The further a society drifts from the truth, the more it will hate those who speak it. ... In a time of deceit, telling the truth is a revolutionary act. George Orwell

Thursday, December 4, 2008

Celtic Tiger - danger zone!

(image from Wikipedia)

I am very concerned on behalf of my friends and my wife's family living there. I think that a deep financial crash with almost all cash running away off-shore and assets prices such as property and commercial paper plunging down in a localized deflationary implosion to near zero (by nine-tenth or so) - is quite probable!

Several factors are critical:

- Euro currency: that was the main positive factor that attracted so much foreign capital in the first place, the excess of which has caused the assets bubble. However the Euro would now make it impossible to prevent the capital (foreign and domestic) from fleeing the economy, making a deflationary collapse more severe than under a national currency system. Once that happens, leaving the Euro zone may be the only option short of reverting to barter.

- Irish economy is one of the most leveraged to the property market in the world (12% GDP, for comparison UK 11%, US 6%) and house ownership is one of the highest in the world. Current property boom last the longest in history, since 1986. The only other strong economic sector is agriculture but that can only sustain a minority of the population.

- Irish banks have potential liabilities equal or exceeding five times the GDP. Such massive amount of deposits since 1980-ties originated from abroad by foreign and multinational corporations seeking tax haven and a convenient corporate base in Europe.

- Irish government guaranteed all banking liabilities for the local banks to the maximum of 400Beu (594B$). More recently it reaffirmed it's intentions to inject some funds. I think that this is a very unwise decision since the government cannot possibly deliver on the promise, yet it creates a politically binding international commitment similar to the one that brought down Iceland. It is one thing to have all national banks declaring bankruptcy and another to renege on the national debt. The country can easily survive without private banks; new banks would spring up and simply take over the market from the failed ones. Surviving a national debt crisis is another story. For those interested please ask Argentinians, Poles or more recently - Icelanders. My personal opinion - let those banks die but don't let some politician sell your country to a pawn shop, or you may loose everything!

I don't know what the time frame might be but I suspect it could be several months. I will try to get a better estimate but I would watch the moment when foreigners start leaving, that is bound to trigger the rental market collapse.

--- Updated 14-Jan-2009 ---

Chuck Butler wrote

There's a rumor going round, that's someone's underground, no wait, there's a rumor going around that Ireland had requested aid from the IMF... Whoa there, partner! I know that things in Ireland have turned around on a dime from boom to bust, but I wasn't aware of a problem that would run that deep... The rumors were denied, of course, but you know me... Where there's smoke, there's fire... I'm reminded of an email I received 2 weeks ago from a reader in Ireland, that talked of a major slowdown in the economy. The writer was very adamant about how bad things had gotten that he compared Ireland to a banana republic! I responded to him and said, no... That can't be, because we've got a corner on being a banana republic right here in the U.S.A.!

You should have seen the sell-off in euros when this rumor hit the streets! It was scary how fast a currency could lose a handle! But after the rumors were denied, the single unit rallied back nearly as fast as it fell and is now trading, as I write, at 1.3225. The dollar is swinging a mighty hammer once again...

--- Updated 31-Jan-2009 ---

"A leading Irish economist has called on Dublin to withdraw from the euro unless..."


Irish debt (gov bonds) CDS'es reached 262 basic points (2.6%). Second highest in Europe, after Iceland (995). Former official at the Irish central bank, UBS director and broadcaster claims that withdrawal from Euro is the only option. My opinion is that nothing can really prevent a banking default regardless of the currency, because all Irish banks are already technically insolvent and their liabilities are external and cannot be re-denominated.

The only relevant choice of action is in:

1) preserving as much of the economic activity and jobs as possible and maintain exports (4/5 of the GDP),


2) preventing banking default from spreading to Irish government and creating a political crisis.

The choice in #1 is either (a) abandoning euro and then gradually devaluing the local currency, or (b) devaluing the wages. I think (a) is easier to implement internally but more difficult externally; while (b) is the opposite. Currently, Irish gov is implementing option (b) but 10% devaluation of wages is not going to make much of a difference, in my opinion. At the end, this gigantic mistake of Irish politicians in the last 15 years, to allow property bubble hijack the local economy cannot be undone by any of the standard financial tricks and will have to run it's full (painful) course! I suspect that both sides - the European Central Bank and Ireland would be or will be better off with the country opting out of euro!

There is practically no choice regarding #2 - retraction of the banking guarantees is probably the only sane option and that includes refraining from nationalization of the remaining Irish banks to avoid the entire country catching the bankers' disease! Basically, I think that bankrupting of all these failed financial institutions is the least harmful option for everybody and probably the least harmful for the rest of the economy. You can run economy using flexible barter, silver, gold and private bonds or whatever surrogate currency available, but not when every business would have to pay average blue or white collar worker a 40k eu/yr salary to support 300k+ mortgages. High wages resulted from bubble-inflated property prices that resulted in killing-off most of every form of business other than builders and bankers.

Otherwise it would require finding an external guarantor big enough to matter. 0.4Teu would do the trick, however I do not envisage any European or any other player rushing to do that.

Currently, Irish gov has already guaranteed all banking liabilities up to 0.4Teu. They will probably have to retract it. The moment that decision is announced, the other "shoe" will drop, i.e. it will trigger a banking collapse of all Irish banks, probably within hours! Anyone who has some euros there, I would recommend to consider alternatives, as soon as possible. It could be months but it could also be a matter of days. Its hard to predict the timing.

If the retraction won't happen then the default of the Irish state is inevitable with very dire consequences such as flight of the capital out of the country, impounding of some Irish holdings abroad, hoarding of the remaining cash, necessity of imposing capital transfer restriction to preserve whatever is left, and eventually - the abandonment of euro to unfreeze the economy (see #1).


--- Update 11-Feb-2009 ---

Irish Times


"The €6 billion to €7 billion in deposits from Irish Life & Permanent at September 30th comprised 8 per cent to 10 per cent of Anglo Irish's year-end deposits from customers and other banks."

That means, most likely that their real cash reserves were only ~1% fraction of the deposits. To make them reach the statutory (Basel) rule of 11% they needed to add 10% more, that is 7Beu "bed and breakfast" cash deposit. That means that the banks' true cash is 1% or less by now! Now if 7B eu is 10% of all deposits then the total liabilities are 70B eu! That's how much the Irish state is on hook for, right now!

We shall keep in mind that Anglo-Irish was the smallest of all 5 Irish banks! This makes me question whether the original 400B eu figure published in September for the total liabilities of all Irish banks may not have been underestimated!

I understand that not all deposits may disappear under normal circumstances but these are not normal circumstances. If there is a doubt about the solvency of Ireland as the state then ALL foreign depositors will rush to the exit!

Last but not least - how much confidence have we that similar window dressing isn't being practiced in other, larger banks like AIB or BOI? What is the true level of total cash reserves across all Irish banks? 400B eu of liabilities would require holding of at least 44B eu total in cash! Have they really got enough cash or is it just the same old tired 7B eu being passed around? Other interesting issue is how politically likely is now, that the European Union would support the Irish banking system?

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