Quick side note:
As I noted yesterday, “If jitters persist in Euro-land, expect a strengthening greenback to take some substantial steam out of the rapidly rising commodity markets.”
Today, the USD surged as capital fled both the EU and commodities. The TSX dropped 200 points and gold closed the trading session down $40. This is not a reversal of a secular bear market in gold, but we will see some strong downward pressure on ALL commodities over the next little while as the USD will temporarily become the best of a crappy bucket of dead currencies. Think buying opportunities down the road.
CFTC committment of traders continues to show significant speculative long positions in a number of commodities. As I’ve noted before, these large speculative positions offer interesting contrarian opportunities. At the very least, they suggest a crowded market on one side of a trade. Couple this with the prospects of a strengthening greenback, and you have some headwinds stacking up against commodities over the short term.
Enough about that. Let’s talk about Ireland!
The toothless Celtic Tiger
Ireland was once the envy of the EU. Impressive economic growth outpaced the rest of Euroland, leading to it being dubbed the ‘Celtic Tiger’. How the mighty have fallen!
My crystal ball was apparently working quite well yesterday as I also said that Ireland may well need a bailout by next week. As it turns out, today it’s been confirmed that Ireland is currently in aid talks with the EU.
One thing I am constantly amazed at is people’s inherent tendency to project current economic conditions into the indefinite future. Ireland may well be the most dysfunctional economy on the entire planet, so the direct parallels with Canada are few. However, it is interesting to at least look back at what people were saying as Ireland’s economy was roaring along, fueled by an enormous property bubble that makes the current US bubble look like a sud. Ireland was the envy of the EU back then. Not so much today.
As with the US, Spain, Ireland, Portugal, Italy, Greece, and the UK, Ireland had an economy that was driven by a property bubble and the economic spinoff of wealth-effect consumer spending. Now this pseudo-growth was really just an expansion in consumer debt, which itself was largely tied to perpetual increases in the housing market. Now the specific dynamics of the economic declines in each country listed above is different, but the underlying engine that gave the illusion of growth was the same: The expansion of consumer debt which itself was directly related to a real estate bubble.
Looking back now, some of the articles written during the Irish boom times are laughable. Yet you can also dig back through articles written during the US boom times, or the Spanish boom times, or the boom times in the UK and see the very same thinking. We know now that growth was unsustainable. Yet plenty of very intelligent people missed the fact that once consumers reach a point of peak credit, things unravel very quickly. Yet at the time, the economy seemed perfectly fine.
Again I will reiterate that I am NOT suggesting that Canada’s future will play out in any way like that of Ireland. The point here is two-fold:
1) When a country relies increasingly on the economic spinoffs of a rising real estate market, as well as consumer spending and associated increasing debt loads debt, it is setting itself up for economic pain at some point in the future.
2) When growth is largely dependent on debt, the economy looks great while you’re in the expansion phase, and many very intelligent people completely miss the big picture. Things cannot continue that way forever.
Case in point:
Date: August 23, 2005
“Bank of Ireland’s Chief Economist Dr. Dan McLaughlin says in the Bank’s Economic Outlook, which was published today, that the current pattern of domestic-led growth in the Irish Economy, with the consumer to the fore, is likely to be replicated in 2006.”
This was not some armchair economist (like my lowly self). This is a REAL economist. Like with real letters after his name. This dude was smart and had access to the best economic data available. More of his wisdom:
“Ireland’s manufacturing led growth has given way to a services and construction based expansion with domestic demand, particularly consumer spending, driving growth.”
Hmmm….an expansion based on construction and consumer spending. Here in Canada, “Housing plays a dynamic and crucial role in the economy. Housing-related economic activity accounted for $307 billion in 2009, over one-fifth of Canada’s total gross domestic product”, from pg 1 of this CMHC report.
And what of consumer spending and the associated consumer debt levels? They’re only at historic highs!
Food for thought. Back to the article:
“Spending by the latter (consumer -ed.) has picked up strongly, as we expected, underpinned by buoyant employment growth (77,000 jobs created in the year to the first quarter), strong wage growth (in a 5%-6% range), moderate consumer price inflation and interest rates at a fifty year low.
This perfectly illustrates how a debt bubble within a society creates the temporary illusion of prosperity. It is a topic discussed often here on this blog and in fact was discussed in one of the primers. The basic dynamic is as follows: Home prices rise. People are more willing to tap their rising home equity and spend money they don’t have since they feel richer. The general shift towards debt tolerance causes all types of credit to greatly expand. This creates an associated employment bounce as all parts of the economy prosper, including those that would not otherwise survive were it not for frivolous consumers. Rising employment buoys consumer confidence and demand for real estate, which sees more price increases. Rinse, repeat. It’s a fantastic self-feeding cycle on the way up, but cuts equally deeply on the way back down, as many formerly ‘prosperous’ countries are now finding out.
One final quote:
“Finally, the Government is on course to record a much lower borrowing requirement than projected last December – we expect a deficit of €1.4bn, thanks in part to a €1.2bn overshoot in tax receipts. This is consistent with a General Government Surplus of some €400m, marking yet another year in which a forecast deficit has failed to materialize.“
This was written only 5 years before this proud country was forced to crawl to the EU and plead for help as no other sane person would buy their clearly un-repayable debt. Do you see how quickly debt bubbles can implode?
Parallels with Canada’s current fiscal situation
Again….all of this is observation, NOT a prediction of Canada’s future. I don’t see the same level of pain seen in some of these countries. But are we out of the woods? Heck no!
So what should Canada expect?
1) Falling home prices for the next several years.
2) Collapsing demand for HELOCs, which will effectively kill off a large part of consumer spending.
3) Stubbornly high unemployment (+10%) for several years.
4) High federal and provincial deficits as tax revenues decline.
5) An austerity movement by governments who will see that it is the only way to bring deficits back in line with bond market expectations, less the bond vigilantes turn their whips on us. The riding partner of austerity is social unrest. Expect protests and rising tensions as the government seeks to trim back on excessive promises made during better times.
Not just the Irish
As a final thought, remember that there are countless examples of these types of articles from all countries during their boom years. It took me all of 3 minutes to pick out these gems, all from different countries listed above.
US economy enjoys faster growth– October, 2005
“The US economy strengthened in the third quarter, driven higher by strong government and consumer spending”
US views positive Greek economic policies– April, 2007
“The sectors of energy, transportation, telecommunications, real estate development and tourism are attracting the interest of American investment community”
“the economy (experienced) high growth rates with a parallel reduction of unemployment”
“Spain’s unemployment rate has been cut in half from 24 percent 10 years ago, to 11 percent in August, and gross domestic product has been the envy of France and Germany for several years running.”
“New economics minister Pedro Solbes isn’t expected to put Spain’s three years of a balanced budget or strong growth at risk.”
“Spain’s property values have been rising by double digits for the past five years, with prices up 16 percent last year alone.”
See the parallels! Our economy cannot continue to grow on the back of unsustainable consumer spending and massive, ever-expanding debt levels. All of this masks structural issues with our economy. We may not be facing the same dire straights as these countries, but by no means are we in the clear.