Joe Craig

1 December 2008

In their recent budgets the British government reduced VAT (temporarily) to 15% from 17.5% while the Irish government increased it by half a percent to 21.5%.  The British government unveiled a temporary stimulus to the economy of the order of £20 billion while the Irish government announced tax increases.  This initiative by New Labour may be seen as part of a wider European approach endorsed by the European Commission which last week called for a coordinated stimulus of €200 billion in tax cuts across the EU.  The Irish State immediately ruled out its participation.  While discussion elsewhere has focussed on some tax cuts for the very poorest, in the Irish State the budget announced an unprecedented levy on the lowest paid which only later had to be withdrawn.  For it, the issue was not how much it could put into the economy but how much it could ‘safely’ take out 

The stimulus packages called for by the EU Commission and introduced in one way or another by governments around the world reflect serious concern that the shift into recession worldwide may prove to be deep and prolonged.  The prospect is raised of a deflationary recession in which prices fall, discouraging spending and investment, and the real burden of debt is increased, while stimulus policies such as lower interest rates become useless.  This, it is feared, may produce a 1990s style Japanese-type slowdown, except that it might conceivably be worse.  The different approaches of Britain and the Irish State show that the former can gamble on minimising the impact of this capitalist crisis while the latter cannot.

Fundamentals

A year ago the Irish State could look down on the relatively anaemic performance of Britain’s economy compared with the high growth of the Irish State.  Now, in less than a year, it has gone from boom to bust in spectacular fashion.  In the process the fundamentals of economic power have been revealed.  These are that the US remains the centre of world capitalism and its crisis is one that none can ‘decouple’ from.  As possessor of the world’s main reserve currency it is in a unique position to adopt policies that no other State can, in an effort to prevent the worst aspects of the world-wide recession.  There are however limits to its power and the origin of the crisis in that country demonstrates this.  Just as it could not prevent the crisis it cannot prevent it getting worse.  Its huge economic stimulus packages, with a further $800 billion announced last week, and rescue efforts for its bust financial institutions will not prevent the laws if capitalism operating.

This means that the massive generation of credit and debt unsupported by equivalent creation of real value must come to a grinding halt.  This contradiction has been exploded by the inability of poor American workers to earn enough from real value creation to pay back speculative mortgage lending.  The collapse of many financial institutions as a result and plummeting share prices demonstrate that the capitalist class has also lost wealth.  Financial institutions now have to undergo a process of deleveraging, cutting the level of debt and reducing the growth of new credit creation.  In order to manage this process the capitalist State in many countries has had to step into the breech, to ensure this destruction of debt and reduced credit growth does not happen too suddenly, thereby precipitating economic collapse. The US State has thus substituted State debt for private debt as have all the major capitalist powers, while deceitfully claiming that the banks must continue to extend private credit which was the problem in the first place.

Unfortunately for capitalism the contradiction between real value creation and extended credit is not abolished if the expansion of credit is undertaken by the State.  The capitalist State does not abolish the laws of capitalism.  This means that the credit worthiness of the State must itself come under examination by capitalism, usually termed the ‘market’, capitalist investors in real life.(1) This led one investment figure, Peter Schiff head of EuroPacific Capital, to remark that the US State’s AAA credit rating (the top one) is a ‘joke’ and must presumably at some point be treated as such.  The US cannot borrow indefinitely because the crisis of its financial system has revealed real, and probable irreversible, long term relative decline.  (The US right understands that the increased role for the State signals the failure of US capitalism even if their protests about creeping socialism are nonsense.)

The US cannot do this because it has been money from the rest of the world that has been financing it for the best part of the last decade.  If this could happen during a boom and come increasingly under question, more and more funded by foreign governments rather than investors, foreign investment in a recession looks more improbable.  Fears are being expressed by UN economists about a hard landing for the dollar in 2009.  The deleveraging must therefore come at the expense of attacks on the living standards of the working class, who must be made to pay, but – such is the depth of the crisis – it must also come from devalorisation of capital.  In other words capital as a whole must lose value – through debt write-offs, firms going bust or drops in the price and value of investments.

The punishment of some capitalist investors in the US e.g. those in Bear Stearns or Lehman Brothers indicate that the scale of the crisis is such that sections of the capitalist class must therefore take a hit in order to save the system as a whole.  This is reflected, in other ways, through the increased top rate of tax in the UK (to 45%) and the increased levy of 3% on higher incomes over €250,000 in the Irish State.

Nature

If the US State is powerless to prevent a deepening crisis how less able is Britain.  Its stimulus will increase public debt to £118 billion.  Sterling used to be the world’s reserve currency but its pre-eminence is long gone.  The scale of the British State’s attempts to reduce the impact of the economic crisis must therefore be more modest for fear of precipitating a collapse of sterling, which has already come under pressure.

The British have however been able to put together some sort of attempt to mitigate the crisis; the Irish State does not have the power to do anything. All talk of an Irish stimulus package would be regarded as a joke that would quickly become a tragedy were it attempted.  The Irish government have more or less admitted they couldn’t afford it. While the British package is too small – who is going to rush out to spend because of a 2.5% drop in VAT when shops have to launch pre-Christmas sales offering 20% to 25% reductions? – at least it could make an effort.  The Irish State, despite over a decade of the Celtic Tiger and the boasting that has gone with it, is revealed to be utterly incapable of maintaining even its current level of spend, and, unlike the British, has so far even failed to spend money on recapitalising its banks.  In fact Finance Minister Brian Lenihan has boasted of how cheap the Irish solution to the banking crisis has been – “the cheapest bailout in the world so far”, in effect attempting to make a virtue out of a necessity.

Only now has the government been forced to eat every word it said about State investment in Irish banks and at long last admit it may have to put money into saving the financial system.  This, after it was reported that the Bank of Ireland and Irish Life and Permanent are the target of private equity investors from the US, backed by sovereign wealth funds from the Middle East; that is US vultures backed by Middle Eastern governments.

After a decade and a half of the Celtic Tiger the great Irish economic miracle might end by its banks not even being indigenously owned.  While socialists might not think it any matter of principle which set of capitalists runs a company or an industry the competitive nature of capitalism means that for any particular part of the system, in this case the Irish part, it may matter quite a lot.  That the Irish State has seemed to countenance private equity control of major sections of its financial system reveals a political bankruptcy that literally reflects its pecuniary position.  Private equity would look for a quick profit by ruthlessly cutting jobs, milking its loan customers and selling off what it could before eventually selling off what it had left, which might not be much at the very end.

But not to worry, Lenihan has informed us that “we cannot characterise foreign investment all the time as predatory or a threat.  Of course, if there is private investment in the banks, I will have to ensure that the public interest is served.”(2) 

But this is capitalism.  It is what the current owners will do, if not quite so quickly.  In any case current ownership has hardly been a success, playing a significant role in the speculative bubble that has just burst so dramatically with the devastation that will result.  Now it will squeeze credit just like every other finance system across the world and will face the same criticism for doing so, exactly the same criticism that we now hear in Britain and the US.  This is what we called deleveraging and it is what the laws of capitalism are forcing on all financial institutions.  “It doesn’t matter if we were to raise up to €20 billion in capital, we still have to reduce our loans-to-deposits ratio and our reliance on wholesale funding”, said one unnamed Irish banker.(3)

In fact the degree of deleveraging that must be undergone by some Irish banks shows the depths of the problem facing these institutions and the impact this process will have on the wider economy.  It has been reported that the average loan-to-deposit ratio of Ireland’s banks in April was 163.1% while that of Irish Life & Permanent was 277.4%, ‘one of the highest of any western financial institution’(4); compared to a typical US commercial bank percentage of about 100 to 110 and a euro zone average of 86.6%.  One economist has pointed out that if current market valuations of the banks are correct then next year they would have to write off three quarters of their capital as bad debt and reduce bank lending by three-quarters ‘driving most companies in Ireland out of existence.’(5)  It is thus not essentially a question of whether the bankers are Irish or foreign. 

Once again the lies told when the bank guarantee scheme was introduced have been laid bare.  If, as the government claimed, the banks are really sound and it was only a matter of creating the conditions that allowed one bank to lend to another, would it now be so reluctant to invest in what must be profitable businesses?  In fact why is recapitalisation even necessary?  The lie that the system could be saved on the cheap; that alone among capitalist countries and unlike the US or UK, the Irish State could get away with paying nothing, has been too ludicrous a position to take seriously, yet for nearly two months we have all been expected to believe such nonsense. 

Recapitalisation is not an option for Irish capitalism, it is a necessity.  The only question is how it will happen, who will pay for it and what mitigating effects it will have on the banks position and that of the rest of the economy.  At least on this the government and bankers have been correct – it will not allow a resumption of lending on anything like the scale that will allow an escape from recession.  The Irish economy is in for a very hard time and the working class in particular is going to be asked to pay the bill for it.

Notes:

(1)Thus today’s (1st December) ‘Financial Times’ quotes Roger Brown, global head of rates research at UBS, as saying that “Governments are already running into problems, which does not bode well so early after the recapitalisations and extra funding needs have been announced.  We do have to ask whether there will be enough investors to buy the bonds, or at the very least over whether this will push yields substantially higher to attract them.  Given the volumes involved investors may decide to wait and see if yields rise.”  As the article itself says ‘ faced with contracting economies, lower tax receipts, and rising benefit payments, countries could face higher debt servicing costs as overall debt levels rise.’  The article warns that even in Germany, with one of the world’s most liquid bond markets, an auction failed in the previous month – ‘something virtually unheard of until this year.’

(2) ‘The Irish Times’ 26 November. How he would do this (even were a ‘public interest’ to exist) he does not explain, otherwise he might have to explain how he and his predecessors have failed to do so these last years.

(3)‘The Irish Times’ 21 November.

(4)‘The Irish Times’ 28 November.

(5)‘The Irish Times’ 24 October.