WE ARE ARGUABLY approaching a very serious crisis, but one that we can be mostly protected from and at little true cost.
Our country has a national debt of approximately €200 billion. About €50 billion of this debt needs to be repaid in the next three years, that’s €10,000 for every man, woman and child. We repay debt by borrowing more money. We face a crisis if we can no longer borrow and need to go back to the loan sharks (the Troika).
How can we protect and help ourselves?
We can borrow €50 billion now, repay in advance the debt due to be repaid in the next few years, and replace it with money to be repaid much further into the future.
This would lock in unprecedented low bond yields reducing the cost of repaying our national debt. We can see this by comparing it to a mortgage. Suppose we had a mortgage of €300,000 and interest rates are say 6%, we’d need to pay back nearly €2,000 per month. But if interest rates were 1%, we’d only need to pay back a little over €1,000 per month. This greatly reduces what we need to repay.
From another perspective, our choice is between a very low fixed rate longer-term mortgage and a mortgage that needs repeated mortgage approval every year, with awful consequences if we ever get turned down.
Why are we needlessly exposing ourselves to risk
We are not borrowing the €50 billion because bean counters seem to be in charge. The problem is that “the way we do things” with our national debt is somewhat divorced from reality. We use Eurostat accounting regulations that distort the financial reality of our debt.
Let’s take an example. There is an Irish government Bond due to be repaid in October 2020. If we repay the bond early and replace it with a longer-term bond that would likely reduce the long-term cost and burden of our debt, the accounting regulations will actually say our debt is bigger. Yes bigger, not smaller.
The issue here is that we are using accounting rather than actuarial-type values for our national debt. An actuary, for those who don’t know, is a somebody who deals with numbers to make informed judgments about the future, as distinct from an accountant who uses numbers to make judgments about the past.
Arguably former Minister Noonan did a good job as Minister for Finance, but he did not understand this or wasn’t prepared to do anything about it. This makes it very difficult for the civil servants in those government agencies to act otherwise.
Approaching a serious crisis
We are arguably in a big bubble. The bubble has arisen from the Quantitative Easing (QE) policies of the European Central Bank and other central banks. QE involves printing lots of money and buying bonds with it but that’s only part of the story.
When the central banks print money, they buy bonds. This causes bond prices to go up, making profits for those who own bonds. Those who sell the bonds (and make profits) then buy other assets to replace their bonds causing those asset prices to go up, and those who sold their assets to them (and made profits) buy other assets. This causes a ripple effect through asset markets, inflating asset prices generally. The aim of QE is to create what economists call a “wealth effect”.
The “wealth effect” is designed to stimulate economic growth. It does so because it fools ordinary people to work for the same wages and salaries. They’ll still be able to buy the same goods in the supermarket but won’t be able to afford a house or other big assets to the same degree. Ultimately it’s only growth driven by pulling the wool over people’s eyes.
The majority get nothing
The more wealth you have, the more you gain from the increase in asset prices. For the vast majority of people this amounts to robbery. The majority gets nothing because they have little or no wealth. Their aspirations get brutalised as house prices and the prices of other assets get further out of their reach.
This brutalises society. In the countries which have allowed inequality to increase the most, they’ve elected Trump and May as leaders. Arguably, the QE bubble is not only causing a financial crisis, it is also destabilising society.
Nobody knows what will cause the bubble to pop. But the US Federal Reserve has begun a new policy of Quantitative Tightening – the opposite to QE. Its aim is to reduce the “wealth effect”. This might be comparable to withdrawing an opioid from an opioid addict, misunderstanding the initial effect of the drug as a sign of health. Such action is more likely to cause a withdrawal symptom, arguable a violent one.
What do we need to do now?
We need to immediately borrow €50 billion to replace the debt that is due to be repaid in the next few years with money to repaid much further into the future.
Bond yields are low but are also rising and we should not look a gift horse in the mouth by waiting.
Colm Fitzgerald is an actuary and an economist and is the director of the Actuarial & Financial Studies degree programme in the School of Mathematics and Statistics in University College Dublin.
To embed this post, copy the code below on your site
have your say