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XMFSinchiruna (27.47)

Ireland Foreshadows Fiscal Ruin of the Western World

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July 29, 2009 – Comments (13)

I have little to add to this commentary by Telegraph International Business Editor Ambrose Evans-Pritchard, except some commentary I would like to insert regarding the second-to-last paragraph.

He comes so close to getting the whole enchilada right, but then he exhibits greater concern for deflation than inflation and advocates continued economic stimulus to stave it off in a completely self-contradictory lapse of logic. As I've said many times, save for this one fatal flaw in his fiscal worldview, his coverage of these events has been of incredible quality and worth every Fool's attention:

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/5857074/Fiscal-ruin-of-the-Western-world-beckons.html

Fiscal Ruin of the Western World Beckons

For a glimpse of what awaits Britain, Europe, and America as budget deficits spiral to war-time levels, look at what is happening to the Irish welfare state.

Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15pc of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous debt compound trap.

A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12pc and heading for 16pc next year.

Education must be cut 8pc. Scores of rural schools must close, and 6,900 teachers must go. "The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb", said the Teachers Union of Ireland.

Nobody is spared. Social welfare payments must be cut 5pc, child benefit by 20pc. The Garda (police), already smarting from a 7pc pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc.

"Something has to give," said Professor Colm McCarthy, the report's author. "We're borrowing €400m (£345m) a week at a penalty interest."

No doubt Ireland has been the victim of a savagely tight monetary policy - given its specific needs. But the deeper truth is that Britain, Spain, France, Germany, Italy, the US, and Japan are in varying states of fiscal ruin, and those tipping into demographic decline (unlike young Ireland) have an underlying cancer that is even more deadly. The West cannot support its gold-plated state structures from an aging workforce and depleted tax base.

As the International Monetary Fund made clear last week, Britain is lucky that markets have not yet imposed a "penalty interest" on British Gilts, given the trajectory of UK national debt – now vaulting towards 100pc of GDP – and the scandalous refusal of this Government to map out any path back to solvency.

"The UK has been getting the benefit of the doubt, both in the Government bond market and also the foreign exchange market. This benefit of the doubt is not going to last forever," said the Fund.

France and Italy have been less abject, but they began with higher borrowing needs. Italy's debt is expected to reach the danger level of 120pc next year, according to leaked Treasury documents. France's debt will near 90pc next year if President Nicolas Sarkozy goes ahead with his "Grand Emprunt", a fiscal blitz masquerading as investment.

There was a case for an emergency boost last winter to cushion the blow as global industry crashed. That moment has passed. While I agree with Nomura's Richard Koo that the US, Britain, and Europe risk a deflationary slump along the lines of Japan's Lost Decade (two decades really), I am ever more wary of his calls for Keynesian spending a l'outrance.

Such policies have crippled Japan. A string of make-work stimulus plans - famously building bridges to nowhere in Hokkaido - has ensured that the day of reckoning will be worse, when it comes. The IMF says Japan's gross public debt will reach 240pc of GDP by 2014 - beyond the point of recovery for a nation with a contracting workforce. Sooner or later, Japan's bond market will blow up.

Error One was to permit a bubble in the 1980s. Error Two was to wait a decade before opting for monetary "shock and awe" through quantitative easing.

The US Federal Reserve has moved faster but already seems to think the job is done. "Quantitative tightening" has begun. Its balance sheet has contracted by almost $200bn (£122bn) from the peak. The M2 money supply has stagnated since January. The Fed is talking of "exit strategies".

Is this a replay of mid-2008 when the Fed lost its nerve, bristling over criticism that it had cut rates too low (then 2pc)? Remember what happened. Fed hawks in Dallas, St Louis, and Atlanta talked of rate rises. That had consequences. Markets tightened in anticipation, and arguably triggered the collapse of Lehman Brothers, AIG, Fannie and Freddie that Autumn.

The Fed's doctrine – New Keynesian Synthesis – has let it down time and again in this long saga, and there is scant evidence that Fed officials recognise the fact. As for the European Central Bank, it has let private loan growth contract this summer.

The imperative for the debt-bloated West is to cut spending systematically for year after year, off-setting the deflationary effect with monetary stimulus. This is the only mix that can save us.

My awful fear is that we will do exactly the opposite, incubating yet another crisis this autumn, to which we will respond with yet further spending. This is the road to ruin.

 

13 Comments – Post Your Own

#1) On July 29, 2009 at 8:03 AM, XMFSinchiruna (27.47) wrote:

Speaking of fatal flaws of logic, and in completely unrelated News of the Weird:

An Asheville NC firefighter apparently shot a bicyclist in the head because the cyclist was being unsafe.

Beyond the insane logic required to try to kill someone you're trying to protect, the strange elements of this case are numerous:

1. Predictably, the firefighter is on PAID administrative leave pending the investigation. More sound use of taxpayer money!

2. Bicycle helmets are stronger than I thought, having apparently protected the rider from harm. Imagine how scary that must have been for his child to witness, though!!!

3. Apparently the time threshold for pre-meditation is very short in NC, as the firefighter has been charged with 1st degree attempted murder. If all those years of watching Law & Order served for anything, I think as heinous as the crime is it's clear claiming premeditation is a stretch.

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#2) On July 29, 2009 at 8:39 AM, catoismymotor (40.16) wrote:

It's Asheville. I can promise you that "Hey y'all. Watch this!" was said by the firefighter before the trigger was pulled.

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#3) On July 29, 2009 at 8:53 AM, Jimmy2008 (< 20) wrote:

Sinch,

I am afraid that current dire situations would lead to big wars. In today's world, many countries have nuclear weapons. How would a big war be fought?

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#4) On July 29, 2009 at 9:17 AM, catoismymotor (40.16) wrote:

Chris,

Thank you for forwarding the article. In this age the fact that the writer got in mostly right is a miracle.

I try to keep myself calm by thinking of the current situation as an earthquake. The giant shock and continued rumblings are going to tear down the week structures, crack the foundations of others and cause panic. After the fires are out, the public has caught their breath and the dust settles you can survey the damage. In the case of today's financial crisis you will be able to see which businesses and programs stand. This will make it easier as for you to spot the established opportunities for investing. It will also provide a chance for new growth. This is a great time to be an investor, even a trader.

I am glad to see government run Ponzi schemes collapsing. Please don't get me wrong, I don't want to see any one hurt by this crisis. I want to see a shift back to an ownership mentality for our country. When you grant the government power to give you something you give them power to take it away. Social Security, Medicare and Wellfare all contrubute to the expansion of the Nanny State. It is time to close the nursery and send the nanny on her way. Libertarianism by bankruptcy might be around the corner.

Cato

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#5) On July 29, 2009 at 9:33 AM, alstry (35.41) wrote:

Cato.

You are right...but many will be hurt.

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#6) On July 29, 2009 at 9:44 AM, FoolishChemist (96.97) wrote:

I find it interesting that they use pc and not %.

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#7) On July 29, 2009 at 10:36 AM, 4everlost (29.36) wrote:

Sinchy,

Great find.   I think the author also missed the mark with this part: "Error Two was to wait a decade before opting for monetary "shock and awe" through quantitative easing."

We are experiencing the problems with QE right now.

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#8) On July 29, 2009 at 10:41 AM, catoismymotor (40.16) wrote:

Alstry,

Everyone will be fine. Obama is having enough unicorns and rainbows printed for everyone.

Cato.

 

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#9) On July 29, 2009 at 10:44 AM, catoismymotor (40.16) wrote:

"Ireland Foreshadows Fiscal Ruin of the Western World"

Are the tickets for the new U2 show really that expensive?

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#10) On July 29, 2009 at 4:34 PM, beatnik11 (< 20) wrote:

Just more doom and gloom.  Reading the comments on the site it really makes you think that this crisis is 100x worse than the great depression was and that in a matter of years, hell maybe even months!  We better hurry up and move to the country and get those bomb shelters built.  Things are bad, there is no doubt about it and I am personally not quite sure I like everything Obama is doing domestically, but I thank my lucky stars everyday that this is not the real great depression and that hopefully that our society will learn its lesson about embracing debt and living beyond our means.  Sure it may hurt, but if people learn to cut up those credit cards and live more sustainably , our world will be much better for it

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#11) On July 29, 2009 at 4:36 PM, beatnik11 (< 20) wrote:

Opps, left something out

and that there will be large scale systemic breakdown and anarchy in 1st world countries in a matter of years, hell maybe even months! 

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#12) On July 29, 2009 at 4:44 PM, TMFMmbop (40.59) wrote:

Love the subtle JM Synge reference.

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#13) On July 29, 2009 at 4:52 PM, portefeuille (99.59) wrote:

It is more or less just a repeat of this earlier article.

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Europe digs its economic grave while the ECB answers to no one

The European Central Bank preens as the last guardian of virtue in a sinful world, yet its actions are devastating the public finances of almost every country under its care.

By Ambrose Evans-Pritchard
Published: 7:01PM BST 12 Jul 2009

Without a radical change of strategy, the ECB risks pushing the weakest states into a debt-compound spiral that can only end in bond crises and/or the disintegration of Europe's monetary union – whichever comes first.

The International Monetary Fund says the eurozone will contract by 4.8pc this year, worse than the UK (-4.2pc) or the US (-2.6pc). The deepest damage will occur next year as Europe remains mired in slump, even as the rest of the world recovers. It is the length of recession that matters most for jobs, social stability, and public finances. I am not easily shocked any longer but I did sit up when Spain's budget chief Luis Espadas said the economic collapse could "easily" push Spanish public debt to 90pc of GDP by 2011. This is up from 36pc in 2007.

Nobody knows where the tipping point lies on public debt, though anything above 100pc of GDP in a currency union is courting fate. Some are already there. The European Commission says Italian debt will jump to 116pc in 2010. Greece is vaulting back to 109pc, Belgium to 101pc, France to 86pc.

Even German finances are falling apart. After screwing down spending to balance the books, discipline has broken down. Berlin says the deficit is heading for 6pc next year, taking debt to 82pc. This is happening all over the world, of course. But the ECB is compounding the effect, whether for reasons of politics, Bundesbank fetishism, or misjudgment. By refusing to join the US, Japan, Canada, Britain, and Switzerland in quantitative easing (QE) the ECB has allowed a contraction of private credit this summer. The M3 "broad" money supply has shrunk since February.

Ignore M3 at your peril. It flashed awarning signal in the US months before the collapse of Lehman Brothers last September; it is flashing the similar warning signals in Europe now.

Professor Tim Congdon from International Monetary Research said the eurozone money figures are "horrifying" and portend a serious crunch ahead. "My verdict is that the senior people in the ECB [and the Fed] have little organised understanding of the debt-deflationary processes initiated in late 2008," he said.

Ireland's M3 contracted at a 30pc annual rate last month, a death sentence for a hyper-indebted economy. The wreckage will be evident just in time for the Irish to vote again – under extreme duress – on the EU's Enabling Act in October. This should make for interesting political chemistry.

In Germany, the Mittlestand lobby (BVMW) says half its members are facing a liquidity squeeze, while the strutting finance minister, Peer Steinbrück, has assumed a ghostly pallor. "We must take seriously the threat of a credit crunch in the second half of this year," he said.

Mr Steinbrück has called for a suspension of the Basel II accounting rules in order to rescue banks, and even suggested that the German government undertake direct lending to boost credit. The regulator BaFin has already told us that bad debts are set to "blow like a grenade" this year. A leaked BaFin memo said "problematic" assets have reached €816bn (£700bn), led by Hypo Real with €268bn.

ECB experts think eurozone banks will have to write down a further €203bn by the end of next year. Yet ECB policy-makers seem unwilling to face the implications. Yes, they have injected €442bn in a one-year tender, but the money is not reaching the economy. Simon Ward from Henderson New Star said the ECB is repeating errors made in Japan when it first trifled with QE, relying on banks to pass on credit rather going for massive bond purchases.

Inevitably, Europe's politicians are taking matters into their own hands. They will not sit idly by as millions lose their jobs. If the ECB deflates, budgets must bear the strain, and that is exactly what Europe cannot afford with a birthrate of 1.53 per woman and the onset of demographic decline. The commission says the number of workers per pensioner over 65 will halve from four to two by 2040. Age-related costs will explode by 15pc of GDP in Greece, 9pc in Ireland, Spain and Holland. The populations of Germany and Italy will soon be shrinking.

Viewed strategically, Europe's mix of monetary deflation and rampant deficit spending by the states is nothing short of lunatic.

Needless to say, Britain faces it own colossal mess, but of a different kind. It is the Prime Minister who is taking the country over a cliff, not the Bank of the England. Voters will soon have the joy of sacking him. How do Europe's voters sack the ECB?

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