Dealing with an economic crisis of biblical proportions
There is concern that Irish people cannot afford to rescue the banks
Thursday January 22 2009
THE Gospel of St Luke helpfully tells us that it is not a good idea to start building a house without first getting an estimate and deciding if there is enough money to finish the job. Otherwise, the builder will be mocked for running out of money before the building is finished.
No, on second thoughts... forget that particular simile. Let us move on to Verse 31, where a king is advised to be careful about going into battle with 10,000 men against an opponent who has 20,000. The point of both stories is that policies must start with the question of the resources available to implement them.
The Government finds itself in a worse position than either the biblical builder or king. The former could decide not to start, while the latter could sue for peace on the best terms he could get. The Government has no choice but to battle with the banking crisis and the public finance crisis, and try to rebuild both systems.
Has it enough resources to do the job? Even if it has, it may well be that that there is nothing left over to tackle the third crisis -- that of the economy itself.
Ministers had better sit down and consider the gospel advice. If their first policy preferences turn out to cost more than can be afforded, other choices will have to be made. There are, of course, huge uncertainties in all of this, but it may help to steady nerves, and even shape policy, if we start with what is possible.
What could the Government possibly borrow? In a crisis as severe as this, one could say theoretically that there is no reason why the national debt should not go to 100pc of GNP -- an entire year's national income. The Italians already owe that much, the Japanese more; the British and Americans seem quite prepared to run their debt up to, and maybe beyond, that level; the eurozone average looks like hitting 70pc of GDP.
National debt
In Ireland's case, 100pc of GNP is about €150bn. With the national debt now approaching €50bn, the Government could therefore borrow more than €100bn to plug the holes in the banking system and pay for the public service until taxation can take over the job. It would leave the country with a heavy burden of debt, but not a debt crisis, and, used wisely, it is a lot of money to deal with the crisis.
That's the theory. The first problem is that, in current conditions, it may not actually be possible for Ireland to borrow anything like that kind of money. Governments everywhere are looking for loans, with the Americans talking in trillions. The capacity and nerve of the possible lenders -- many of them banks -- has been badly damaged.
It is not certain there will be enough to go round. Even if there is, it is not clear it will go round to everyone. Because of the banking crisis, Ireland's credit rating is one of the worst in the EU. Besides, with everyone in such a highly nervous condition, investors want government debt they can sell quickly if needs be, which is not always the case with the debt of small countries.
Until a few months ago, an actual shortage of credit for a sovereign government whose debts did not exceed one year's output would have been unthinkable. The only question would have been the interest rate to be charged on the loans, not availability. But the unthinkable has become the new normality.
One conclusion for Ireland is that it would be better to borrow as little as possible for as long as possible. Conditions can only improve over the next couple of years, surely? So, string out the banks' bad loans, and hammer both public sector costs and and the taxpayer as much as possible this year, and limit borrowing in 2009. Government loans may remain expensive in 2010, but if there is still doubt over their availability by then, it can only mean the whole world is in terminal trouble.
A second concern, though, is that rescuing the banks will simply cost more than the Irish people can afford. The banks' balance sheets, after all, amount to three years' national income. This is a problem for several small countries, such as Belgium. It reached its apogee with Iceland, whose banks were ten times the size of its 300,000 inhabitants' income.
Danger
The events of the past few days, clearly, have increased the danger that the Government would face banking difficulties on a scale where the cost of conventional re-capitalisation or nationalisation would simply be too high. In which case, unconventional policies will have to be tried.
One idea, already being aired in Britain, is that problem bank loans and assets simply be taken over by the State, without compensation. The banks would not be paid for them until their final value had been realised, many years hence. But the banks would be back in business, more or less immediately, with clean balance sheets.
Experience elsewhere suggests that, while the immediate costs of a crisis could overwhelm the Exchequer, the final costs, if spread over time, need not. According to the OECD, the Finnish banking crisis -- which was about as bad as it gets -- cost the exchequer 22pc of GDP in the end. Such a worst case scenario would amount to €40bn for Ireland, which would require some years of severe spending restraint, rising taxes and below-trend growth. But a clear national determination to carry that sacrifice, if required, might actually limit the cost.
It does appear to be about the same as the cost of the 1980s crisis. It is truly dreadful that we should be facing a disaster of similar magnitude again so soon. At some point, those persistent questions about the damaging nature of the Irish political system will have to be addressed seriously.
This crisis may not, in the end, be any more costly than the one of 20 years ago. The difference is that the earlier one could be dealt with -- admittedly with great difficulty -- over five years. This one requires immediate action. The delays of even the past four months have been hugely damaging. It is time to accept that the hostile army is on the hill, is not going away, and must be faced with the best we can muster.
