Current public debt issues are different from those faced by the Irish and other economies in the 1980s.
THOSE WHO say Ireland’s public debt position is not so dire frequently point out that the State was similarly burdened in the 1980s and it managed to avoid default then. But this argument carries little weight, because both domestic and external circumstances are utterly different now.
At home, nominal GDP growth is much lower than it ever was in the 1980s, and it may continue to stagnate given the existence of a number of growth-inhibiting factors not present a quarter of a century ago. These include battered household balance sheets and a shattered credit provision mechanism.
If the economy remains on the canvas, the debt to GDP ratio will continue to rise. The higher it rises, the more likely that a restructuring/default will occur.
But the manageability of Ireland’s public debt will depend not only on what happens to the economy here. Access to international capital markets, and the price of that access, will also be a factor.
The Irish State has long raised an unusually large proportion of its funding needs from foreigners. More than 90 per cent of the stock of Irish Government debt was held by non-residents at its peak in 2008. This was more than double the average proportion in developed economies and higher than in the 1980s.
One of the reasons for such low national uptake of Government bonds was the decision of Irish pension and insurance fund managers to diversify out of Irish assets after Ireland joined the euro – in stark contrast to their counterparts in the banks who put every egg they could get their hands on into a single asset-class basket (fund managers’ diversification has been crucial in protecting people’s wealth in Ireland, an unusually large amount of which is held in pension and insurance pots).
If the sovereign’s pre-bailout dependence on foreign funding was greater than in the 1980s, the difference in international market conditions is greater still. In the 1980s, only Belgium, Italy and Ireland had public debt to GDP ratios in excess of 100 per cent among developed countries. By 2012, the OECD believes the US, France and Britain will be there or thereabouts. With Japan and Italy already supporting burdens well above 100 per cent, five of the six biggest advanced economies are highly indebted. This is unprecedented in peacetime.
Even if the bond market were to return to its behaviour of the past decade, when it was indiscriminating in its treatment of rich country debt instruments, the sheer volume of new debt issuance is bound to push long-term interest rates up for everyone.
But it is neither likely nor desirable that the market will return to its old ways. Countries considered at risk will pay big premiums. It is hard to see how they could be smaller than in the 1980s when concerns about rich country default were very low or non-existent.
Now, that spectre looms ominously across much of the rich world. It loomed larger again this week when the triple-A rating of the most indebted sovereign in absolute terms – the US – was placed on negative watch by Standard and Poor’s.
The debate on the timing and magnitude of fiscal tightening in credit-worthy countries has waxed and waned. But with the Conservative-Liberal coalition in Britain firmly on the path towards stimulus withdrawal and the US increasingly likely to follow suit sooner rather than later, the two most aggressive stimulators in the developed world will no longer be supporting demand.
The risks attached to allowing public debt to accumulate at the rate it has over the past three years are increasingly seen to outweigh the risks of tightening. The way in which markets turned against some sovereigns, including Ireland, could happen to others. The situation is very fragile and looks set to remain so for the foreseeable future.
Of the big triple-A rated economies, France and the US are the most vulnerable to downgrade. Their debt-GDP ratios passed the 90 per cent threshold last year.
None of this is to say that the risks of premature fiscal tightening have gone away. They remain large, particularly if many economies tighten at the same time, and even more so when monetary authorities raise interest rates. If the recovery is more fragile than believed, the withdrawal of an accommodative fiscal-monetary mix could tip the developed economies back into recession. Damned if you do and damned if you don’t.
For Ireland, even in a best-case scenario of being able to return to the markets as scheduled next year, interest rates look set to be high for a long time to come.
The head of the European Central Bank Jean Claude Trichet never tires of pointing out that the euro zone’s public debt level is lower than America’s. That has been the case in net terms since 2008 and in gross terms since last year. This is partly to do with the vestigial Keynesian influence that exists in the Anglosphere.
As the chart shows, gross public debt almost doubled in Britain between 2007 and 2010, and grew by more than half in the US. There were two reasons for this. First, the domestic economies of Britain and the US suffered deeper contractions than the more balanced, less credit-dependent continental economies – the latter’s output contractions were caused more by a decline in net exports.
This greater domestic shock in the two big English-speaking economies led to higher welfare payments and an easing of the tax burden kicking in automatically (this is known as the “automatic stabiliser” effect).
The second reason is that both countries proactively ramped up state spending to support aggregate demand more than in continental countries. This shows, among other things, that faith in the interventionist state is sometimes stronger in the Anglosphere than continental Europe, where Kenysianism never really caught on.
