When one lives through momentous change, it is often easy to fail to notice it happening. Irish banking is a case in point. Over the past decade or so we have seen a dramatic decline in the number of financial institutions operating in Ireland, and the banking landscape has been totally and utterly transformed. Names such as Anglo-Irish Bank, Irish Nationwide, Rabobank, Danske Bank and Bank of Scotland have all exited the market, and our memories in some but not all cases. Throw in on top of that names such as ICC, ACC, Northern Bank, National Irish Bank, TSB, and the scale of the change over an even longer time horizon has been even more striking.
After months of speculation and a growing sense of inevitability, the owner of Ulster Bank, NatWest, has announced that it is about to begin a gradual winding down of its operations in the Republic of Ireland. This does not come as a surprise as the owners have had to pump in around €17 billion to its operations on the Island of Ireland since the crash, and it has a cost base that is totally out of kilter with the other competitors in the market. Arguably, it is doubtful if the current operation could ever have been turned into a slick and profitable entity, not least because of the potential cost of the IT investment that the Bank needs. NatWest also argues that the onerous capital requirements in the Irish banking market render it a less than attractive banking market in which to operate in. This is a legacy of the banking crash and is one of the reasons why Irish mortgages are so expensive relative to many Euro Zone countries. It is unlikely to change anytime soon, particularly with the dark spectre of COVID-19 hanging over the Irish economy.
Despite this sense of inevitability, the exit of Ulster Bank from the Irish banking market is bad news on many fronts. Ulster Bank is the third largest mortgage and business lender in the Irish market. It has a loan book of around €20.5 billion; it accounts for 15 per cent of the mortgage market, or around €14.5 billion; it has around €4 billion in SME lending, equivalent to 20 per cent of that market; and it holds €22 billion in deposits, including a small one from the author of this piece. Of greater note is the fact that it has been in Ireland since 1860; it has 88 branches; it employs 2,800 people; and it has 1.1 million customers. All in all, it has been and continues to be an influential player in the Irish banking market. Alas that is all about to end.
The spin being put on this is that it will be a gradual winding down of the operation and that it will be managed in an ‘orderly and considered manner’, whatever that means. It is hard to see how it can possibly operate as a proactive force once a decision has been taken to shut it down. Why would one enter into a business arrangement with an institution that has a relatively short shelf life?
The possible sale of part of the commercial loan book to AIB, and of certain retail and SME assets, liabilities and operations to Permanent TSB is noted, but this will not solve the fundamental problems that will be caused to the Irish economy and Irish society due to the exit. Indeed, AIB will assume an even more dominant position in the market if it buys these assets. The sale of some assets to so-called ‘vulture funds’ is also not a very enticing prospect. All in all, it is hard to see too many winners out of this.
Following the announcement, we have effectively been left with the sort of banking model that those of us of a certain age grew up with. That is a model where two players dominated the market, and a couple of other smaller ones struggled to gain any real traction. AIB and Bank of Ireland now control around 60 per cent of the Irish banking market and effectively have a duopoly, with all of the negatives that inevitably flow from such a market structure. With the exit of Ulster, this duopoly domination will be accentuated.
Competition in any market is generally good for the consumer, provided of course the competitive structure is regulated properly. In September 1999, one of the most dramatic developments in the history of the Irish mortgage market occurred when Bank of Scotland entered the market with a variable mortgage rate of 3.69 per cent, compared to an average variable mortgage rate of 5.17 per cent at that time. The new entrant made a pledge that it would not charge a differential of more than 1.5 per cent above the official ECB rate. By December of that year the average variable rate mortgage differential over the ECB rate had narrowed to just 1.14 per cent, compared to 2.86 per cent before the new bank arrived. This is an example of how competition can help the consumer.
Of course, this competition eventually helped fuel a property bubble and a banking collapse due to a total failure of Central Bank regulation. The key points are that competition does benefit the consumer, but that competitive forces do need to be properly regulated in any market.
The question now is what can be down to prevent greater market concentration and the negatives that flow from monopolistic tendencies. Is it possible that an outside player could now enter the Irish market and shake it up? Highly unlikely. The other option would be to create a meaningful third force. The state still owns 75 per cent of Permanent TSB. So, the question is if this could be somehow linked up with the Post Office and credit unions to create a national banking institution? It would not be easy and would require considerable capital investment. In addition, the State’s 71 per cent holing in the ordinary shares of AIB probably complicates the situation.
However, the bottom line is that something needs to be done. I particularly worry about what might be in store for many smaller businesses who are already struggling as a result of COVID-19 restrictions, and who may struggle to get a bank to support them. The Government has some big decisions to make, but make them it must.
GOVERNMENT HAD NO CHOICE OTHER THAN TO RE-OPEN
2020 is a year that we will all want to forget about as quickly as possible, and we hope that we can look forward to a better 2021. Naturally, how good 2021 will turn out to be from a societal and economic perspective will be totally influenced by vaccine-related issues, rather than anything else. In that context, there are certainly grounds for optimism at the moment. We can only hope that safe and effective vaccines will delivered over the coming months, and equally our health authorities will do a better job of dispensing it than they have done in managing the crisis since March.
Last week we heard some government heads pointing out that many of Ireland’s COVID-related statistics are now amongst the best in Europe. I guess that is what is achievable, if policy makers are prepared to sacrifice business, livelihoods and the mental health of the nation. Ireland has endured the toughest restrictions across the EU, so naturally we should be doing better than others on the infection front.
We could obviously have remained locked down for another two months, in which case our COVID statistics might look great, but at what cost? A series of rolling lockdowns is not a good strategy, and is indicative of policy failure in other areas. As Government has said, but had until Friday last appeared to ignore, we have to learn to live with the awful virus.
I was somewhat amused and somewhat angered over the weekend by the reaction of some of the health-related talking heads that have dominated our media since March. They cannot appear to accept that the decision taken by Government on Friday has any justification, and they are promising us very rough times early in the new year. Perhaps these dire predictions will come to pass, but rational thinkers would have to accept that Government did not have much choice, if viewed in the context of livelihoods, mental health, and business survival. Another four or five weeks of lockdown would have resulted in a type of anarchy from many young people in particular. It is the right decision to open many businesses in as safe and controlled way as possible, while recognising there is nothing risk free.
A quick perusal of the most up to date labour market statistics is a sobering experience. On 23rd November, 352,078 people were in receipt of the Pandemic Unemployment Payment (PUP). Of this total, over 16 per cent are from the retail sector, and over 29 per cent are from the accommodation and food services sector. In total, these two sectors account for over 160,000 people. In addition, over one quarter of total PUP recipients are under the age of 25. Not alone has our younger generation suffered disproportionately on the labour market front, they have also had the potentially most exciting time of their lives put on hold, by health policymakers. This situation cannot be sustained.
Between the PUP, the Live Register and the Employment Wage Subsidy Scheme, over 900,000 workers have been in receipt of some form of welfare payment during Level 5. These dire labour market issues, their associated fiscal cost, and their impact on the mental health of the nation were instrumental in the Government decision to stand up to the scorched earth policy recommended by NPHET. The Minister for Finance has estimated that remaining at Level 5 for December would have cost a further €1 billion. Of course, the various tax revenues that would have been foregone through VAT etc, would increase this cost considerably.
Opening up is a risky strategy from a health perspective, but I sense that sticking with Level 5 would actually have given rise to behaviours that could have turned out to be riskier than the path that is being chosen.
As the economy is being re-opened, Brexit is of course grinding slowly towards some sort of conclusion, but we are not yet sure what the nature of that conclusion will be. Deal or no deal, we are heading towards some variation of a hard Brexit that will fundamentally alter how we do business with the UK. There is not a lot we can do about that. The UK is on the brink of making a once in a generation mistake of monumental proportions. We will have to adapt to the new scenario and make sure we manage the downside and be prepared to exploit as fully as possible the opportunities that will be presented. We have no choice.
THE ECONOMIC BACKGROUND
Budget 2021 is all about COVID-19, housing, health, Brexit, and climate change. It marks the third part of a fiscal trilogy that included the pandemic employment package announced in March, and the July stimulus package. In some respects, framing this budget was very challenging, given the dramatic impact of COVID-19 on the economy and the public finances A record contraction of 6.1% in GDP in the second quarter contextualises the challenge. On the other hand, framing it was relatively straightforward, because there was no choice other than to spend and borrow aggressively, just like almost every other country in the world, and in an environment of engineered historically low bond yields.
Many sectors of the economy were forced to close in March and economic activity contracted sharply in those sectors. As the economy gradually re-opened over the summer months, activity in most sectors has recovered. However, activity levels have been constrained by the various COVID-19 protocols and restrictions in place, not least the localised lockdowns, and more recently the national move to Level 3 restrictions. This is likely to represent the future until it becomes possible to treat the virus, or a safe and effective vaccine is delivered.
The labour market has been the most noteworthy economic casualty of COVID-19. Coming in to 2020, there was concern about the challenges posed by an economy approaching full employment. These concerns have been replaced by very different and much more worrying ones since the beginning of March.
In the year to the end of June, total employment declined by 77,500 or 3.4% to 2.22 million. The greatest rate of decrease was in accommodation and food services (29.6% or 53,600); administration and support services (17.2% or 18,900); construction (12.1% or 17,800); and the wholesale & retail sector (5.2% or 15,600).
At the end of September, the seasonally adjusted unemployment rate, as measured in the standard way, stood at 5.4% of the labour force, or 126,200 people. This represents an increase of 9,200 over the past 12 months. However, if all of those in receipt of the Pandemic Unemployment Payment (PUP) were classified as unemployed, the adjusted unemployment rate would have stood at 14.7% of the labour force at the end of September. This is down from a rate of 24.5% in June.
In the week to 13th October, 228,858 people were on the COVID-19 Pandemic Unemployment Payment scheme. This is 369,142 lower than 5th May, but it increased by 23,265 over the previous week as the Level 3 restrictions started to impact. Table 1 shows the breakdown by sector of those in receipt of the PUP payment and clearly shows those sectors that have been most adversely affected by the health crisis. Accommodation & Food Services, and Wholesale & Retail Trade account for 43.7% of the total numbers in receipt of the PUP. 47.1% of those in receipt of PUP on 13th October were under the age of 34.
Table 1: Sector Breakdown of Pandemic Unemployment Payment (13th October)
|% OF TOTAL
|Agriculture, Forestry, Fishing, Mining & Quarrying
|Electricity, Gas, Water & Sewage
|Wholesale & Retail Trade
|Transportation & Storage
|Accommodation & Food Services
|Financial & Insurance Activities
|Real Estate Activities
|Professional, Scientific & Technical Services
|Administration & Support Services
|Public Administration & Defence
|Human Health & Social Work
|Arts, Entertainment & Recreation
Source: Department of Employment & Social Affairs, 6th October 2020.
FISCAL BACKGROUND TO BUDGET 2021
The fiscal challenges informing Budget 2021 are challenging. In 2019, the General Government surplus was equivalent to around 0.4% of GDP or €1.3 billion. Following the response seen to date by Government and the slowdown in economic activity, a deficit of €21.2 billion (6.1% of GDP) is now targeted for 2020.
In the first 9 months of 2020, the Exchequer ran a deficit of €9.37 billion, compared to a surplus of €38 million in the same period in 2019. The ongoing COVID-19 crisis is undermining tax revenues to some extent, but the pressure on public expenditure is very intense.
Total net voted government expenditure at €48.1 billion in the first 9 months of the year was 24.9% higher than in 2019. Current expenditure was 25.9% higher, and capital expenditure was 16.9% higher. Net voted expenditure in the Department of Employment Affairs and Social Protection was 76.9% higher than last year at €14 billion; and the Department of Health was 15.6% higher at €14.5 billion. These 2 departments accounted for 59.3% of total spending in the first 9 months of the year.
In the month of September, total tax revenues at €5.3 billion were €411 million or 7.2% lower than September 2019. Income tax was down by 7.7%; VAT was down by 14%; and corporation tax was up by 8.9%.
Overall tax revenues were 3% lower than the first 9 months of 2019. Income tax receipts were 2.1% lower; corporation tax receipts were 27.9% ahead; and VAT receipts were 19.9% lower. The weakness in VAT receipts reflects weaker consumer spending as a result of the lockdown. The relatively strong performance of income tax once again reflects the fact that lower paid workers who pay little tax, continue to be the main labour force casualties of COVID-19. For workers in FDI companies, financial services, professional services, and the public sector, earnings and employment are being sustained.
Table 2: Tax Revenues (January-Sept 2020)
|% OF TOTAL
|Capital Gains Tax
Source: Department of Finance, Fiscal Monitor, September 2020.
On the expenditure side, net voted government expenditure to the end of September was €7.5 billion higher than expected and €9.5 billion or 28% higher than the first 9 months of 2019.
In the circumstances, a deficit of €21 billion for the full year is justifiable and unavoidable, as it is necessary to support the economy, business, and ultimately employment in the face of an unprecedented and totally unexpected economic shock. Such support will also be required in 2021.
It is clear that the economic, social and political imperative is to get as many people back to work as quickly and as sustainably as possible. In this context, it is essential that a longer-term perspective will be the key theme in Budget 2021 and the National Economic Plan.
THE DEPARTMENT OF FINANCE BUDGETARY ASSUMPTIONS
The economic assumptions underlying Budget 2021 are based on 2 assumptions. Firstly, from the beginning of 2021, bi-lateral trade with the UK will be conducted on the basis of World Trade Organisation (WTO) terms, which is estimated to knock 3% off GDP growth in 2021; and secondly, a widespread vaccine will not be available in 2021.
- GDP is projected to fall by 2.4% in 2020 and to grow by 1.7% in 2021.The decline in 2020 is not as large as previously forecast, due mainly to the strong contribution of the multi-national sector, but the impact on the domestic economy has been severe. The recovery in 2021 is projected to be significantly weaker than previously forecast, because of the assumptions relating to Brexit and COVID-19.
- Modified domestic demand, which is a better proxy for the domestic economy is set to fall by 6.1% in 2020, and to expand by just 4.9% in 2021. Consumer spending is forecast to decline by 7.5% in 2020, and to expand by 7% in 2021.
- Employment is set to fall by 13.7% in 2020, and the unemployment rate is set to average 15.9% of the labour force. Employment is set to grow by 7.6% in 2021, and the unemployment rate is set to average 10.3% of the labour force.
- The forecasts for 2020 could deteriorate, depending on how COVID measures evolve in the final quarter of the year. The overall risks to growth in 2021 are still very significant.
Table 3: Macro-Economic Forecasts Underlying Budget 2021
|Modified Gross National Income
|Modified Domestic Demand
Source: Department of Finance
The key strategy in Budget 2021 is:
- Budget 2021 is focused on providing further support to the economy.
- Decisions prioritising management of the COVID crisis and Brexit.
- Significant measures are targeted at the three priorities in the Programme for Government – health, housing, and climate change.
- The Budget is based on the assumptions of a disorderly Brexit and no vaccine in 2021.
- There are no broad-based increases in income taxation.
- Budget 2021 is targeting a modest improvement in the headline fiscal position, while allowing deficit-financed spending to continue in the short-term.
KEY ELEMENTS OF BUDGET 2021
Budget 2021 is the most expansionary budgetary package introduced in the history of the state. In the face of the pandemic, fiscal policy is justifiably strongly counter-cyclical. There is no other choice. The tax measures and the very significant increase in public expenditure contained in the budget are aimed at sustaining businesses and households that are in serious difficulty due to the evolving restrictive measures put in place to deal with the virus. There is no option other than to increase spending significantly in the Department of Employment Affairs and Social Protection, and the Department of Health.
In an environment where long-term bond yields are close to zero as a result of the bond buying programme of the ECB, and the relaxation of the EU’s fiscal rules, the Irish Government is correct in borrowing heavily to sustain the Irish economy and Irish society for as long as it takes.
The appropriate response to the health crisis is to ensure that a functioning economy is maintained, and when growth resumes, that will result in a cyclical reduction in government borrowing and debt. Fiscal austerity would not be an appropriate response from a social or economic perspective in the face of the COVID crisis.
Before any changes to taxation or expenditure in Budget 2021, the Department was projecting a general government deficit of €21.2 billion in 2020, equivalent to 6.1% of GDP; and €14 billion in 2021, equivalent to 4% of GDP. Following the changes announced in the budget, a deficit of €21.5 is now forecast for 2020 (6.2% of GDP) and €20.5 billion (5.7% of GDP) in 2021.
The budget package is worth €17.7 billion, that includes €3.5 billion in core current expenditure; €1.5 billion in capital expenditure, which at €10.1 billion is the largest ever capital programme; €3.5 billion is being set aside for a Recovery Fund; and there is a tax package of €270 million net.
Overall tax revenues are forecast to increase by 6.5% in 2021 to reach a record high of €60.4 billion.
Table 4: Tax Revenue Projections Post-Budget 2021
|Capital Gains Tax
|Capital Acquisitions Tax
Source: Department of Finance
The key measures included in Budget 2021 included:
- A General Government Deficit of €21.5 billion is pencilled in for 2020, equivalent to 6.2% of GDP. Following the budget day changes to expenditure (+€17.4 billion expenditure measures, over and above the planned expenditure for 2020 pre-COVID; and €270 million in net tax changes), a deficit of €20.5 billion is projected for 2021, equivalent to 5.7% of GDP. The national debt is projected at €219 billion at end 2020, equivalent to 107.8% of Gross National Income, and 114.7% of Gross National Income at the end of 2021.
- A Recovery Fund of €3.4 billion is being introduced. This will relate to infrastructure development, reskilling and retraining, and supporting investment and jobs. This fund will be related to COVID-19 and Brexit effects.
- Gross Voted Capital Expenditure is projected to increase by 2.8% to €10.1 billion and Gross Voted Current Expenditure
- Expenditure on health to increase by €4 billion.
- The tax debt warehousing scheme is to be extended to include the 2019 balance and 2020 preliminary tax to allow such taxpayers to defer payment for a period of a year with no interest applying; 3% will apply thereafter and will attract no surcharge.
- The EWSS will be extended beyond 31/3/21 to the end of the year. Changes may be made to it, depending on economic circumstances.
- Multi-annual house building programme, with a significant allocation of funding to local authorities to provide social and affordable housing.
- A COVID Restrictions Support Scheme (CRSS) will provide to closed or effectively closed business due to COVID-19 restrictions, a payment of up to €5,000 per week, based on their turnover in 2019.
- The VAT rate for the Accommodation and Food Services sector has been cut from 13.5% to 9%, with effect from 1/11/20 and will expire on 31/12/21. The cut in the top rate of VAT from 23% to 21% that was introduced on 1st September will be allowed run out on 28th February as originally envisaged.
- The enhanced Help-to-Buy Scheme is being extended beyond the planned year-end, to the end of 2021. This entitles first-time buyers buying a new house or apartment relief of up to €30,000.
- No changes in PAYE, PPRSI or USC. However, tax bands and credits were left unchanged. Modest increase in the ceiling for the second USC threshold from €20,484 to €20,687 to prevent minimum wage workers from moving into higher USC band. The weekly threshold for the higher rate of employer’s PRSI increased from €394 to €398.
- In Budget 2020, the carbon tax was increased by €6 per tonne to €26. In line with the Government’s climate targets, this is now being increased by €7.50 per tonne, for motor fuel from midnight on night of Budget, and for other fuels from 1st May 2021. This will lead to a €1.47 increase in the cost of a 60-litre fill of diesel and €1.28 for a similar amount of petrol, as well as add 90-cent to a bag of coal and 20 cent to a bale of peat briquettes. An increase in the Fuel Allowance of €3.50 per week is being introduced to help offset the carbon tax among vulnerable groups and the low paid.
- The Earned Income Tax Credit for self-employed has been increased by €150 to €1,650, to bring it into line with PAYE employees.
- Changes to Vehicle Registration Tax, to disincentivise people from buying higher emission vehicles.
- Rise in pension age to 67 on 1/1/21 scrapped.
- A significant budget package is being introduced for the entertainment and arts sectors.
- The commercial rates waiver has been extended to the end of the year.
In overall terms, Budget 2021 is a very expansionary and counter-cyclical budget that is totally dominated by the COVID-19 crisis, and the possibility of a no-deal Brexit. It is an appropriate strategy in current circumstances, but this is an evolving situation and clearly Government will have to remain very hands on in terms of management of the economy for at least the next 15 months.
A STRONG COUNTER-CYCLICAL BUDGET TOTALLY APPROPRIATE
In Budget 2020, Paschal Donohue adopted a pretty conservative approach to the public finances despite the fact that it was the last budget before the general election. In the aftermath of that election in February, I heard a number of bruised and battered Fine Gael voters lament and even criticise his approach, but I think history has already shown that he adopted the correct one. A year ago, the economy was growing strongly and a budget surplus, albeit a small one, was most appropriate in the circumstances. Fiscal policy should be counter-cyclical if at all possible, and 2019 certainly was not a year for an injection of fiscal stimulus. On the contrary, 2020 and 2021 are most definitely years for a strong injection of fiscal stimulus and that is exactly what we were treated to yesterday. Budget 2021 is an example of a sensible and most appropriate counter-cyclical fiscal strategy.
The run up to Budget 2021 was challenging and unusual. The challenges emanated from the ongoing havoc that COVID-19 is wreaking on the economy and the public finances; and the very real threat that Brexit now poses. Unusually, yesterday’s budget offering was the third part of the ‘2020 fiscal trilogy’. In March, there was a significant fiscal stimulus in the shape of the various COVID-related employment supports, and then the July stimulus package. It is unlikely that a fourth one will be required in 2020, but that may not be the case in 2021.
Budget 2021 was sensibly predicated on two assumptions – namely, that from the beginning of 2021, bi-lateral trade with the UK will be conducted on the basis of World Trade Organisation (WTO) terms; and secondly, a widespread vaccine will not be available. Both of these assumptions are credible based on what we currently understand, but of course both could turn out better than expected. Given just how influential both of these issues will be for the trajectory of the economy and the public finances over the next couple of years, it is sensible and prudent to plan for the worst and hope for the best.
Budget 2021 is the most expansionary budgetary package introduced in the history of the state, totalling €17.7 billion. Unlike Irish fiscal policy in my living memory, this year’s budget is sensibly very counter-cyclical, and it stands out in marked contrast to policy in the aftermath of the banking crash over a decade ago.
The Government is set to run a budget deficit of around €21.6 billion this year, and following the spending and taxation measures announced yesterday, a deficit of around €20.5 billion is projected for 2021. These are big borrowing numbers that will add significantly to the level of outstanding national debt. However, in the face of the pandemic, there is no other choice. The tax measures and the very significant increase in public expenditure contained in the budget are aimed at sustaining businesses and households that are in serious difficulty due to the evolving restrictive measures put in place to deal with the virus. There is no option other than to increase spending significantly in the Department of Employment Affairs and Social Protection, and the Department of Health in particular. There is also no option other than to use taxation and expenditure to support those sectors and those households most adversely affected by the crisis, and the potential pressures that could emanate from a bad Brexit.
In an environment where long-term bond yields are close to zero as a result of the bond buying programme of the ECB; where the EU has relaxed its fiscal rules; and where the International Monetary Fund (IMF) is strongly advocating capital spending and investment in infrastructure, the Irish Government is correct in borrowing heavily to sustain the Irish economy and Irish society for as long as it takes. Thankfully, bond markets are not overly concerned, because virtually every country in the world is doing what Ireland is doing.
The appropriate response to the COVID crisis is to ensure that a functioning economy is maintained, and that the foundations for an eventual economic recovery are laid. A resumption of economic growth would result in a cyclical reduction in government borrowing and debt, so it is important to ensure that we do whatever it takes to guarantee such an economic recovery. In the face of or indeed in the aftermath of this crisis, fiscal austerity would not be an appropriate response from a social or economic perspective. Of course, it goes without saying that Government does need to be vigilant in terms of how the money is spent, because history should show us that merely throwing money at a problem does not necessarily solve it. It is also important to remember that much of the money spent will find its way back into the economy through wages and consumer spending, and thereby support employment and tax revenue buoyancy.
The economic assumptions underlying the budget look sensible and appropriate based on what we know now, but the level of uncertainty is currently elevated to a degree that we have never seen before. Anything is still possible over the coming months, and the good thing is that there is a level of flexibility built in that will allow Government respond to whatever might arise. The already very pressurised motor industry will justifiably have most to complain about after this budget, but for all other sectors it looks reasonable, if one accepts that scarce resources must be allocated in the best manner possible.
Budget 2021 is all about COVID-19, Brexit, housing, health, and the climate. In overall terms, Budget 2021 is a very expansionary and counter-cyclical budget that is totally dominated by the COVID-19 crisis, and the possibility of a no-deal Brexit. It is an appropriate strategy in current circumstances, but this is an evolving situation and clearly Government will have to remain very hands on in terms of management of the economy for at least the next 15 months.
ASSESSMENT OF US PRESIDENTIAL ELECTION 2020
Election 2020 possibly the most important in generations…
It is generally accepted that US Election 2020 is possibly the most crucial presidential election in generations, if not in US history. In 2016, Donald Trump upset the odds and came to power without any real political pedigree. During his tenure, he has been extremely divisive and has exposed and exploited the very real divisions in US society. He also adopted a very confrontational approach to international relations and had a very fractious relationship with former international friends and allies of the US. He pushed a strong nationalistic, inward looking agenda, and arguably did serious damage to the US’ longstanding status as leader of the free world.
He tapped into something in the US, and delivered what his supporters wanted him to deliver, as evidenced by the fact that he garnered considerably more votes in 2020 than in 2016, and he was only narrowly defeated. If President Trump had been re-elected, the possibility is that free from the shackles of election, Trump would have thrown caution to the wind in his second term and really move to push the various agendas that dominated his first term. This would not have been good for global trade, global growth, or global political stability. It may have been good for the US economy, but would have further increased divisions in the US, and further damaged the international political order. A Trump victory would also have given further belief to the nationalistic leaders and movements that are being nurtured around the world.
The election of Biden may not result in the reversal of these trends, but perhaps it might just slow some of them down. It is also important to bear in mind that Biden won narrowly, and on 20th January next he will take over a very divide and fractured country.
Trump leaves a mixed legacy…
Somewhat unusually for a politician, President Trump delivered a considerable amount of what he promised to deliver. He has cut corporation and incomes taxes; he cut red tape for business; he has clamped down on immigration and some of the ‘wall’ has been constructed; he has taken on China in an aggressive manner; and he has sought to re-negotiate or pull out of trade deals. He also packed the Supreme Court with conservative judges. On the other hand, he has failed to resolve the healthcare crisis; he has failed to rein in the US trade deficit; and the national debt has widened dramatically during his presidency, not helped of course by COVID-19. This health crisis exposed the real lack of a social safety net in the US, and the need for massive investment in infrastructure.
Trump was basically anti-free trade and anti-globalisation and did not believe in multilateralism. He took the US out of the Paris Climate Accord, and is in the process of taking it out of the WHO. The UN and NATO could have been next.
In terms of his management of the economy, arguably President trump presided over a relatively good period for the economy, at least until COVID-19 struck. In 2017, GDP expanded by 2.2%; in 2018 by 3.2%; and in 2019 by 2.3%. This year GDP growth is forecast to decline by 4.3%, and to expand by 3.1% in 2021. Without COVID-19, GDP would have been expected to grow by around 3% this year. COVID-19 has certainly taken the gloss off his economic legacy, but his handling of the crisis has not been good. Of course, he is not unique in that respect.
In the third quarter of 2020, the seasonally adjusted annualised growth rate expanded by a massive 33.1%. President Trump latched on to this number in the final days leading up to the election. This annualised growth number is basically calculated by raising the quarterly growth rate to the power of 4. Q3 growth was obviously exaggerated by a rebound from a very weak Q2 as a result of COVID. The reality is that growth in the third quarter was 2.9% lower than a year earlier, and was 3.5% lower than the final quarter of 2019.
The labour market performance under Trump was strong, at least until 2020. At the end of 2019, the unemployment rate was down at a historic low of 3.5% of the labour force. This jumped to 14.7% in April, and gradually declined thereafter to 7.9% in September. Total employment in September was still 10.4 million jobs lower than in February.
President Trump was good for the US economy, and despite the damage inflicted by COVID-19, his strong vote and ultimately narrow defeat were largely due to his economic management. The exit polls showed that the economy was the most important issue for many voters, and Trump was seen as a good choice by a large segment of the electorate.
President Trump was good for the equity markets. The cut in the corporation tax rate from 35% to 21% boosted corporate profits and share buybacks. The domestic economic performance was also quite good. Between 1st January 2017 and polling day on 3rd November 2020, the S&P 500 gained 49.1%. The gains would likely have been considerably higher but for COVID-19.
What might we expect from a Biden Presidency…?
The new President Elect, Joe Biden, who is now 77 and will be 78 by the time of the inauguration on 20th January, came in to this election with a long and experienced, albeit not particularly strong, political pedigree.
President Trump argued during the campaign that Biden would succumb to the wishes of the left and dramatically expand the role of government and do untold damage to business. This is somewhat ironic, as Trump has overseen a massive increase in Government involvement in the economy since COVID hit.
These accusations about Biden are not likely to materialise. Biden has been a centrist all of his political career and is not likely to radically shake up the economic or political landscape. It would not be in his nature. His Vice-President Kamala Harris on the other hand, would possibly be more radical if she were to assume the presidency for some reason.
The big question now is what we can expect from a Biden presidency. The platform on which he built his 2020 election campaign was titled ‘Build Back Better’. This basically revolves around fostering economic recovery; improving infrastructure; bringing broader benefits to lower income communities and minorities; improving education, R&D, and the skills of the workforce; and creating a greener economy and society.
This overall agenda is set to include some of the following:
- A €2 trillion investment in Green Energy to radically cut carbon emissions. This would be bad for the oil industry and fracking and would fly in the face of Trump’s environmental policies over the past 4 years. From a global perspective this would be good, and he will probably also re-engage with the Paris Climate accord.
- A significant increase in long-term infrastructure investment, which would have a significant fiscal multiplier effect. This would start to correct for years of under-investment in infrastructure. This expenditure would be funded by tax increases, with his tax changes targeted to raise $1.4 trillion over his 4-year term.
- His tax policies include an increase in the corporation tax rate from 21% to 28%; higher income taxes for those earning over $400,000; and higher capital gains taxes for the very wealthy.
- An increase in the Federal Minimum Wage from $7.25 per hour to $15 per hour.
- More support for small business, through grants and other mechanisms.
- Universal pre-school education; tax credits for childcare; and free public university education for families who earn less than $125,000 per annum.
- He seems to believe in a soft form of protectionism. This could involve bringing supply chains back home by adopting a ‘made in America’ government procurement policy; tightening of the rules on labelling of products; and the use of US steel for transport projects.
- He would likely promote multilateralism and seek to rebuild the damaged relationship with the EU and other countries. However, give the popular support for Trump’s approach to China, he is unlikely to row back significantly on the tariff regime with China, or indeed the fractious relationship between the US and China that gathered momentum during Trump’s presidency. However, Biden is an internationalist, and hopefully he will seek to rebuild the damage done to US international relations over the past 4 years. This would be good for global trade, global growth, and perhaps global political stability.
- He would likely adopt a more constructive approach towards immigration, although he will have to be mindful of the popular support for some of Trump’s approach to immigration.
What might it mean for equity markets?
The aforementioned agenda does not look radical, and in fact looks very sensible from an economic and societal perspective. If implemented, this agenda should be good for the US and indeed the global economy. Traditionally, equity markets have tended to perform better during Democrat presidencies. It may not be as clear cut this time, given the elevated level of US equities.
It is estimated that the proposed corporation tax changes could trim S&P earnings by 9%, which would not on the face of it be good for equity markets. However, the investment programme in infrastructure, the Green economy agenda, and some of the other policies should benefit growth in the economy, and consequently, be good for equity markets.
There is some speculation that anti-trust laws could be used to address the tech sector. However desirable this might be, the markets would most likely not like it. Time will tell.
Biden will not find it easy…
For President-Elect Biden, the implementation of his agenda will not be straightforward.
The US is set to run a budget deficit of close to 16% of GDP this year, and the national debt is at record highs, equivalent to 106% of GDP. On the current trajectory it could hit 200% of GDP by 2050. The need for fiscal constraint could become a strong political pressure point over the coming years.
In addition, without control of both houses, the power of any president is seriously curtailed.
The Outgoing House of Representatives (435 seats) was controlled by the Democratic party. The Democrats had 232 seats; the Republicans had 197 seats; 1 Libertarian; and 5 vacant seats. 218 seats are required for a majority. The Democrats have maintained control of the House.
The Senate is controlled by the Republican party, who have a majority of 6. There are 100 seats in the Senate. The Republicans have 53; the Democrats have 45; and there are 2 Independents. Despite high hopes in the Democratic party, it appears likely that the Republicans will maintained control of the Senate, subject to runoffs in January.
The House of Representatives and the Senate are equal partners in the legislative process. Legislation cannot be enacted without consent of both chambers. The division of Congress will make it difficult for Biden to pursue his agenda, but this is the norm rather than the exception in US political life.
The Supreme Court is also controlled by conservatives, which will make it more challenging for a Democratic president. Perhaps the biggest issue of all for Biden is the fact that Election 2020 has really highlighted just how dangerously divided the US is.
Arguably, a Biden victory would be better for Ireland than another 4 years of President Trump.
- If the corporation tax rate is increased from 21% to 28%, this will make Ireland even more attractive for US multi-national investment. Given that post-Brexit, Ireland will be the only English-speaking country in the EU (excepting tiny Malta), so it could benefit from Biden’s tax policies.
- Biden will likely engage more constructively with the EU, which would be good for bilateral trade, which would be good for the small, open, Irish economy.
- In the context of Brexit, Biden would be better for Ireland. The speaker of the House, Nancy Pelosi, has said that the House would not ratify a UK-US trade deal, if the UK exit from the EU undermines the Northern Ireland peace process. Biden agrees with this perspective.
Biden also has Irish heritage, so his general approach to Ireland is likely to be warm and positive.
COVID-19 POSES SIGNIFICANT CHALLENGE TO GLOBAL ECONOMY AND FINANCIAL MARKETS
There is an old maxim in the world of economics and financial markets that one should always expect the unexpected. Coming into 2020, there were grounds for a slightly higher level of optimism relating to the coming year, following on the back of what was quite a challenging 2019 for the global economy.
The slightly heightened level of optimism was predicated on a view that ahead of his re-election bid in November, President Trump would wind down his trade dispute with China and concentrate on ensuring as strong and stable an economy as possible in the run up to the election. This has transpired as President Trump and the Chinese have become more conciliatory and the threats of a damaging trade war have been averted, at least for 2020. 2021 may be a different matter.
However, all has changed over the past month and the escalation of the COVID-19 crisis has thrown global financial markets into crisis and has generated a massive level of uncertainty about the economic outlook. At the moment, the prognosis does not look good, but there will inevitably (or at least hopefully) be a strong and co-ordinated global policy response.
The US Federal Reserve shaved 0.5% off its key interest rate on March 3rd as an emergency measure to address the economic impact of the virus. The real point of note is that this was the first emergency rate cut in the US since the collapse of Lehman Brothers in September 2008. This should send out a clear message of just how seriously global authorities are now starting to take the threat posed by COVID-19. The economic and financial risks are very real.
The Organisation for Economic Co-operation and Development (OECD) has pointed out that global economic growth was already weak, but was stabilising until the Coronavirus hit. It cites restrictions on the movement of people, goods and services, and the various containment measures taken, such as factory closures, as impacting very negatively on manufacturing and domestic demand in China. It went on to warn that the impact on the rest of the world through business travel and tourism, supply chain disruptions, commodities and lower confidence is becoming more significant.
The International Monetary Fund (IMF) has issued a similar prognosis and has created a $50 billion fund to help low income and emerging market countries cope with the negative repercussions of the virus. It believes there will be significant economic fallout from the global health crisis. It is hard to disagree.
COVID-19 is somewhat different than many previous shocks, because it has both supply side and demand side effects. The overall impacts will be felt through voluntary curtailment of activities and from official restrictions to certain activities.
The disruptions to business, particularly in China, has impacted negatively on the supply of materials, particularly intermediate materials for further production. The lockdown of businesses and the imposition of quarantines is having a negative effect around the world, and this is already being reflected in dry bulk shipping of materials and commodities.
On the demand side of the equation, global demand will be affected by the reluctance of consumers and businesses to spend. Business investment will likely be cut back, as consumer demand will be dampened by a potential loss of income; by a fear of contagion; and a basic increase in uncertainty which will cause consumers to spend less.
At the end of the day, economic activity is made up of people buying goods and services; travelling; companies providing goods and services; and all of the billions of other transactions that take place every day. If people and companies curtail these activities due to fears over the virus and engage in voluntary curtailment of their activities or are forced to do so, then economic activity will inevitably suffer. That is now clearly happening and is likely to get worse. The point of course is that 2019 was a poor enough year for the global economy and it was already quite vulnerable coming into 2020 and certainly did not need such an unanticipated shock.
There will have to be a strong policy response to prevent this temporary crisis from turning into something more permanent. There is a distinct risk that many viable businesses and jobs will be permanently undermined due to cash flow difficulties. A strong official policy response at a global level will be required.
The Federal Reserve has already cut interest rates, and the likelihood is that we will see a more co-ordinated monetary policy response from central banks around the world, comprising of interest rate cuts and more extensive asset purchases. However, with interest rates already so low and trillions of euro and dollars pumped in to the global economic and financial system in recent years, it is hard to see how much real impact monetary policy can have, other than psychological impacts. It is akin to pushing on a piece of string.
It is important that banks are given sufficient liquidity and use it to support vulnerable businesses and households for as long as this crisis lasts.
The real response will have to be delivered via fiscal policy. In the EU, the fiscal rules will have to be relaxed to allow governments support businesses, health services and consumers for the duration of the crisis. This support will have to be provided through targeted tax relief, expenditure supports and health service investment. A relaxation of the EU fiscal rules was becoming necessary ever before the COVID-19 crisis hit, but is now an even greater priority.
Examples of policy support to date around the world include the extension of tax deadlines for business, and a wage supplementation fund to help provide financial support to laid off workers in Italy. China has waived social security contributions from business. These sorts of initiatives and more will be necessary all over the world to help households and businesses come through what will hopefully be a temporary disruption. How long is temporary is of course the big question that nobody in all honesty can answer.
At the end of the day, the broad reach of the virus across so many countries, the strong cross-border economic linkages, as well as the large confidence effects impacting economic activity and financial and commodity markets, make the argument for a coordinated, international response very compelling.
Here in Ireland, the economic backdrop was certainly stronger than the rest of the Euro Zone in terms of the growth performance going in to this crisis. However, as a small and very open economy that is very exposed to the vagaries of the international economic cycle, the Irish economy is clearly under a certain level of threat. The lack of a permanent government is not helpful.
The cancellation of sporting events and the Saint Patrick’s Day parades around the country is a tough blow to the tourism and hospitality sector coming in to what is the beginning of the tourism season. These are just early examples of economic activity being cancelled, but we are likely to see a lot more of the same. International tourism is incredibly important to Ireland and particularly to rural areas. If people stop travelling for the duration of the crisis, then tourism businesses will inevitably suffer. On the upside, if less Irish travel overseas, they might just decide to holiday in Ireland, although any congregations of people will be under threat. Hopefully, the peak of the health crisis will have passed before we enter the summer season.
Inevitably, there will also be supply chain issues, meaning that Irish businesses may not be able to access stuff that they import, while export trade might also be adversely affected.
All in all, it is not good news from an economic perspective at a global or domestic level. However, we cannot be terribly prescriptive at this stage because we really have no idea how bad the virus is going to get and inevitably, different people will react in different ways. The hope is that it will peak and pass quickly and that much of the lost economic activity will be a postponement rather than a permanent cancellation.
In the context of financial markets, the reaction to date has been pretty dramatic. Bond yields have fallen a lot further; official interest rates everywhere look set to fall further and remain at historically low levels for a much longer duration; and already stretched equity markets from a valuation perspective, have come under serious and sustained pressure. It would take a brave individual or investor to call a bottom to the markets at this juncture, such is the magnitude of the uncertainty and the unprecedented nature of the COVID-19 shock.
Oil prices have also fallen dramatically. This obviously reflects a belief that the inevitable slowdown in the global economy will hit the demand for oil, but the decision by Saudi Arabia to discount its crude oil prices and increase its production has resulted in the largest one-day fall in crude oil prices since the Gulf War in the 1990s. This move by Saudi Arabia is a direct affront to the Russians who failed to support an earlier proposal by Saudi Arabia to lead an OPEC production reduction to keep prices supported as the Coronavirus crisis gathered momentum in recent weeks. The global politics of oil production, which includes the US shale oil industry, adds a further complication to what is an already very uncertain period in world economic history.
We live in very interesting if not scary times, and it looks set to become even more interesting and potentially scarier over the coming weeks.
IRISH GROWTH HEALTHY IN 2019, BUT THAT IS NOW HISTORY
Last Friday the Central Statistics Office (CSO) published the first estimate for growth in the Irish economy last year. There were no surprises and the picture presented is of an economy that experienced decent levels of growth last year. Gross Domestic Product (GDP) expanded by 5.5 per cent, with consumer spending expanding by 2.8 per cent and exports of goods and services expanding by 11.1 per cent. As most people are by now very aware, the GDP numbers are grossly exaggerated by Intellectual Property Products (IPP) and by aircraft leasing activities. When these items are adjusted for, a more realistic growth rate of 3 per cent in Modified Final Domestic Demand was recorded. For people who operate on the ground in the Irish economy, 3 per cent growth resonates much more accurately with the real story on the ground.
There is good news and bad news attaching to these data. The good news is that the year ended with considerable momentum, which would normally set a very solid springboard for the following year. However, the bad news is that given the global and domestic events of the past month, there is now little or no visibility on what the coming months hold in store for the global or domestic economies. The portents are not particularly good right now, which should also come as no surprise.
We have seen a pretty dramatic correction in equity markets over the past couple of weeks; there has been a total collapse in Government bond yields in a number of countries, but not all; we have seen the first emergency cut in US interest rates since the collapse in Lehman Brothers in 2008; the Bank of England followed with a half per cent emergency rate cut this week; and increasingly we are witnessing a significant restriction to many events and activities, much of it voluntary and some of it officially imposed. The latter is becoming increasingly important as various countries seek to contain the spread of the virus.
The world is indeed in a state of chassis now, and anybody who claims wisdom or foresight on how this is going to evolve over the coming months is a charlatan. We are in totally uncharted waters and the blind are certainly leading the blind.
It is astounding to see the level of criticism directed at our Government over both what they have done and what they haven’t done. Earlier in the week there was a clamour to cancel the Saint Patrick’s Day festivities; this has now happened, but some people are still not happy. We must realise that these are totally uncharted waters. At one level there is an ongoing requirement to ensure that the spread of the virus is contained insofar as is possible; but on the other hand, life has to go on, and businesses need to be given as much support as possible and jobs and livelihoods need to be protected. We cannot simply let economic activity collapse, but it is a thin line between success and total failure just now.
There is an intense air of unreality out there at the moment. Conferences and other events are increasingly falling victim to the virus, and we are now starting to see the first impact on schools and colleges. If schools are forced to shut down and younger children are sent home, then there will an onus on parents to stay home to mind them, which in turn will further pressurise businesses. Uncertainty is the byword.
For many businesses, cash flow will increasingly become a big issue. Fixed and other costs simply do not go away, but if revenues collapse, then there is a real businesses survival issue. Banks need to play a role in supporting businesses and households through the crisis, and they need to be given the necessary liquidity to do this. We are also going to have to see the EU fiscal rules relaxed to allow governments spend more money on health and to ease the financial burden on households and businesses. Desperate times require desperate measures.
The hope is that the virus will pass through the system relatively quickly and that the seemingly inevitable recession proves short and sharp, and that growth subsequently rebounds in a strong and sustained manner. Perhaps that is naïve optimism. There is a long road ahead.
The Taoiseach’s address to the nation on Saint Patrick’s night set a pretty perfect tone for where we find ourselves at the moment. It was factual, measured and pulled no punches. The people of Ireland have been left in no doubt about the gravity of the situation, and we can certainly rest assured that the Irish government acted more quickly and more aggressively that our neighbours on either side of us. The facts are that we are certainly in a calm before the storm; significant economic damage will be done; it will likely take years to fully recover; and the crisis still has some way to run. It is difficult to disagree with the prognosis provided by the Taoiseach and indeed things are moving so quickly at the moment, 24 hours can bring dramatic changes.
Financial markets are continuing to go ballistic and we are seeing some pretty dramatic market movements from hour to hour. Market participants are as confused about the implications of the unprecedented crisis that is evolving as the rest of us ordinary mortals and hence market movements are proving very dramatic in all asset classes.
Gold prices are soaring, which never comes as a surprise during periods of intense nervousness. Its safe-haven status is coming to the fore once again. Likewise, the safe haven status of the US dollar is being highlighted, as it makes massive gains against currencies such as the sterling and the euro. Sterling is falling out of bed across the board, which says a lot about how the markets are viewing the disastrous handing of COVID-19 by Boris Johnson, and also the disaster that Brexit represents, particularly given the continued insistence on exiting the transition mechanism on 31st December next. Despite assertions by Dominic Raab, it seems inconceivable that the UK will exit the transition mechanism at the end of the year, and before the end of June we are likely to see the UK seeking a one or two-year extension to the transition mechanism. Or at least that is what logic would suggest, but the behaviour of Boris over the past few weeks would suggest that logic is in short supply between his ears. The images of thousands of commuters in packed London Tube stations on Wednesday really says it all as does the decision not to close schools until Friday this week.
On bond markets, the moves of recent weeks have been similarly dramatic. 10-year bond yields in countries such as Italy and Greece have spiked sharply, as they should. A proper and proportionate response from the European Central Bank (ECB) on the monetary policy front, and from EU governments on the fiscal policy front, which would necessitate a binning of the EU’s fiscal rules, is now essential to avoid an all-out crisis in the Euro Zone, akin to or worse that seen during the Greek crisis a few years back. Countries such as Italy and Greece who have massive debt levels and badly struggling economies are particularly vulnerable at the moment. 10-year bond yields in Ireland are also rising, albeit from negative levels a couple of weeks ago that could not possibly be justified. Thankfully, in an emergency meeting on Wednesday night, the ECB announced a new package of bond buying totalling €750 billion by the end of the year. This is a step in the right direction, but more will be needed.
Equity markets are also in freefall at the moment and one can only surmise that there is quite a distance to go before ‘bottom pickers’ enter the fray. It would take a brave investor to step into markets that have no visibility at the moment.
Whatever way one looks at it, the global economic implications of what is happening look pretty catastrophic. The global economy fell off a cliff in 2008 and it has definitely gone over the cliff edge again over the past couple of weeks and unfortunately, the beach looks a long way down, with some very craggy looking rocks in the way.
For the Irish economy, thousands of jobs are currently being lost and economic activity is effectively grinding to a halt, with the exception of public services, and the very important food-supply chain. I hope at the end of all of this, whenever that comes, Irish people will once again realise the importance of domestically provided food that is produced to the highest safety standards possible. Food safety and security are just so important, but unfortunately it takes a crisis such as this to hammer that message home.