Five reasons we could be on the verge of another crash
WHEN Finance Minister Paschal Donohoe takes to his feet in the Dáil on Tuesday to present Budget 2019, the shadow of the crash a decade earlier will still hang over what he has to say.
From the housing crisis, to the universal social charge, the gaps in public services to the squeezed middle, its legacy will shape the content of his speech.
But so too will the growing risks of a second crash that could see jobs, Exchequer finances and economic growth badly impacted. It is hard to conceive of ‘Crash II’ when the economy is growing at such a clip, but failure to address the risks would show the political class have learned nothing from a decade of financial pain for so many.
To understand the risks associated with a possible future external economic shock, we have to understand what happened last time.
The causes of the last crash, which resulted in a crippling bank guarantee and an IMF bailout for the State, are well known.
Suffice to say that the risks built up in the system were internal and home-made – from poor regulation, to property mania and excessive bank lending, combined with irresponsible government spending. The triggers were all external – the sub-prime mortgage scandal in the US, the liquidity crisis in banking, rising interest rates, etc. We got ourselves to the cliff ’s edge, but the gust of wind that pushed us over was outside our control.
This time round it looks very different. The risks that are building up are largely external and outside our control, as are the triggers.
The government, the regulators, the business community and consumers are not powerless in insulating themselves from the impact of a second crash, but it may arrive at our shores at hurricane speed.
Here are the main risks:
1 Exchequer weak spots
Despite all of the pain of the last crash, we still have Exchequer weak spots where the State’s finances are vulnerable to an external shock.
We have become too dependent on the Corporation Tax take, which relies massively on a small number of multinationals. Just 20 of them paid half of the corporation tax in 2016 or €3.7bn.
But it isn’t just corporation tax. Workers at multinational firms account for over a fifth of all income tax paid in the State and the large number of high earners at these firms poses a real risk to the tax base, an Oireachtas report found.
Mr Donohoe hopes to bag an extra €375m from stamp duty this year, as commercial property transactions continue with major deals. What happens when the fizz goes out of that market and the stamp duty receipts drop along with it?
Transactional taxes such as VRT boomed in recent years swelling the State’s coffers. But already we are seeing a significant drop-off in new car sales which will also hit VRT.
The economy is growing at the fastest rate in the EU for the fourth year in a row. Yet the Exchequer is still borrowing money to balance the books. The Government intends to borrow next year too unless Mr Donohoe tweaks his figures or hikes a lot of new charges and taxes next Tuesday.
Despite broadening the tax base after the crash and ensuring that workers pay more in tax now than a decade ago, there are real vulnerabilities in our tax mix that could hit public services, public sector workers and overall expenditure in a downturn.
Studies have shown that a hard Brexit or no-deal Brexit could cost tens of thousands of jobs. The real danger is that many of those losses would be in indigenous exporting sectors located in small towns, where they are much harder to replace. But it isn’t just about a hard Brexit. If anything the last two years has shown the chaotic state of British politics in general.
Whether it is a second referendum to Remain or a Jeremy Corbyn-led government that comes to the rescue on Brexit, our nearest neighbours have shown they are highly susceptible to a new brand of promise-all populism, whether it is leftwing or right, that is capable of damaging Ireland’s economic interests.
A no-deal Brexit will keep sterling low for the foreseeable future which will seriously hit our indigenous exporters. Their best option might be to locate more production outside this country, as we are already seeing in with the larger beef processors.
3 President Donald Trump
There are several risks posed by Mr Trump’s economic policies. If his corporation tax reforms work as he wants, his new taxation regime could undermine the investment case for Ireland. We won’t lose our multinationals en masse – but we could lose some or find it harder to attract new ones.
The other potentially damaging issue is his insistence on trade wars. We are not immune from his trade war with China given the potential this protectionism has to stunt global economic growth. As an open trading economy we are very vulnerable to such a slowdown.
4 Global debt
The world is more indebted that it was a decade ago. Mr Trump has increased US borrowing by over $1.4trn since he became president. He expects to run up a budget deficit of over $1trn next year, partially to fund his corporation tax cuts.
Our own national debt, at €200bn, is four times what it was a decade ago when we entered the last crash. We have raided the kitty already.
Global sovereign debt remains higher than it was at the beginning of the last crash. So any major economic downturn or financial shock, would be felt even harder and more likely to spread.
5 Interest rates
Nama CEO Brendan McDonagh recently warned about the potential impact of interest rate rises on the property market. Property will become less attractive to investors as interest rates begin to rise.
“Quantitative Easing (QE) has produced investment behaviour which is unprecedented in the property market and that’s not just in Ireland,” Mr McDonagh said. “You have to be realistic. When interest rates start rising then property values might stagnate or go down because people look for alternative investments.”
Interest rates have been at historically low levels in many advanced economies for several years. QE has been unwinding in the US now after six successive rate rises. However, its new target range of 2pc to 2.5pc is still extremely low by historical standards.
The US Fed, the ECB, the Bank of England and the Bank of Japan, have chipped in a combined $14 trillion of QE since the crash.
This is new money created to buy assets. Unwinding all of that could prove tricky.
As economies like Germany grow faster, so too will the need to put up interest rates. In Ireland we do not have a new credit bubble in housing, as we did 10 years ago.
But we do have an old one.
There are still legacy debts and many people who have borrowed substantial sums to buy their homes in recent years. They should have been stress-tested by the banks on interest rate hikes, but that doesn’t mean rate increases would not be very painful, and erode their disposable income.
But QE and massive central bank buying programmes have created bubbles everywhere from the bond market to equity prices. There is a real risk of a massive correction.
Restricted by the mistakes of a decade ago, on Tuesday Mr Donohoe must cast an eye back to ensure the right lessons have been learned. At the same time he must keep a stern fix on the road ahead and the troubles it may bring.
A hard Brexit or no-deal Brexit could cost tens of thousands of jobsMoney talks:As the eurozone gets set to follow the Fed and unwind QE, the threat from rising interest rates will grow