The French Correction

(full version of newspaper version available here)

France got a credit rating downgrade this week, they are no longer a AAA nation, coming down one notch to Aa1. This is a true demonstration of French ‘égalité’, they won’t leave the rest of us to simply get downgraded without joining in!

Sadly, it wasn’t motivated or created by ideals, it was due to a lowered economic outlook. The USA got a downgrade last year, they probably will again when they face the next big headline which is called the ‘Fiscal Cliff’ (we’ll cover that another week) and no doubt Germany may get one within the next 12 months.

Oh, and lest I forget, France looks primed to face a property market correction in the next year or two as well.

As for Ireland we actually got a good score card for a change, Fitch ratings agency gave us a stable outlook (it was negative in the past) and we are at BBB+ which is the bottom rung of ‘investment grade’ debt, below that you are referred to as ‘junk’.

When we hear about the credit worthiness of nations we often hear ‘Debt to GDP’ which is like your debt to income ratio, in Ireland due to having lots of multinationals a better metric is Gross National Product or ‘GNP’ but perhaps better again is to consider debt versus savings or income after costs.

This is almost never mentioned in Irish press on any facet.

You can have a flatlined output but if national savings is growing then you are getting better. It might not look great on paper but your ability to pay down debt is getting better.

At the same time you could have a higher GDP or national output that isn’t great (if it was due to a credit bubble for instance) and national savings is getting worse meaning your ability to service debt is lowered.

The savings I’m describing are effectively the ‘cashflow’ of a country, the un-owed portion left after paying bills. In Ireland we don’t have that right now, hence we can expect another stinger of a budget in which there is a kick in the teeth for everybody.

Debt to cashflow ratios of 30 times or less are good, countries like Norway, Austria and Germany all have this. For every euro of output they have between 25c and 40c in savings which they can use to pay down debt or spend. In Ireland it’s about 10c per euro of output but we have a high gross debt with a high interest rate on it compared to other countries.

We have to find a way to make this figure bigger so that we can get back on the right track, when you hear people say ‘austerity isn’t working’ ask them for figures and sums, because frankly, there is no other way to resolve this.

Some critics say ‘devaluation is the answer’, that is far from painless, ask elderly savers who find themselves poor in retirement and too old to get back earning a wage if that plan doesn’t come with barbs embedded in it.

And the oft cited Scandinavian ‘model nations’ aren’t so pretty when viewed from a cashflow perspective, Finland, Sweden and Denmark are all 35-42 times leveraged in a debt to cash-flow scenario.

We started the article with France, it is worth noting that France has a Debt to Cash-Flow ratio of over 62 times, meaning they are deep in the ‘danger zone’ using this metric. People might say it isn’t a fair way of looking at things but take a simple example.

Imagine you are the head of a household and you have a mortgage (that is the equivalent of government borrowing in this case) and you charge some of the grown ups in the house to stay there a certain rent (taxation) and with others you support them and you pay the heating bills (expenditure and welfare etc.).

At the end of the year if after paying the bills and collecting rent you are left with €10 and your debts are €300 then you are in the ‘ok’ range, meaning that as long as your mortgage rate doesn’t shoot up significantly you’ll make payments.

If (like Ireland) the loan amount is more like €2,000 for the €10 you have then you need a zero interest rate and 200 years to pay off your loans. This cannot sensibly happen, which is why we will eventually earn our way (by showing we can make and take hard decisions and painful cuts) into some kind of deal.

Europe will deliver, eventually, after every other option has been explored, but make no doubt about it, our salvation lies with Europe, not with leaving the Euro, if it was that simple states like Tennessee would have left the US dollar 60 years ago, and Texas (which is the only state which still holds that right – to leave the US or ‘secede’ ) would have done so.

Ireland is unfortunately off the charts when you look at our debt from this perspective. And that means there is no easy way out, we can’t merely work hard, economically we have a tough up-hill walk with horizontal rain and a headwind to look forward to. Translation, tax increases, spending cuts and eventually some kind of debt deal.

So keep your head down, eyes forward and make the best of a bad lot, because we have a long road ahead of us.

Post a Comment

Your email is never published nor shared. Required fields are marked *