David McWilliams: Swing in interest rates will torpedo 'Trackerville'
Published 02/01/2013 | 17:00
GOOD morning and Happy New Year. I hope your Christmas went well and the virtuous resolutions are still intact after day one. This week, let's have a look at the international factors that will dominate the global economy in 2013 before looking at the main issues likely to influence Ireland. This isn't a forecast, rather an assessment of the forces that will emerge as pivotal in the path of the economy.
For the first time in a long time we kick off with Japan. For so long the sick man of the global economy, having suffered the missing decade or two following its property crash, Japan will have a disproportionate impact on the world economy via the financial markets this year. The news reflects the impact of political change in Japan and the fact the economy is still in the doldrums.
Unnoticed in this part of the world over the Christmas period are the moves by the new Prime Minister Shinzo Abe, who said this week that he wanted to push up the target rate of inflation in Japan. He wants to generate inflation over and above the rate that the central bank is happy with. Why might he do this? Surely that sounds wrong?
Well, not if the people in Japan are still saving too much of their income because they believe prices will fall next year. As they are caught in a deflationary frame of mind, they react unusually to retailers dropping prices to coax people to spend. Because they believe prices will keep falling, the very act of cutting prices makes them postpone rather than bring forward spending. The only way to break this deflationary psychology is to officially increase the target rate of inflation.
How do you do this? You adopt your own version of quantitative easing to infinity and beyond. So you force the central bank to buy up all sorts of assets from the banks, pumping money into the economy and not stopping until the price of goods in the shops starts to rise, not fall. This is what Mr Abe has said he is going to do.
Now what does this mean for Japanese interest rates and the yen? This is where events in Tokyo have an impact here. As the yen falls because Japan is printing money hand over fist and Japanese interest rates fall for the same reason, the global casino that is the financial markets will obviously want to borrow in yen and then place bets all over the world with this money. The more the yen falls, the less these guys will have to pay back next year because they are borrowing in a currency that is falling. This is likely to lead to another "carry trade" opportunity for investors to borrow at ultra cheap rates and buy up assets outside Japan.
This has huge implications for large infrastructural projects outside Japan and in Europe in particular – and maybe in Ireland, if we have any such projects. So, for example, if our country was to try in the next few years to finance, maybe energy projects in whatever technology we decided was appropriate, a trip to Japan might be helpful in this environment. Thus the global carry trade orchestrated by Japan might have positive implications for large projects in Ireland, if we get the right type of advice.
The next big issue in the global economy is really a less aggressive version of the Japanese carry trade. One thing is almost certain next year and that is that the era of very low interest rates will remain. In the US, Europe and the UK, mega low interest rates will allow the destroyed balance sheets to be gradually nursed back to health, but without economic growth lots of restructuring will be needed.
THIS brings us back to Ireland and the place I term Trackerville – the ticking, financial, social and political time bomb which will determine the next election.
Trackerville is a place that knows no county boundaries. It is a vast swathe of thousands of starter homes financed by tracker mortgages, built at the height of the boom, existing in the precarious twilight world between huge loans that can only eventually go up in cost and depleted take-home incomes that can only decline.
Starting in the early 2000s, trackers spread though the country like a virus. The great Irish tracker pandemic was fuelled by people who were desperate to get on the housing 'ladder'.
The figures for tracker mortgages are startling. There are about 400,000 tracker mortgages in Ireland. Trackers account for close to 60pc of the €26bn in residential loans issued by Permanent TSB. Just over half of AIB's €27bn mortgage book is accounted for by trackers, as is a quarter of the €16bn lent by EBS. The prize for King of the Trackers goes to Bank of Ireland: tracker loans make up 62pc of its €28bn mortgage book.
The continuation of low interest rates this year means that hundreds of thousands of Irish people will continue to enjoy subsidised mortgages. But this situation is merely playing tricks on them because they are lulled into a false sense of security about their ability to pay these huge mortgage debts. As defaults rise around them – over 150,000 mortgages at this stage in Ireland – the residents of Trackerville are wrapped in financial cotton wool because their repayments are artificially low.
Over the next few years, as the global economy eventually recovers, the Germans will insist European interest rates are raised aggressively to reward its savers who are being punished now by excessively low rates that are in turn "rewarding" the debtors of Trackerville.
Over the business cycle, or the life of any loan, the pendulum of interest rates swings towards and away from the saver and the debtor at various times. When rates are low, the saver is punished; when rates rise, the opposite pertains.
Ireland's mortgage debtors – particularly those in Trackerville – are right now at a stage where they are being rewarded (although it doesn't feel like that). Imagine what it will be like when rates go up? A recovery in the global economy will trigger mass defaults here via higher interest rates. This is why a huge programme of debt restructuring should be top of the agenda for the Government's EU presidency. The Government should reiterate to our partners that the moment interest rates rise, Ireland will be torpedoed below the water line.
Pointing this out when rates are low and looking for a solution is not economic opportunism, rather it sounds more like the height of prudence.