Cash is King
It is not that I don't enjoy a good old bull/teflon run as much as the next guy but just to provide some form of balance to the current QEeasy Money Hymn I almost choked on my oatmeal earlier this week when I loaded up Bloomberg and learned that everything suddenly was fine in the erstwhile whipping boy (alongside Greece) of the Eurozone as the economy apparently has the cash to starve off any foreign bond vigilantes;
Ireland expects its 20 billion-euro ($28 billion) cash pile to stave off a Greek-style rescue, as the government taps the funds to avoid paying record rates to borrow. The government canceled next week’s debt auction and another scheduled for November after the yield on 10-year Irish bonds rose to a record 454 basis points above benchmark German bunds. Finance Minister Brian Lenihan has said Ireland is “fully funded” through the middle of 2011. The country has 4.4 billion euros of bonds maturing next year, compared with about 27 billion euros in Greece.
I find this fascinating for a number of reasons. First of all there is root of the problem itself in the form of Anglo Irish Bank which will cost Ireland perhaps up to 30 billion Euros and will be responsible for a fiscal deficit in 2010 to the tune of of an unbelievable 32% of GDP. Naturally, this is expected to be a one-off expense and the whole exercise on cancelling auctions is because Ireland feels that the yields it would be able to borrow for at the moment would not reflect the long term health of the economy.
This makes sense. Why borrow if you don't have to and especially if you are not happy with the terms put forward by your potential creditor. On this point I am, in principle, on Ireland's side as it were. But what if costs for bailing out Irish banks are understated? Indeed, what is the real cost of assuming the entire bad loan book of Irish banks with no haircuts to bondholders or no restructuring of any kind? I don't know, but more importantly; I am not sure the people concerned in Ireland know either. After all, the fact we are now looking at a +30% deficit as % of GDP in 2010 was not part of any of the official rescue manuals I think.
Consequently, let me throw another number at you; 3 % of GDP which is the fiscal deficit targeted for 2014 and which the market is supposed to take as collateral for a lower yield on Irish debt offerings in 2011.
Yet, is this plausible?
Basically, you have a confirmed 32%/GDP deficit today and you are promising to bring this down to 3% in a manner of 3 years. What are your assumptions here? What kind of nominal growth in GDP is build into the model? How will national debt evolve over this period? I am sure the good people at the National Treasury Management Agency are busy calculating just that as I type, but the problem is more profound.
Ireland has basically made the bet that in using its remaining reserves today and thus avoiding going to the market it can bring back its house in order and then return to borrow at that time, but this is circular thinking. The main question is whether Ireland has enough money to bail out its banking system such as it is. Alan McQuaid, quoted by Bloomberg, puts it well;
“They are taking a gamble that the budget will deliver and get spreads down,” said Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin. “If that doesn’t happen, maybe you skip a few auctions at the beginning of the year. But at some point, you have to go to the market. If you can’t go to the market, then you have to look at outside aid.”
And Danske is even more sanguine, but then again they would be wouldn't they as they own National Irish Bank and thus effectively depend on this gamble to succeed (at least in terms of the health of their Irish operations).
“The government has a significant problem” unless yields fall, said Soerensen of Danske Bank, which owns Dublin-based National Irish Bank. “But it isn’t under any immediate pressure to raise cash, and even in the unlikely event that the government had to call upon IMF/EU aid, investors would still get paid. There isn’t going to be a default.”
But I think that we are still missing the main point here. This is not only a question of how dubious it is that Ireland can get its house back in order (and what kind of economic pain it will take) it is also a matter of whether it is in Ireland's interest to enter the market at all. Essentially, the current interest rates are unpayable for Ireland today but also in the middle of 2011 since this is where, presumably, the full force of fiscal contraction will be put on the Irish economy.
So, my reading of this is that Ireland has now played itself into whatever deal it can broker with the IMF and EU and while I may be persuaded otherwise by a credible fiscal plan it is not the actual promise I will be looking at but the assumptions of debt/gdp and nominal GDP growth which underlies it.
Until then, Ireland can continue to heed the old proverb that cash is king; it sure is ... until you run out.