Why Inflation will not be Temporary

 

The current conventional wisdom is that inflation in Ireland will only be temporary as the economy recovers from the covid lockdowns. But this can only be the case if there was deflation during the lockdowns which the re-opening induced inflation would now be negating. The only deflation that occurred during the lockdowns that I can remember was petrol prices. Core consumer items such as food, electricity bills and rent did not fall or at least not in any noticeable way. A period of deflation is not equivalent with an economy being closed down. A rental freeze is not deflation. This is the mistake the economic experts are making. They also have not taken into account the effects of the large government spending. 

When a hotel or other business is shutdown, its prices do not reduce, the service simply ceases to exist. In fact, inflation will likely occur. Say two hotels close down in a region leaving only one hotel open. This will lead to a period of inflation as the remaining hotel raises its prices to take advantage of the increased demand and reduced supply. The difference between this scenario and the lockdown was that  during the lockdown all three hotels were shutdown meaning there was no deflationary pressure. Then when the hotels opened, they could charge high prices because people had a lot of savings. This was an unintended consequence of the high level of unemployment support.  And the same happened with rent, an opportunity was missed during lockdown to bring about rental deflation through a smaller Pandemic Unemployment Benefit. Instead, the government went along with the calls from the most populist spending cheer-leaders.  

Another point that is missed is that many businesses may never re-open again. This will bring further inflationary pressure as supply reduces. 

As you can see from the graph above, the sharpest fall in prices was in November 2020 when year on year deflation reached -1.5%. This was the sharpest fall in a decade. In less than 12 months however , the inflation has skyrocketed to +3.7%.

While there are other factors impacting inflation right now, such as our high dependence on global supply chains, the high levels of pandemic payments paid out last year are part of the reason why Ireland has inflation above the EU average and even above UK's inflation rate of 3.2%. People saved up, then spent most of it in-between the lockdowns leaving little pressure on businesses to drop their prices. Little haggling took place with landlords who should have been under severe pressure to drop their rents during a period of very little house moving by job hunters both within Ireland and those coming from abroad. 

But as every economist should know but seems to have forgotten, all this money had to be printed, which was happening at a high rate prior to the pandemic anyway. Too much money printing or quantitative easing (or whatever you want to call it) , and the inflation snail eventually catches up with you. Too much money ends up chasing too few goods.  And then the snail begins to look like a rabbit. 

The Financial Wonderland of Covid-19

According to economic experts, Ireland does not have to worry about paying back the massive borrowings that were needed to fund the endless lockdowns : 

“Government debt does not have to be paid back, particularly the kind that sits minding its own business in the vaults of the ECB” - Chris Johns, Irish Times

 The problem with that is Article 123(1) of the Treaty on the Functioning of the EU :

 

 This means that it is illegal for any Member State to use the ECB as a bank overdraft facility.  The only reason why we can afford the luxury of endless lockdowns is our access to lots of free money. The Irish government have already borrowed €20 billion interest free this year and they plan to borrow another € 20 billion next year.   This is in addition to around €35 billion borrowed at very low interest rates since 2015 from the ECB's PSPP programme, prior to the covid "pandemic". So the free money bonanza that has enveloped the EU is not a new thing as some commentators have argued. 

All this free money being created by the ECB has resulted in the ECB becoming the largest single creditor of the member states in recent years. The German Council of Economic Experts have warned that this could present a threat to monetary policy independence in the long term.

In 2008, after the banking crash, the debt laden on to the backs of the Irish was paid back through taxation. This makes the situation at present different as there is no pressure to increase taxes. 

The natural effect of all this free money is massive inflation but we have not seen any sign of that yet (it may help to reduce government debt by de-valuing the euro). What is the most likely outcome - my guess is that we will see some inflation next year but more importantly negative interest rates will skyrocket so that most of the extra cash lying around on deposit will be recouped.   

There is already a similar precedent for this in the EU banking system, when deposits were confiscated in Cyprus in 2013 in what became known as a bail in. 

So as Mr Johns maintains, the ECB may well continue to play ball by printing infinite quantities of free money but the price will be an eradication of savings, either through inflation or negative interest rates or a combination of both. It will also mean that the EU will once again bend and mold its own laws laid down in it's treaties. This further erosion of the rule of law will sow yet more discontent within the union. 

Negative Interest Rates - How They Came About

Negative interest rates are well and truly with us here in Ireland with the news that Bank of Ireland are to begin imposing negative interest rates on pension funds that deposit cash with them. This means pension funds holding cash will be hit on the double (also inflation).

Here is a quick summary of how negative interest rates came about. Many articles that you will have read in the media about negative rates don't fully explain how we have got here, so this could be the first such article.

The ECB gave the game away here : 

Meanwhile, the first-order and tangible effect of Negative Interest Rates Policy on financial stability has been that it has enhanced it by improving the sustainability of outstanding debt.

There is nothing sustainable about the mountains of debt piled up, it is not possible to improve the sustainability of colossal amounts of debt except by eradicating it and preventing it from happening again by implementing high interest rates . Negative interest rates are actually doing the opposite - they help create new debt by making it so cheap. 

So, the main reason why negative interest rates are here is because spending is out of control in the EU and in Ireland and we are more reliant on debt than ever before.

The other main reason is because of Quantitative Easing (QE), or money printing. As you can see in the figure below, after QE, the commercial bank such as Bank of Ireland or AIB, holds more reserves with the central bank. The central bank has been charging negative interest rates for holding these reserves, so the commercial bank has no choice but to pass this on to consumers.   

 

So as economies in Europe become increasingly dependent on QE, the central bank will come under pressure to charge for holding these higher reserves, and the commercial banks will have no choice but to pass on these costs to consumers. 

This process of never ending debt and continuous QE is a feedback cycle, whereby more QE allows governments to borrow even more by offloading longer term bonds into the market. As you can see from the above, the pension fund sells their government bonds to the central bank to get the QE process going.

Negative interest rates are the direct consequence of this continuous cycle of QE and debt that has been the central policy of the ECB since 2014. Only recently are customers feeling the pinch from negative rates so we are in uncharted territory as to what will happen. But my prediction is that they are the harbinger of a very bad recession and widespread poverty. As it becomes clear that no real production is taking place and the high consumption levels are a mirage.

There is also a calamity coming when people retire, as savings are no longer being encouraged  and the alternative of investing in pensions are now being hit. The days of high interest rates are over but that also means prudence is over and that can only end one way. 

  

Rainy Day Blues

It's been a very strange six months in Irish history. It began in October when the finance minister failed to top up the Rainy Day Fund he had set up the previous year. At a time when the economy was very strong, this seemed like a reckless move and so it has has proven to be in light of recent events. Unfortunately, government ideas of merit are not followed through with the same enthusiasm as the bad ones are.

After this, an early election was called in January 2020, which led to an historic result, but one that was still very much in favor of the status quo.

Then, a month later, as government formation talks continued to drag out, the coronavirus pandemic landed on Ireland's shores. This event has shaken the global order at its very core. The consequences of open borders and free trade are now very real for everyone. Critical thinkers of the global based economic system, who were branded outdated and backward as recently as January during the election debates, are now being proven correct weeks later. It was the governments allegiance to this system that prevented them from acting early,  closing the airports, and putting travelers from Italy in quarantine as the Icelandic government did right from the start. A contact from Iceland wrote to me :

Iceland put everyone in quarantine coming from Italy very early on and a few days later everybody coming from a ski resort in Austria. Now there are more than 6,800 people in quarantine at home. Last week everybody living in Iceland (not tourists) coming home from abroad had to go into quarantine. Authorities also put a big effort into contact tracing. A team of policemen and health workers (at least 60 people) trace every single case. Everyday 50% of new confirmed cases are amongst those in quarantine.

Back in Ireland, a match with Italy on the 7th March was cancelled but thousands of Italians were still allowed to wander the capital Dublin that weekend. In the week before the scheduled match cases in Italy had jumped by 5000. There is some talk about China not releasing information quick enough. I disagree, the authorities in Europe had plenty of notice, they just failed to act decisively. Iceland have managed to slow the virus, comparatively speaking. Since the 11th March, cases in Iceland  have increased by about 12 times, whilst in Ireland cases have increased by about 50 times. The cases are most likely understated in Ireland, because Iceland have tested 3% of their population, including people who do not have symptoms.

Now that we are in lockdown, climate change is well and truly off the agenda. Which reminds me, if we are in the middle of a climate crisis with the ice melting as the schoolchildren (sorry, teachers) are so fond of reminding us, why were schoolchildren flying fossil fueled airplanes to Italy to ski in the snow in February on their holidays ?

Switzerland and Sweden Used as Models for Irish Carbon Tax

A Benchmark for the Carbon Tax, no Benchmark for cheap electricity  

As part of a comprehensive policy package, carbon taxes will have a central role in guiding the energy transition by providing the economic incentive to switch from high-carbon to low- or zero-carbon technologies and products. In Ireland, the Climate Change Advisory Council has recommended a phased increase in the carbon tax from the current €20 per tonne to €80 per tonne by 2030. In terms of benchmarking, it is worth noting that some countries already have carbon taxes at the upper end or even in excess of this range, with the Swedish carbon tax currently at $139 (e112) and Switzerland at $101 (e81).

The Central Bank have now thrown their weight behind the sudden political push for an increase of the carbon tax in Ireland. Their recent report about climate change and it's alleged impacts on the economy fail to address the issue of the unsustainable levels of government and private debt in Ireland, which allow us to live far beyond our means and consume resources at a far greater rate than previous generations. There is no mention of unsustainable government spending and the bloated welfare state (The cost for a new hospital in Dublin has risen from €400m to nearly €2bn, welfare spending still stands at €20bn despite lowest unemployment for over a decade).

The Central Bank fails to understand that emissions are coupled with economic growth so that if climate change were really having an impact on the economy, we would be seeing economic decline right now, followed by a consequent reduction in emissions. They make the observation that 1991-2016 temperatures were higher than the period for 1960-1990, which actually supports the natural cyclical theory of climate change rather than the man made theory.  They also claim that insurance payouts due to extreme weather events are up. The 1940s were perhaps the worst decade for flooding and crop devastation in recent history but I can find no evidence that there were any insurance payouts at all. But I want to focus on one particular part of their report, the carbon tax. 

The purpose of the Central Bank presentation on climate change appears to be to groom Irish people for more taxes, specifically carbon taxes. 

They present Sweden and Switzerland as models for Ireland to follow in this regard.  What they fail to state is that Sweden has electricity prices at least 25% less than Ireland. But more importantly, Switzerland, which has a carbon tax equal to that proposed by Irish politicians, has had one of the lowest electricity prices in the world for many years, roughly half that of Ireland, which now ranks as one of the most expensive countries for electricity in the world.  Switzerland generates most of it's electricity from hydro and nuclear (as does Sweden). How is it that Ireland's indigenous wind industry cannot compete with Swiss hydro, an indigenous renewable source that does not lead to high Swiss electricity bills ?

The examples of Sweden and Switzerland actually undermine the central banks case for more carbon taxes in Ireland as it shows that we are already paying comparatively much higher for energy. A carbon tax similar to what was introduced into these countries could make Ireland the most uncompetitive country in the world for energy with actual knock on impacts for our economy far worse than "climate change". 

One could have perhaps made a better case for the carbon tax if wind energy had led to the cheap energy revolution that Irish people were promised.  But as we all know that never materialized.

https://ec.europa.eu/eurostat/web/products-eurostat-news/-/DDN-20180807-1

Trumponomics Good For Ireland (So Far)

Irish Exports to US up € 1 billion in 2017 

Export figures published by the Central Statistics Office show that Irish exports to the USA since Trump was sworn in as President in January 2017 were up €1.1 billion (3%) from 2016 to €33 billion. And compared to 2015, Irish exports to US have shot up by 23%, a total increase of € 6.2 billion.

The biggest increases were in dairy, cereals and other food products, beverages, textiles, medical and pharmaceutical products, power generating machinery and manufactured articles. 

Trump's "America First" policies of tax cuts, reduced regulation and energy independence have led to increased investment and economic growth in America. This in turn means that America have imported more goods from Ireland. Some commentators warned that the opposite could happen - that USA would become more isolated and less dependent on imports - but the reality is that people living in strong performing economies purchase more goods, including imported goods.

USA remains Ireland's largest exporting market. The impact of Trump's tariffs is not known yet. He has also attempted to lure FDI back to America.