less, likely to be repaid. Reducing incomes while increasing debts only raises the risk of default, hence yields continue to rise. A crucial, but widely ignored point from S&P when downgrading Greek and Portuguese debt, is that the austerity measures have depressed activity and tax revenues. The slash & burn approach has only made matters worse.’

Too many of our commentators listen to ‘salesmen’ and pay too little attention to what is actually happening in the markets. This is not an argument that we should become slaves to every blip on a graph. As Nat O’Connor points out:

‘ . . why are the markets being treated as a singular entity with consciousness, rather than the aggregate of diverse individual and corporate investors? It would be much more accurate to report which investors are expressing concern or fear, and on what basis.’

But what this does show up is the degraded state of not only the Irish debate but of the presentation of relevant facts – facts that get pushed under the carpet because it might force the current consensus to explain itself. For deflation hasn’t worked, spending cuts haven’t worked, sitting idly by while employment has collapsed hasn’t worked.

Yes, Ireland is not like Spain or Portugal or Italy. We're worse.

Comments

[Aidan R]

Excellent analysis Michael. It would appear that those who support a cut and burn strategy blame the increase in the cost of our borrowing on 'bad luck' brought on by the 'Greeks'.

Colm McCarthy wrote in the Times a couple of weeks ago:

"While Ireland has no immediate need to borrow again, it must return to the markets in due course, and there is now a risk that it will face higher borrowing costs. This is unambiguously bad news, and a piece of bad luck since the decline in Irish spreads, a recognition of the early and sustained efforts to rein in the budget deficit, has now been reversed"

He then goes on to argue:

"Ireland’s vulnerability has, through no particular fault of ours, increased substantially these last few weeks.....The benefits of firm budgetary action through 2009 are evident – Ireland has had to pay less interest abroad because of these actions".....

So, it is no longer a strategy of blame the Irish public sector but blame the Greek public sector........You couldn't make it up.

Whatever about Irelands 'capacity' for fiscal consolidation - it is clear that the cut and burn strategy(regardless of ones ideological preference) is simply not working. But, facts - if they get into the public sphere - rarely speak louder than political ideology.

[Eoin O'Mahony]

Anyone else think that bond markets have just become totemic? "the markets must be pleased! sacrifice education!"

[WorldbyStorm]

Sure looks like it Eoin.

Michael, what's mightily depressing is not that there are no alternative viewpoints - there are as you continue to demonstrate, but that they're now so completely ignored. It's almost literally as if some have their fingers in their ears and hum loudly for fear that they might actually have to engage.

[D_D]

Hats off to you again Michael.

[Pidge]

Idiocy of unnamed-but-all-too-obvious commentators aside, I get the sense that I'm missing the point here.

Could it not just as easily be the case (and I think this is more likely) that Ireland's cost of borrowing, while increasing, has not increased as much as it would have without cuts? The market's response to cuts is not binary, and it could well be that Ireland's cost of borrowing would be well, well above what it is now were those cuts not put in place.

Correct me if I'm missing something here.

[Michael Taft]

Pidge - whether Ireland's borrowing costs would have been higher had it not been for the cuts may be right or it may not be; this depends on what means by cuts. If regressive tax expenditures had been cut, had investment programmes designed to get people back into work been implement (cutting unemployment costs, increasing tax revenue) - given that this would have been a more rational approach, I suspect our borrowing costs would have been lower, since it would have been more successful.

However, the point of this article is not to argue that toss - merely to point out that many commentators here are making unsubstantiated statements re: international markets, when the fact are available to all. To concede this point would mean serious questions would be asked of the assetion: 'the markets are treating Ireland differently, more kindly, because we are doing what the markets want us to.' Apparently we're not - if the 10-year spread is anything to go by.