My Friday post on Irish credit default swap (CDS) spreads seems to have fed into a productive debate among experts on the Irish economy. Still, there is something of a puzzle here.
I was reporting public information from the CDS market, previously covered by Bloomberg, to motivate a call for action by the G7. The potential parallel between Ireland and Iceland is also an idea that has been around for quite a while.
The Irish Economy blog features contributions by some very smart people with a great deal of global experience. The tone in some comments on my postings is therefore a suprise. I was particularly struck by this,
“While the Irish fiscal and economic situation is severe, Ireland does not require any external assistance. It has a low public debt, an asset-rich sovereign wealth fund and plenty of capacity to raise taxes and cut public spending after a decade of rapid fiscal expansion.
Moreover, it is quite unhelpful for outsiders to call for intervention, since it adds fuel to ill-founded concerns about sustainability.
The CDS dynamics are similar to those of a speculative attack on a currency. While speculative attacks can be self-fulfilling if the fundamentals are weak enough, plenty of speculative attacks peter out and this is the most likely scenario in the Irish case also”
The first and third paragraphs make sense, and hopefully are correct. The middle paragraph is striking. If the fundamentals are strong, there should be no trouble fending off a speculative attack. Such attacks only have serious impact when they uncover deeper problems, or when the problems are already obvious to everyone, or when there is tactical mismanagement (very unlikely in this case, surely).
“Don’t make reference to our difficulties, if you are from the outside and speaking in public,” reminds me of Malaysia in 1997-98, where I did some (not well received by powerful people) work. I know why Malaysia was so defensive, but Ireland has always been open to all kinds of ideas and arguments.
If your country’s economic situation is strong, you can laugh off any suggestion that outside assistance is needed. If your situation is weak, discussing the pros and cons of approaching others for help makes sense. It is seldom a good idea to limit debate.
Markets are not moved by comments on someone’s website. They are moved by policy actions or inaction. Do you want policymakers to listen to a wide-ranging debate or not? If not, why not?
The Baseline Scenario 
You definitely should have titled this post “The Irish Problem“.
In relation to the insider/outsider point, I had already corrected my original comment that such a distinction is not appropriate at all – I would have the same opinion of a call by a domestic commentator for external intervention.
I am all in favour of vigorous intellectual competition in relation to the state of the Irish economy. The concern is that there are plenty of ‘noise’ traders in markets, in addition to fully-informed rational traders and the “limits to arbitrage” problem means that there is no guarantee that the latter group will dominate.
This problem is especially acute for small economies since fixed costs in ‘information acquisition and analysis’ mean that there is less incentive for traders to become fully informed, increasing the sensitivity of traders to ‘rumours’ (or, more generally, blog postings by very influential former Chief Economists of the IMF). This phenomenon is well described by Calvo and Mendoza, “Rational Contagion and the Globalization of Securities Markets”, Journal of International Economics, 2000.
There is certainly a significant set of international traders who are excellent analysts of the Irish economy and, on net, I think the role of international investors (including hedge funds etc) has been very helpful in signalling problems in the Irish economy. However, it is also possible that, at some point, the set of less-informed traders may become more influential, especially in very thin, non-transparent illiquid markets such as the CDS market for Irish sovereign debt.
As is well known, there are many models in which ‘multiple equilibria’ are possible in asset pricing (so long as the macro fundamentals are sufficiently weak to give some weighting to ‘collapse’ scenarios). Accordingly, calls by eminent economists for external intervention can influence markets for the reasons given above.
The post suggests that the audience for this kind of debate is the set of policymakers. If this were the only audience, I am all in favour of a wide-ranging debate that considers all possible scenarios. However, my concern is that the larger audience consists of the global pool of investors and opinion makers that relies on influential commentators such as Simon Johnson to learn about the Irish economy. It is in this context that I believe that the original posting was not helpful.
That’s the trouble with forums like the Internet: the audiance is everyone. When a country feels that the only way to preserve confidence is to guarantee all private debt held in its banking system, you have to question its ability to honor that promise.
Ah… the wonderful “public information from the CDS market”. It would be a fantastic indicator if it weren’t a contradiction in terms.
As Mr. Lane points out above (and as I also did before), the CDS market is a very illiquid market, and as such a very, very, very poor indicator.
Just to give an indication, the current spread between 5-year Irish and German bonds is 258bps; in comparison, the Irish CDS was 377bps on Friday evening — and most of the difference was created in just two days (Thu.-Fri.). Clearly, the much larger and much more liquid bond market is not as concerned as some people are.
Meanwhile, 5-year CDS on US Treasuries currently trade at 87bps (and have been creeping up almost continuously over the past 12 months). In other terms, the CDS market sees a 1-in-115 chance (per annum) that the US government could default in the next five years — something which should probably send tremors down the spine of all the Finance professors who have been teaching for decades that US Treasuries are the world’s risk-free asset.
Or should they? Because if the US were to default, the systemic damage to the system would be so huge that we can assume that no counterparty would be able to deliver on these US CDS. So these CDS should be worthless…
I would be interested in learning what Mr. Johnson thinks of it. Are CDS prices poor indicators, in which case we should all try to sound a bit less catastrophic (and too bad for all these journalists looking for dramatic soundbites)? Or are they decent indicators, in which case we should all start buying gold and stockpiling food cans in our basements?
Thank you for this.
You “hope they are correct.” Well, should you know? I mean this is key fundamental info about their economy?
who is kidding who private debt to income ratios in Ireland are ridiculous, in a global Fisher debt deflation scenario they become unsustainable. Folks borrowed short and cheap to go long on assets, now we face a classic Minsky instability scenario the Irish economy is facing an income shock and folks have move from speculative finance to ponzi, as asset prices tumble more folks are moved from speculative finance to ponzi survival, who care what the spreads say you can work this out by look at the debt to income ratio projected against a global slowdown thats knocking the socks of Irelands trading partners.
Private Irish debt to income is x3 US and x2 UK your suggesting its a geopolitical psychological problem ? The world simply needs therapy, nothing to fear but fear itself :)
The problem with Ireland and also the world is that no-one really knows the state of the banks. We might be looking at complete and utter insolvency. If no-one knows, we can only guess. The market has guessed that the Irish banks are insolvent.
Asset prices are now in a downward death spiral in Ireland as unemployment increases, perpetuating the spiral to the bottom. This is going to get a lot uglier, so if the banks are insolvent now, they definitely will be in the years to come. The debt just got way too big in Ireland.
Ireland can’t deal with this debt politically because the banks own the politicians, dictating policy decisions. AngloIrish advising Lenihan to screw over the school kids and the pensioners to save money so that the banks could be saved. Increased pension levy to save AngloIrish (which was not only incompetent, but its directors acted in a criminal manner). Are the directors fired let alone in prison? Fitzpatrick has stepped down. That’s it.
Outsiders will view the spinelessness of its political class with aversion.
The problem with Ireland and also the world is that no-one really knows the state of the banks. We might be looking at complete and utter insolvency. If no-one knows, we can only guess. The market has guessed that the Irish banks are insolvent.
Asset prices are now in a downward death spiral in Ireland as unemployment increases, perpetuating the spiral to the bottom. This is going to get a lot uglier, so if the banks are insolvent now, they definitely will be in the years to come. The debt just got way too big in Ireland.
Ireland can’t deal with this debt politically because the banks own the politicians, dictating policy decisions. AngloIrish advising Lenihan to screw over the school kids and the pensioners to save money so that the banks could be saved. Increased pension levy to save AngloIrish (which was not only incompetent, but its directors acted in a criminal manner). Are the directors fired let alone in prison? Fitzpatrick has stepped down. That’s it.
Outsiders will view the spinelessness of its political class with aversion.
Pete
Simon Johnnson makes exactly your point
http://www.pbs.org/moyers/journal/02132009/watch.html
Yes, I too remember Mahatir’s comments on global capital flight and the blame game (George S.). It’s nomadic by nature.
The Dublin financial sector is not the economy.
Ireland led out the gate with a variation of “our currency, your problem” statement in guaranteeing banks.– Our problem your currency. So, an EU accomodated solution will be enabled. Iceland is not an EU member.
Ireland is also impacted in its major export market, the UK,with the Sterling moving down. With a corporate tax rate of about 12% there is still scope.
Brussels is terrified of seccession and unravelling and all peripherals know this. To paraphrase Bernanke ” the mere threat of of doing this”-managing perceptions and expectations.
If offered a “Cromwellian” (to Hell or Connaught) by vested parties there is always the geostrategic ploy–A Russian naval base. This would upset the UK tremendously, as well as the EU and USA. Or the mere threat of such like. This is just tongue in cheek to demonstrate to the myopic financial cliques that there is more than one way to skin a cat. Nations don’t have friends they have interests. By the way the Soviet Union was the first to recognise the Free State.
The truth hurts, eh Philip?
Personally I was shocked by what I read in the Times online about the Green Jersey Agenda. Basically the Irish regulators appear to have sanctioned the kiting of monies between Anglo Irish Bank and ILP to create a potemkin village of solvency. That information alone calls into question both the competence and solvency of the Irish government.
http://www.timesonline.co.uk/tol/news/world/ireland/article5733823.ece
Once my initial shock wore off, I realized that the US government had done something very similar with JP Morgan and tried to do it with Citibank.
As Warren Buffet put it, “There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and we’re winning.”
Now the oligarchs fear that the peasants are waking to the situation, will they rise or be distracted by some new bauble? Or will it take a war or pogroms to protect the elite?
I want to know what numbers Phillips looking at ? Is it the private debt to income ratio? Is it the percentage of economy deovted to housing? Is it the household balance sheet of your average family worker?
On what comparitve basis would the so called “informed” trader conclude that Ireland has a healthy stable economy?
The truth is the neo classical equalibrium based inflation targeting forget about debt level economist are in the tar pit Minksy/Fisher have returned form the deep freeze to shovel the BS over their heads
After reading the Irish press over recent months I had come to the conclusion that the Irish were being done a great disservice by their own media. Either the journalists/columnists do not understand even basic economics and are totally incapable of satisfactorily explaining Ireland’s frightening predicament; or there is a deliberate policy of keeping the general populace uninformed…
and yes, I do detect a “feck off outsiders” stance.
I’m truly convinced that big banks world wide should be broken up. If you’re too big to fail than you’re too big to exist. Lobbyists should be summarily executed as well. Banks are suppose to serve the people not control them. Capitalism is good but, should have close oversight and, criminal law should apply to all, even to Rothschild s and Bush’s alike; whether it’s written or not. The masters of the universe know right from wrong, just because they pay a congressman not to write it into law doesn’t make right. If my kid told me “you never informed me that what I did was wrong” he’d be eat’n soup for a month.
Hey, Phillip.
Stop whinning and go sell some CDS then.