The economic situation is unprecedented….John Hurley Govenor of the central bank.

Amid talk of pay cuts, cuts in general and emmigration John Hurley Govenor of the central bank in the republic speaks to RTE, and states clearly that the traditional model of banking is broken. He says there are many challenges to the Irish economy,and he expects it to shrink by 4% next year. Below is some video footage of report from RTE’s week in politics on the efforts to rescue the ailing economy in the republic.

The document discussed in the first video is not without its criticisms….

and finally a little bit of explanation of the recapitalisation of the Irish banks.

  • Harry Flashman

    I have a friend who is very successful in business and who was the first to tell me the nature of the tsunami that was on our way in early 2007, he even accurately predicted the percentages that would be the scale of what was about to hit us. I was utterly incredulous at the time but now see what he was talking about (not too hard really by this stage).

    Anyway I was chatting to him the other day and asked him what he saw for the New Year, my alternatives being major once in a century global recession or total societal meltdown, hoping he’s opt for the former. To my surprise, no fan of this (UK) government he, he thought for a while and said that the “quantitative easing” might just actually work.

    Now a lot of “ifs” were thrown in but his basic point was that if as we all seem to agree that deflation is the nightmare then in strictly British terms (not so sure about the state of the Irish economy) simply throwing open the doors and running the printing presses at the Bank of England 24/7 might well do the trick. Given the huge part of the economy in the public sector who have no fears about losing their jobs and the slashing of interest rates wiping out a huge part of the mortgage bill by about June there could well be a sudden in surge as spending kick starts the economy again.

    Now like I said there were a lot of “ifs”, chief among them the ability of the Bank to throw it all into reverse gear as inflation kicks in, and timing hasn’t really been their strong point thus far. Anyway maybe, just maybe, we might pull this one off. I asked my friend what would be the scenario if it didn’t work.

    “Oh then we’re absolutely fucked!” he replied.

  • frustrated democrat

    Harry

    Unfortunately printing money is not the answer, if only it was.

    The problem is that we would have a further massive devaluation of the £ against other countries and since we import so much all we would do is introduce rapid inflation into the system.

    The total UK debts, including personal, are currently £4.3 trillion or about £140,000 for every employed person in the UK this will take about 20 years to repay, as a consequence the UK’s current credit rating is lower than McDonalds, we could finish up around the local chippie if we print more money.

    The answer is to defer all expenditure that does not provide employment in the UK and redeploy it to areas that do. Thse deferments would include defence projects, health, welfare and education, all expediture that is related to increases in civil service employment and wage rises should be frozen as should MP’s overseas trips.

    We need decisive action, not borrowing more and more money or printing it.

  • Comrade Stalin

    FD,

    The whole point of printing money is to stop deflation and quite deliberately cause inflation. It’s a case of getting the balance right so we don’t drop off into hyperinflation. It shouldn’t be that hard to get right.

  • Dewi

    Greenspan in The Economist – Well worth a read:
    I quote:
    “All debt and derivative claims are offset in global accounting consolidation, but capital is not.”

    I’m not sure that’s strictly true if:
    a) Admin costs of the global trading system (bankers’ bonuses…hmm) are not offset in this zero sum game and

    b) The failure of financial institutions also implies a mis-balance somewhere.

  • Dewi

    And Harry – public sector job losses in the UK:

    Job bloodbath

    “Oldham council is axing 543 jobs while Denbighshire council wants to cut 450 posts. Northumberland County Council is preparing to shed 800 employees with 510 going at neighbouring Newcastle City Council. There will be 400 staff cut in Peterborough and Aberdeen, 300 from Wolverhampton Council with a further 150 next year, up to 190 posts lost in Coventry and 100 in North Somerset. Other councils planning redundancies include Worcester (84), Amber Valley (72), Swindon (up to 50) and Ealing (40).

    Elsewhere in the public sector up to 2,000 mainly white-collar posts will go at Transport for London.

    Seventy hospital staff in Whitehaven, Cumbria, have lost their jobs and the union Unison is warning that NHS staff could be under threat from long-term spending cuts. Widespread redundancies are expected in the Civil Service, where union leaders fear nearly 10,000 jobs will go in courts and the prison and probation services because of cuts at the Ministry of Justice. An estimated 3,500 more will be axed to meet efficiency savings at HM Revenue and Customs.”

  • frustrated democrat

    CS

    I know the point, but in our current financial position it would be a disaster, if it wasn’t already so weak it might have a chance.

    We need consumption to rise and inflation to be stable at around 2% I think it will be much higher as the pound crumbles.

  • Mack

    Comrade Stalin

    The whole point of printing money is to stop deflation and quite deliberately cause inflation. It’s a case of getting the balance right so we don’t drop off into hyperinflation. It shouldn’t be that hard to get right.

    You are joking right? That has got to be the toughest thing possible to get right. First of all, deflation is the destruction of money (redutction in the money supply) – so how do we know how much credit is being destroyed (the banks aren’t renowned for their openness) to offset that destruction accurately? Print to little and it’s failure, print too much and it’s hyper-inflation. In order to ofset the destruction of money (deflation) we need to create new money, which will be lent out and multiplied by the banks thanks to fractional reserve banking.

    But, what happens if some of the new money is hoarded by the banks instead of being lent out? (Maynard-Keynes’ pushing upward on a piece of string). To compensate you would need to create more money, in proportion to the proportion of new money that is actually lent out by the banks. Then what happens if something changes and the banks begin lending the hoarded money (as well as the money you assumed would work it’s way into the economy)? You could have a tsumani of credit, and hyper-inflation virtually overnight!

    All the time investors know you are debasing the value of each pound. Who would buy Sterling bonds in such an environment? What would happen to the pound… I leave that to your imagination…

  • Mack

    To clarify my point about hoarding. You keep printing money to offset the credit destruction (bad loans = destruction of money in the frational reserve chain), but some (or most of that) doesn’t get lent out – banks need to find credit worthy borrowers at a time appetite for borrowing is non-existent thanks to fear of deflation – which makes debt an ever tightening noose. They may find some borrowers – so some new money makes it out there. The government prints a lot more money on the basis that 10 or 20% actually makes it into circulation. Once the money enters circulation it gets deposited and borrowed through multiple accounts so £100 created and lent out becomes £1000 by the end of the process. The hoarded £100 stays at £100. If the government are successful in staving off deflation – demand for borrowing may well rocket and all those hoarded £100’s very quickly get borrowed, deposited and borrowed all the way up to £1000 too. You could end up with a hell of a lot of Sterling in circulation, and a severe inflationary problem to solve (also the borrowers are probably borrowing to invest in something, when you cut the money supply – that investment bubble will also collapse perhaps leaving a bigger mess than now exists).

  • Comrade Stalin

    Mack,

    I thought it was as simple as the bank increasing the balance on the Government’s current account, and the government then spending that money. And if it’s going to be done, it can be done in controlled bursts, not in a Weimar-style uncontrolled fashion.

    I do appreciate your point, though, that this isn’t something that can be done lightly.

  • Mack

    CS – I hope you are right! The mechanism probably is quite simple, and although the government can control what they do – they lose control once the additional money is in circulation. Once it’s deposited in a bank, you can’t force them to lend it out, esp to customers who don’t want to borrow. The Japanese tried it without disasterous consequences, but I’m not sure it was a success either. One of their goals was to increase credit creation in the commercial banks, that continued to decline, although at a slower pace than before. (So arguably, they got less bad deflation as a result).

    I made a mistake above – £100 becomes £900 under Fractional Reserve if 10% of deposits have to be held in reserve.

    Bernake on deflation –

    http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm

  • Jocky

    CS, you have faith in the brain trust at the Treasury to judge the timing on the printing presses to avoid hyper inflation and the pound collapse.

    The same brain trust that was still worried about inflation until September then someone handed them the same script that everyone else had and they then cut rates by 3% in the space of 3 months.

    The same brain trust who thought a cutting the VAT rate by 2.5% was a good use of £15Billion.

    The same brain trust that thinks we will be out of this by next year, without saying how this will be achieved.

    The inflation solution removes the last scrap of moral hazard from the UK economy. The responsible punished and the foolish rewarded yet again.

    You know maybe this is the problem wih the UK economy, you make a bad decision, no worries, the state will bail you out.

    I’ve yet to hear one coherent arguement why if borrowing too much got us into this mess why unprecendented levels of borrowing will get us out this mess.

    If you need a fiscul stimulus anything apart from the VAT cut would have been a half decent option.

    Reducing employers National insurance. Make it cheaper to employ people!

    Or increase Personal allowance, so everyone who is working has more money in their pocket.

    Labour are obsessesed with taking your money off you and then devising ever more complicated systems to decide how much you can have back.

    Pay for it by cuts in public services. First thing any business does when times are tuff is cut back on overjeads. That’s what public sector is.

  • frustrated democrat

    Jocky

    I agree we need much smaller government, the additional number of Civil Servants in the last 10 years should be removed by banning all recruitment for 2009 (c 100,000 or a 20% increase or 2 billion £ per annum, including transfers to agencies)and then freezing all salaries.

    We also need to introduce real business practices into government with hiring and firing and efficiencies that are decided by best practice and not political whims.

  • Glencoppagagh

    Mack
    “Once the money enters circulation it gets deposited and borrowed through multiple accounts so £100 created and lent out becomes £1000 by the end of the process”
    Can you elaborate on how this process operates?
    My understanding of monetary growth is that when a bank makes a loan, the borrower uses it to purchase goods and services which increases the bank deposits of the sellers. The result is that within the banking system as a whole assets (loans) equal liabilities (deposits)and the supply of money is increased by the amount of the loan and no more. Banks’ capacity to make loans is constrained by regulation which dictates the amount of capital and liquid assets they are required to hold.

  • Mack

    Glencoppagh –

    If a person A has a new £100, they spend it in B’s shop. B then deposits it in the bank. The bank can then lend £90 out (it needs to keep £10 in reserve). So C borrows £90 and spends it in D’s shop. D puts in the bank – so now we have £190 on deposit, from an original £100. As far as B and D are concerned they own £190 between them.
    The bank can then lend a further £81 out (to E – and once E spends it in F’s shop the process continues). So C and E owe the bank £171. As long as they can pay that back, everything is fine – the bank can meet it’s liabilities (the £190 it owes to B and D). If they can’t pay it back, then the bank can’t meet it’s obligations to B and D and the bank may then be insolvent (the money supply has effectively been reduced as B and D’s deposits could be worthless). If it is not insolvent it will have to struggle to find another way to meet it’s obligations via asset liquidations – which may cause deflation anyway.

    This process (lending out 90% of the deposit) can continue until there is no more money to lend out (works out at £100 expanding to £900 assuming 10% reserves, I think – There is a handy graph on the wikipedia entry: http://en.wikipedia.org/wiki/Fractional-reserve_banking#Money_multiplier).

    All (or nearly all) money in a fractional reserve banking system is backed by credit / loans of one form or another. So the system should balance out. The problem then is how to make interest payments. They can only be made by expanding the money supply every year. If the money supply goes into reverse the system collapses in on itself.

  • Glencoppagagh

    OK Mack
    I more or less follow your reasoning but…
    “A has a new £100, they spend it in B’s shop. B then deposits it in the bank. The bank can then lend £90 out (it needs to keep £10 in reserve).”
    Meanwhile, A’s bank is short by £100 so B’s bank could simply deposit the money with A’s bank thereby balancing the system.
    You seem to imply that the chain of lending is inexorable which it isn’t. Look at any bank’s balance sheet and see that its assets don’t comprise solely loans and approved reserve assets.

  • Mack

    Glencoppagh – I agree, the system is balanced – that’s why every banking system has adopted it.

    Obviously my example is a gross simplification to demonstrate a point – money gets multiplied in a fractional reserve system. My original point was that there are many unkowns, multiplication of the money they created being one , the amount of money they need to create being another – the government can’t control them easily once it starts to print money. They could end up with more or less credit creation than they think they might. Investor psychology is very different if the environment is deflationary than if it is inflationary.