Economic Policy Options: From Crisis to Control
November 2008
The essential message of this paper is that unless urgent action is taken, the Irish banks will suffer massive losses in the next year or two. Because these losses are now the responsibility of the state as a result of the guarantees the banks have been given, Ireland may have to default on its obligations.
The amount of money in circulation is shrinking rapidly. In August 2007, Irish residents had €32,857 million in their current accounts. This August they had €29,601 million, a 10% fall; , a 12.6% decline. In July alone. If the money supply continues to contract it won’t be enough for the present level of trade to continue and national income will fall even more. As the money supply contracts, borrowers will have increasing difficulty getting the money together to service their loans. As every billion the banks lose means ten billion less they can lend, a frightening spiral of bad debts leading more bad debts would develop.
In order to stop the spiral, the government would have to make good the banks’ losses by injecting capital. If half of the developers’ loans have to be written off over the next two years, the state would have to borrow €45 billion to inject into the banks. This would double the national debt. Some commentators put the banks’ likely losses at less than this figure – analysts at JP Morgan estimate that €7.6 billion will be needed while NCB Stockbrokers say €14.1 billion – but €45 billion is not unrealistic, particularly as other types of borrowing will turn sour too.
Injecting €45 billion into the banks to make good their losses would be to pour it down the drain. It would be far better for it to use the money now to prevent as many as possible of the bad debts being incurred rather than throwing it away in a year’s time to honour the guarantees.
To avoid having its guarantees called, the State must get more money into people’s bank accounts to spend, so that their spending gives at least some of the businesses which have borrowed the means to service their loans. Any new loans should be invested only in ways which bring down Ireland’s demand for imports and thus free up enough money to allow the foreign portion of the borrowed money to be serviced and repaid.
The government should initiate this money-creation-by-lending cycle by the stimulation of projects with the priority of either reducing energy use or producing it from renewable resources.
For the economy to return to the state it was a year ago requires an increase in bank borrowing of around €50 billion. The government could stimulate that extra borrowing if it borrowed €5bn itself (on top of whatever it is going to need to borrow anyway) and spent it wisely. This is less than the amount it would have to inject into the banks if they default. It should aim to stimulate borrowing at three levels, domestic, community and industrial.
Domestic Scale:
€20 million for the Home Energy Saving Scheme in 2009 and the €5 million for the Warmer Homes Scheme is inadequate as is likely, the new scheme for energy savings in local authority housing stock through the retrofitting of older heating systems with new green energies. Even the CIF scheme of 15% grants to homeowners costing 6 billion over six years would be inadequate, although well worth doing.
The use electricity billing to facilitate financing should be reconsidered with existing energy suppliers or with new Energy Service Companies (ESCos). Locally produced materials and products should be prioritized in the new grant schemes.
Management companies of new apartments and housing estates are particularly well suited to initiate and run retrofit and CHP schemes as described below and should be offered inducements and capacity building to do so.
Community Scale:
New schemes for distributed energy combined heat and power energy using local organic waste and biomass offer great potential. A guaranteed high level tariff for distributed energy generation-circa 17cent per kw- worked in Germany and can work here. In addition the ESB should borrow whatever it takes to upfront investment in the distributed grid and cease its requirement that first movers pay for grid up-grades.
Pilot schemes should be grant aided to establish best practice and identify unnecessary regulatory impediments in community scale AD of wet organic waste and low temperature pyrolysis of biomass.
Capital Allowances for non grant aided element of distributed energy generation should be given against income from any area (subject to a cap) to enable rapid and wide scale rollout. Pension fund investment should be facilitated.
Farmers should be incentivised to maximize CO2 sequestration in their soils such as planting for short rotation biomass to provide feedstock for distributed energy generation, co2 sequestration and organic fertilizer production.
The cost of the above measures is difficult to estimate at this stage but 2 billion public investment matched by 10 billion private sector finance will produce at least 120MW per annum of dependable electricity as well as heat energy, fertilizer and co2 credits co-products. A large part of this investment will go to Irish construction firms especially of steps were taken to attract the more sophisticated component manufacturers to relocate here- see next.
Industrial Scale:
Massive investment can be made in interconnecting and strengthening the grid so that our abundant wind and wave and tidal energy potential can be realised.
The transmission grid will need to be strengthened before more wind energy can be allowed on to the network. Commit €4 billion to enable the grid to carry 60% more power under the Grid 25 plan by Eirgrid.
The Hibernian Ring; The grid needs to be strengthened between the west of the country, where many of the windfarms will be, and the east, where the power will either be consumed or be exported by the interconnectors by a high voltage direct current (HVDC) system.
The government should establish a cluster of energy product manufacturing companies here in the way that it has done with pharmaceuticals and computing. A combination of research and capital grants could be effective. The IDA’s shopping list could include firms making:
• Smart meters. The Irish market is worth €600 million and one of the leading companies, Landis & Gyr is run by Cameron O’Reilly, Sir Antony’s son. It is based in Switzerland.
• Flow batteries: These enable large quantities of electricity to be stored. The leading firm is in Vancouver.
• HVDC cable: The market leader is ABB, another Swiss company. This type of cable obviously needs to be made in a seaside location so that it can be loaded straight on to cable laying vessels.
• Wave power devices: The snake-like Pelamis device is currently the leading technolpgy. The first commercial installation is in Portugal because the Portuguese government wants it to be made there.
• Floating offshore platforms for wind turbines: The strongest winds are off the west coast but the water there is often too deep for the turbine tower to be mounted on the sea bed. Floating platforms are being developed. Ireland should lead this technology.
Investment in infrastruce and technolgy for transport includes:
• Light trams: Parry People Movers might be induced to move from England. Its technology could be combined with that used in the Swiss-developed gyrobus so that the trams use electricity at each stop to store enough energy in their flywheels to carry them on to the next..
• Electric cars: A consensus seems to have developed that we’ll be driving electric cars in future and several policymakers, including one from the ESB, have visited Israel and Denmark to follow developments there. The Electric Transport Programme will be announced by Minister for Energy Eamon Ryan and Minister for Transport Noel Dempsey shortly.
Seven points can be made about the borrowing strategy Feasta proposes;-
- Any further fall in the money supply is likely to destroy the business confidence required for people to take on new loans. Action therefore needs to be taken urgently, particularly as there is only a limited amount of time before lenders begin to question the value of the state guarantee
- The prices of houses and other properties will still fall but a deep overshoot before they stabilise may be avoided. No attempt should be made to prevent the fall happening because property prices are out of line with incomes and forcing people to tie up extra money in unproductive assets would mean that they had less available for energy investment.
- Because of the property price fall, some of the outstanding property debt will still go bad. However, if the banks can make money in other areas because of the new activity, the losses which the government has to bear will be reduced.
- The energy investments made will put Ireland in a much better situation in relation to its climate obligations and give it increased energy security. They will also cut the costs of fuel imports.
- The country will get a better balance between state and private borrowing. The state was borrowing indirectly during the property boom, collecting perhaps a third of the amount the private sector borrowed. It would have been better had it borrowed itself because the cost of servicing the loans would have been lower and no capital repayments would have had to be made. If the state now borrows itself in a way that enables private lending to fall as a proportion of total debt, the overall debt burden will be reduced.
- The government should be far more concerned about getting enough money borrowed than ensuring that the borrowed money is well spent. It should weigh the losses that will result from rushed projects against the losses it will have to make good if the banking system collapses.
- If the strategy fails and the state cannot prevent a banking system collapse which forces it to default itself, the financial consequences would be no worse than if the strategy had not been tried. The country’s economy and infrastructure would, however, be in better shape.
Controlling Emisisons and Energy Prices: Cap and Share
Even with generous grants, none of these projects – the domestic ones included – will go ahead unless investors are convinced that energy costs will be high enough in future to make them worthwhile. The trouble is, now that the world economy is entering a depression, oil prices are falling, This is weakening the immediate incentive to save energy and to develop renewable sources.
The solution to this, and the foundation for the success of the strategies outlined here, is to introduce Cap & Shareand use it to restrict the use of fossil fuels to such an extent that their price, in Ireland at least, is high whatever happens on world markets. This is because C&S would guarantee that the carbon price, and thus the price of energy, would not fall below a specific figure for each year. Essentially this provides a feed-in tariff that rises each year for all types of renewable energy production and for energy saving. Another way of looking at C&S is that it imposes a declining annual quota on energy imports so that domestic energy production can develop to fill the gap. This would give borrowers/investors the security they need. C&S is an essential part of any plan for a rapid transition to a low-carbon economy.
Protect Commons Assets
On no account should the government consider the sale of state assets, to meet its debt obligations. In particular, the major land assets held by Coillte and Bord Na Mona should be retained in the national energy and food security interest. In the first instance, the price obtainable at this time or in the near future will be heavily discounted from recent past, secondly it will be worth considerably more post Kyoto as carbon accounting for land use and soil sequestration is adopted. Oil, gas and other potential fossil energy assets should be held in trust for future generations or used to build a new renewable infrastructure. Non-material commons such as the broadcast spectrum should be leased to the private sector in competitive auction for the highest price subject to a reserve to ensure community communication rights.
Debt to Asset: Limited Liability Partnerships
Augmenting Policies will be necessary such as the restructuring the existing debt and future financing of property and infrastructure development for the future. No interference with the altogether necessary fall in property values should happen until overshoot levels are reached. There is no avoidance of a painful write down of property asset values, especially development land. What should be avoided if possible is excessive calls on developer security of other income producing property and the resulting fire sales that would further accelerate write-down of assets.
The budget proposals for local authority lending to first time buyers are premature and at the very least should have been accompanied by a requirement for a high sustainability rating – i.e. high DEAP energy rating and good access to transport infrastructure.
The banks, developers and State should investigate restructuring conventional financing of investor equity capital, bank loans and State supports into Limited Liability Partnerships LLPs. In effect this mechanism converts developers, looking for short term profits from property sales, into long term partners with the banks, local authorities, pension funds etc. Tenants also become part of the LLP and can move to ownership in a gradual process as their income allows. LLPs also suit pension funds as the return, although modest, is protected against inflation losses.
LLPS are very attractive to Islamic Sovereign Wealth funds investors as they do not include an interest element. The PPP model for major infrastructure investment that seeks to move risk to the private sector is demonstrably fragile in the current climate even where banks were still willing to lend or insurers underwrite. Instead the LLP model that seeks to manage and share risk should be considered.
The introduction of a Parallel Currency : Liquidity Network
The money supply in Ireland is contracting rapidly – it fell by 11.4% in the year ending September 30 – and the only safe assumption is that an emergency money system will be needed to prevent hardship and maintain a reasonable level of economic activity. Emergency monies were used in Argentina during the peso crisis in 2001-2 and prevented a great deal of social unrest and distress. At one stage, they provided over 20% of the money in circulation.
If the money supply continues to fall, it will be because people are either unwilling to borrow because of uncertain market conditions or that, despite the encouragement of energy-related investment, they cannot find a potentially profitable project which appeals to them sufficiently to risk borrowing for it. In theory, interest rates should be reduced to overcome this reluctance to borrow until sufficient investment is taking place but Ireland no longer has control over its interest rates and, in any case, they cannot be reduced below zero to bring forth adequate borrowing. This situation is known as a liquidity trap and the only way to escape from one is for the additional money to be put into circulation on a non-debt basis.
Both Milton Friedman and Ben Bernanke have spoken, facetiously, of scattering it from a helicopter. In fact, it can it can either be spent or given into circulation. In Argentina, both methods were used.
Feasta is developing plans for an emergency currency which would be given into circulation according to the amount of trading an individual or company was doing and thus the amount of liquidity they required. The money, which would be transferred from one account to another via the web or a mobile phone text message, would be issued by a Currency Trust mandated under its Trust Deed to operate in the interests of the money’s users.
The Trust would track the velocity of circulation of the monetary units it issued – which would not be euros. If the velocity was rising, it would indicate that more money was needed in the system and this would be given to those accounts which were most under stress in proportion to their average balance for the month. If it was falling, units would be removed from the accounts with the lowest velocity in proportion to the average amount of units held. It should be noted that this “money” is designed to be a pure means-of-exchange currency and its exchange rate with the euro will not be guaranteed.
The operation of such a currency could greatly ease the banks’ situation because, as it would ensure that an adequate supply of a means of exchange was available for day-to-day dealings, euros would be more readily available for the repayment of debts. This would reduce the banks’ losses and, consequently, the amount the state had to find to cover them.
Ensuring Housing Affordability & Funding Infrastructure : Land Value Taxes
Land value should be measured before and estimates made of the upswing of value after investment as part of cost benefit analysis and impact assessment. Nearby landowners not directly involved in the development but created by it should be required to pay back the unearned upswing in value in the form of annual land value taxes (LVT). This measure will go a long way to recouping investment by the State in the years to come. It should also form the central criteria against which projects are assessed. Most important, it would ensure that a property bubble and resultant bust would never reoccur.
Current fiscal supports for first time buyers, affordable and social housing and rental supplements require a fundamental review. These siloed programmes hinder transparencies and much needed efficiencies. A single housing benefit that could be used for any tenure and in any local authority should replace them. All housing sectors should continue to design and build housing so as to provide genuine competition, flexibility and choice to the consumer.
The public sector must take a more proactive role in sustainable settlement development particularly in rural areas where, against trend elsewhere, an increase in one off house building is very likely. Development agencies should be resourced to open up land for self-build in existing villages and in new eco villages pioneering distributed energy, waste recycling and carbon negative construction as described in the earlier sections.
An annual land value tax (LVT) should be announced and when a proper cadastre and land value assessment made, introduced for all land in phases as conditions allow. The LVt should replace transactional taxes that hinder investment i.e. Rates, Stamp duties and Development Levies. The LVT could provide the greater part of local authority funding for infrastructure development and management to encourage responsible planning and development control.
Citizens Income
As receipts rise, along with receipts from Cap & Share, it can form the basis of a citizens income. A citizens income is the least the public should expect for their bailout of the wealthy financial sector, the failure by the government of their regulatory function and their pandering to landowner and property developers lobby groups.
