OPINION:Why isn't Ireland's shrinking money supply being widely discussed? Do too few people appreciate the alarming problems being created,? asks Richard Douthwaite
MONEY SUPPLY can be measured in several ways, but one of them, M1, covers the two types of money generally used for day-to-day trade. One type is the cash in people’s wallets. The other is the money they have in bank accounts to which they can get immediate access.
Central Bank figures released on December 31st show M1 fell by 14.2 per cent between November 2007 and November 2008. This is serious since, if there’s less ready money about, less trading can occur. The contraction in the money supply is forcing the whole economy to wind down.
The decline in M1 actually began last April, so it’s not surprising that small businesses have been complaining on radio phone-ins that they are having greater and greater difficulty getting paid. Their sales are suffering as a result, since most firms will not allow customers who have not paid their previous bills to buy again until they do.
The slow-down in payments also means that borrowers are having increasing difficulty getting the money together to service their loans. They are, in effect, playing musical chairs, and as the monetary chairs are taken away, fewer of the players can find the means to repay their debts when the music stops at the end of each quarter. Those who fail are eliminated, causing the banks’ bad debts to increase.
The taxpayer will have to make good at least part of these losses. This would have been the case even if there had been no government bank guarantee, as every billion the banks lose means ten billion less they can lend. Thus, if the Government had failed to step in as losses mounted, loans would have been more tightly restricted and perhaps even called in. A frightening spiral of bad debts leading to more bad debts could have developed.
But injecting billions into the banks after they have made losses is to pour it down the drain. All such cash can do is prevent matters getting worse. The problem of too little money in circulation for private debts to be repaid stays unsolved. It would be far better to use the money now to prevent bad debts being incurred rather than to throw it away in a year’s time either to stop the banks imploding or to honour guarantees.
The State therefore needs to get more money into people’s bank accounts if it is to have any hope of avoiding a banking collapse. The resulting increase in the public’s spending would give at least some of the businesses which have borrowed the means to service their loans.
Money gets into circulation, and thus into people’s bank accounts, in three ways. One is that the country earns it by selling more goods and services outside Ireland than it imports.
Unfortunately that way is closed off, as the country is running an €8 billion-a-year deficit on its balance of payments current account and it is hard to see how this could be corrected in the next few months. Indeed, that deficit, which was exacerbated until recently by high fossil fuel prices, reduces the amount of euro in circulation and thus increases the amount of money that has to be brought into the country by other means.
The second way to get more money into circulation is to get foreign firms to invest here, a strategy which Ireland has been following for years and which does not deliver rapid results.
The third way is for the country to borrow it. However, Irish residents are already massively over-borrowed. In 1997, Irish private sector debt was roughly equal to the total income accruing to Irish residents (including resident companies) each year. At the end of last year, however, the debt was around 2.6 times national income.
This is by far the highest level of indebtedness in the EU – in Germany and France the ratio is still 1:1. It makes Irish costs higher than elsewhere because the country is having to pay to service a much greater burden of debt than its international counterparts. When Forfás bemoans the loss of Irish competitiveness, this is something it should blame.
Should families and firms really take on more debt in view of this massive burden? It would certainly be the height of folly for them to borrow to invest in the property market or to maintain current rates of consumption. Any new loans should be invested only in ways which bring down Ireland’s demand for imports and thus free up enough money to allow the foreign portion of whatever money they borrow to be serviced and repaid.
Only a fraction of the required loans would need to come from outside the country. Just as €1 billion lost by a bank means that €10 billion disappears from circulation, so an inflow of a billion from abroad creates an extra 10 billion in deposits here. It also creates €9 billion extra in debt owed to Irish residents.
In early November, Joan Burton of the Labour Party asked the Minister for Finance whether “his attention has been drawn to the fact that there was a fall of 10 per cent in the amount that Irish residents held in their current accounts between August 2007 and August 2008 . . . and that there was a 12.6 per cent fall in their demand deposits over the same period?”
She pointed out that a rapidly shrinking money supply meant borrowers “will soon be unable to service their loans, while small businesses will face serious cash-flow problems”.
In his written reply, Lenihan said the “amount of deposits held by Irish residents in overnight deposit accounts between September 2007 and September 2008 declined by 12.9 per cent. However, this was more than counterbalanced by the increase in term accounts of 22 per cent, or €18 billion. This would suggest that Irish people may be moving their deposits from overnight deposits, which generally offer low interest rates, into accounts with much higher interest rates, such as those with an agreed maturity.”
Since he gave that answer, however, the amount in term deposits has fallen too. While Lenihan’s present view is unknown, some Cabinet members realise the dangers presented by the declining money supply, and want the Government to initiate a money-creation-by-borrowing cycle. They argue that as most of Ireland’s energy is imported, the State should borrow funds abroad for use in bringing forward private investment projects (hence private borrowing) which would reduce imported energy use.
To be effective, the scale of the combined private and public borrowing would have to be substantial – around €50 billion perhaps. Of that amount, the State might get away with borrowing a tenth if it spent it cunningly on energy infrastructure and investment incentives. Guaranteed feed-in prices for renewable energy supplies would be needed too.
Whatever sum the State borrowed could be much less than the amount it would have to find to inject into the banks if it did nothing, particularly as there would be substantial offsets as a result of the taxes that the increased activity would generate.
Certainly, unless Ireland can find a way to halt the decline in its money supply, it will be relying on the stimulus packages introduced by other countries to do so instead. If that strategy fails, it may have to abandon the euro and revert to a currency that it does not have to borrow because it can create it itself.
Richard Douthwaite is an economist and a co-founder of Feasta, the Foundation for the Economics of Sustainability