A very significant bit of news was a little overlooked recently in the midst of all the mad stuff going on about politicians’ expenses and the economy generally going to hell in a handbasket.
Prices are falling by 6.5 per cent, the highest rate of deflation in 78 years. The last time this level of decrease happened was 1931, in the throes of the Great Depression. That fact alone should send shivers down our spines, but the implications for all of us go much, much further than that.
Deflation is a scary concept. As prices fall, wages go down too and the Government gets less money in taxes and is less able to repay its debts – which pretty much sums up the mess we’re in at the moment. It’s called a deflationary spiral, but it’s not all bad.
We need to get prices and wages down to attract back the multinationals like Dell which moved to Poland because wages are a third of what they are here. The private sector is already showing itself to be very dynamic in reacting to these straitened times. Everyone from your local barber to the big high street stores are tightening their belts and helping Ireland regain some of the competitiveness. Well, not quite everyone. The Government-run sector – surprise, surprise – isn’t pulling its weight.
The public paradox
The breakdown of the 6.5 per cent deflation figures from the CSO show that health and education costs actually went up by 3.9 per cent and 2.5 per cent respectively. In the middle of the biggest deflationary spiral in nearly 80 years, Government agencies continue to take the lazy option and shove up prices.
Public sector wages are also up 3.2 per cent – 4.7 per cent in the civil service – which means that the latter got a 11.2 per cent pay hike when you factor in falling prices. Those figures don’t take into account the 7.5 per cent pensions levy introduced late last year, but even so, public sector workers are still getting a jump in salary at a time when private sector workers have had wages slashed by 11 per cent – if they’re lucky enough not to be laid off.
A void of common sense
Another example of the Government’s extraordinary ineptitude is that it hasn’t used the simple fact of deflation to defuse the public service pay row. Wages only go up every year because prices go up and so, they are usually linked to the inflation rate. So if prices go down as they are now, surely wages should follow suit as a natural part of the same process?
The fact that people can’t seem to get their heads around this is hardly surprising as financial advisers will tell you we have enough problems getting across the concept of inflation, let alone deflation. And so, prices are falling like a stone and the State is effectively bust, yet everyone who works for it is clamouring for wage increases!
What is also not recognised is that public sector workers were the biggest beneficiary of the property bubble – not the developers and, ultimately, not the Government. The government cashed in alright on higher property prices through taxes – but then it blew all the money on public sector pay hikes.
The Government and the developers are now broke, but public sector workers are still getting billions every year after years of pay hikes that stretched their premium over their private sector counterparts to 22 per cent by 2006. The problem is there are no property bubble taxes to pay for these wages any more.
So what are other implications to deflation? Well, it’s bad news for borrowers because their loan repayments remain static while their ability to repay goes down. Mortgage holders are used to things getting easier every year as wage increases compensate for inflation eating away the value of your money – but not any more.
In deflationary times, that mortgage bill just keeps getting bigger as the cash you need to pay it becomes more valuable.
A saver’s heaven
However, it is a boon for savers, who now have the chance to make extraordinary double digit returns just by salting their money away (check out the deposit rate tables below).
An Post is back in vogue now with the top fixed rates on the market thanks to its immunity from DIRT of 4.3 per cent over three years.
Deflation is unlikely to last that long, but with short-term interest rates above three per cent, savers are currently clocking up guaranteed returns of 9.5 per cent at the moment. This is an extraordinary guaranteed return that’s probably unprecedented.
Remember when optimistic brokers used to predict eight per cent per annum as a likely return from the stock market – with all its associated risks? The big question for savers is how safe is your money in a bank?
All the fuss about NAMA and the bank guarantee scheme doesn’t change the fact that the Government is playing a confidence trick on the market. It has taken over all the dodgy debt in the country and issued a blanket guarantee on practically every cent held on deposit in Irish banks at a time when it is effectively bankrupt itself.
Is it really in a position to meet those guarantees if they are all called in at once? It’s a bit like a dishevelled drunk staggering into a casino and offering to cover everyone’s bets – it’s nice of him to offer, but does he really have the financial wherewithal to back it up?
If the Government is suddenly presented with a bill for hundreds of billions of euro to back its bank guarantee, where is it going to get the money?
With state coffers worse than empty, they would have to borrow the money – but who in their right mind would lend it to them?
The possibility of a run on the banks is admittedly remote, but it could happen if the Government bottles its commitment to deliver on at least E4 billion in cuts. If it instead bows to the powerful and wealthy public service unions, international institutions might lose confidence in Ireland Inc. and take their money out – to be shortly after followed by private savers and investors.
The possibility of a run on Irish banks is unlikely, but it hasn’t gone away just because a Government bankrupt of cash and ideas has given a dubious pledge to guarantee the whole shebang.
Buyer beware!
Savers should check out the terms of the myriad of deposit protection schemes now in place. Most Irish banks are covered by the Government Bank Guarantee Scheme, which covers all deposits (see panel), but some come under the Irish Deposit Protection Scheme instead and this has only 100 per cent of deposits guaranteed up to a maximum of E100,000
The Dutch Central Bank covers Rabobank up to E100,000, but UK institutions are only guaranteed up to £50,000 – apart from Northern Rock, which has all deposits guaranteed. Most UK and foreign-owned institutions are not as well covered as Irish banks are under the Government’s Bank Guarantee Scheme.
However, on the positive side, they just might be better able to withstand an Irish “run” if such an unlikely event were to occur.
The best bet is probably National Irish Bank. It has the best of both worlds as it’s Danish-owned – and therefore less vulnerable to an Irish meltdown - and also covered by Denmark’s pledge to guarantee 100 per cent of deposits for two years, which beats the UK version (apart from Northern Rock).
See the Financial Regulator’s website at www.itsyourmoney.ie for up-to-date interest rate comparisons and details of deposit protection schemes.
