Richard Cur­ran

Irish Independent - Business Week - - FRONT PAGE -

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.

2 Brexit

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

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