News David McWilliams

Saturday 20 September 2014

David McWilliams: No matter how Coalition dresses it up, we cannot afford to pay Anglo's debt

Published 08/02/2013 | 17:00

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FIRST, the good news. Swapping the debt from a promissory note to a long dated government bond will mean that, in the short-term, the State won't have to find so much money to pay for the sins of Anglo. My back of the envelope calculation suggests that the savings will be substantial. Had Ireland kept paying the promissory note over the next 10 years, we would have had to come up with €30bn in a decade. That's a huge figure, more than 20pc of GNP. Clearly, this was not on. This new arrangement means Ireland will have to come up with about €5.8bn.

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Paying over a longer period is good news for all of us relative to paying the lot over 10 years. But it is not good news relative to paying nothing at all or to extending the promissory note out for a few hundred years. After all, we could have set the terms of our own promissory note schedule had we the inclination to do so.

More interestingly, we could have paid nothing at all, let the Central Bank continue to finance Anglo and positioned ourselves on a collision course with the ECB. The Government didn't have the stomach for this scrap and so the ECB's sweetener for taking the debts of Anglo on as sovereign debt is a long-term horizon to pay the stuff.

The ECB has got what it wants. The pesky promissory note, which it never liked, is gone. Ireland has more debt but at low rates of interest.

Now let's focus on the downside.

There is a massive bubble building in European bond markets at the moment and Ireland's deal yesterday will feed it. This will blow up as all bubbles do. Debt issued at the top of the debt boom, just like houses bought at the top of the housing boom, will eventually come crashing down because we know that you never make a balance sheet with too much debt better with yet more debt. You make it better with less debt.

Countries with huge debt/GDP ratios – such as Ireland – which add to their national debt in a cavalier way, will default in huge and dramatic fashion. Not unlike the banks that became ludicrously exposed to the property market, countries that become overdependent on these debt markets will find the markets shut off to them in short order.

When your debt/GDP ratio is over 100pc, the economy has to grow faster than the rate of interest in order for the debt ratio to stay stable. According to Minister Noonan, in 2011 total Irish debt was 494pc of GDP. Take that in. That's all household debt, national debt and corporate debt. This means our economy has to grow nearly five times faster than the rate of interest for our debt ratio to remain stable.

It isn't hard to see that adding to this debt figure – as we did yesterday – hardly makes the debt sustainable. The only thing that is making this debt look stable is the fact that interest rates have collapsed in the past few months. But you might ask, doesn't this fall in interest rates, which is making the debt swap yesterday look like a good thing, reflect the fact that Ireland has suddenly become more able to pay its debts? No of course not.

The ability of a sovereign country to service its debts is simply the aggregation of our ability to pay our individual debts. Defaults in Ireland are rising, as are bad debts, revealing that the average person is finding it harder, not easier, to pay their debts.

So what's driving this faltering picture of our debt profile?

The force behind this fall in interest rates is the huge wall of cheap money being printed by the ECB to prevent another debt crisis in Europe. The ECB is lending money to bust banks who are lending this on to bust countries and they are calling it success. But it is not. It is only a giant debt-pyramid selling scam.

So the more and more debt we add now, the more future generations will have to pay or will have to default. There are only three ways out of huge debt. The first is you grow your way out of it. That's unlikely. Second, you inflate your way out of it, but the Germans won't allow us inflate. The third is you negotiate or default your way out of it.

My hunch is that we will be forced to choose option three and the backdrop will be the bursting of the great European bond bubble, which will reveal the inconsistencies of a Europe that has 7pc of the world's population, produces 25pc of global GDP and finances 50pc of global welfare payments.

At the moment, it is not fashionable to talk about the bursting of the debt bubble but it will be commonplace in time. But why rain on yesterday's parade?

The high-fiving in the Dail and in the media remind me of a scene I witnessed many times in the housing boom. A young couple hosts a house- warming party. They have paid well over the odds for their starter home, but who cares? Prices are going up and will only continue to go up. They have managed to secure interest-only finance from a bank manager and are focused on the monthly payments rather than on the huge principal. They agree they couldn't have done it on an interest-plus-capital loan. Do you remember how that story ended when the bubble burst?

Now think of the great bond bubble, the historically low interest rates and think about the future when the world wakes up to the fact that this money – the money for Anglo – can never be paid back. Remember today when that day comes.

www.davidmcwilliams.ie

Irish Independent

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