Irish economy mirrors Asia's before the bust

The very disturbing aspect of the Asian crisis which is still threatening to engulf the entire global financial system is that it has got almost nothing to do with economics and everything to do with simple property and stock booms.

The Asian story is simply one of boom and bust stemming from bad investment and lending. Financial implosion in countries such as Indonesia, South Korea and Thailand has resulted from a lethal combination of overlending, too much investment in the wrong things and to cap it all, a rather ridiculous weakness for believing your own propaganda which in itself caused investors to look at only the most rosy scenarios for returns when placing their bets.

It is essential to remember that the Asian economies collapsed at a time when traditional measures of performance such as unemployment levels, government borrowing, budget deficits and inflation were at historically low levels, while growth rates in all economies were roaring away at above 5 per cent.

The first thing to appreciate is that the background noise was all positive. Thus, politicians could bang on about enviable "fundamentals" while failing to see the wood from the trees. Economic numbers gradually became a sort of meaningless mantra, a thin veneer under which a property-price bubble grew and grew. Innocently, sanguine domestic punters borrowed up to the hilt at low interest rates to finance speculation in property and

other assets, falsely secure in the knowledge that with these so-called fundamentals, everything was fine and dandy. Fundamentals how are you!

It is this apparent contradiction between glittering macroeconomic numbers and a meltdown in asset prices which makes the sorry tale an extremely cautionary and pertinent one for our own economy.

The first lesson for Ireland is that previously sacrosanct numbers such as the budget deficit, the debt/GDP ratio or the trade surplus, although valuable in certain contexts (like qualification for EMU for example), are in effect yesterday's acid tests. "Yesterday's" in the sense that their sell-by date as barometers of the health of the economy is well past us. If you have a persistent budget, government debt or trade problem then these figures are important; if you don't, such numbers are about as useful to an investor as a bicycle to a fish.

The second lesson is that nowhere is different. As recently as last summer, most people were sold on the myth that Asia was different and there was something inherent which predisposed Asians to be smarter with cash than the rest of us. Tripe! Similarly, when people tell me that the present Irish boom is different all I say is look at Asia and tell me about it.

The third lesson is that booms lead to busts as sure as night follows day; the question is when, not if. So when I come home at Christmas and hear about friends' frenzied efforts to get on the property ladder before it all gets too expensive, I look at Asia and take a deep breath. The striking similarities between our own feline version and the real big cats in Asia are worrying.

As things stand, most economists here seem to be taking a traditional view of the Asian crisis from a "big picture" perspective, based on four central pillars.

First, the slowdown in Asia will puncture demand for western goods, reducing profits for our exporters.

Second, the fall of the exchange rates in the Pacific Rim will make the region an extremely cheap place to set up shop, thus prompting companies like Seagate to relocate from "expensive" Ireland to "cheap" Thailand.

Third, the Asian countries will now try to export their way out of trouble, eating into our market share.

Fourth, the combined impact of these events will be an unemployment rise in our exporting sector or a fall in wages (to remain competitive) or both.

This chain of events may unfold over the coming years to varying degrees, but there is nothing we can do about it. That's the way an integrated global economy works. If you want to play the game, the rules are there for all to see.

In contrast, my major concern is not this "big picture" stuff which, although undoubtedly important, misses the point. The real dangers are much closer to home and are based in escalating asset prices. If we look closely at Asia, we see that the present currency crisis followed, rather than led, earlier collapses in property and stock prices.

Last spring, when the crisis began to unfold in Thailand, the problem was too much lending by less than prudent bankers in property, pushing the stock and property markets through the roof. This lending was coupled with a misguided view that the government would protect savers. Equally, there was an unstated perception, based on the closeness of big business and the governments, that the state would ultimately bail out institutions if the worst came to the worst. Investments were channelled into various parts of the economy, notably property, via a complex network of tax breaks and other fiscal incentives.

Finally, the western banking world fuelled this boom by lending dollars to domestic banks which then converted them to the local currency, lending them out again to local punters. As long as the economy continued to motor, driven ironically by this very overlending, all the big figures such as government debt ratio and budget deficits looked kosher.

Sounds familiar? Let's look at Ireland at the moment. Mortgage lending has been growing at 15 per cent per annum for the past four years. This cash has been funnelled with the help of significant fiscal incentives, into bricks and mortar, pushing, as we all know, prices through the roof. On top of this, general credit in the economy is up more than 20 per cent in 1997 alone. A quick glance at property prices suggests that we are definitely entering Asian asset-price bubble territory.

More worryingly, like the Asians who fuelled the fire with huge borrowings in dollars at very low interest rates, we appear to be galloping head-first into the same policy trap. With both the pound falling and the economy hurtling along, it should be only a matter of time before inflation begins to take off. At the same time, due to EMU, interest rates are set to fall by at least 1 percentage point.

The combination of these factors may result in both inflation and interest rates being around 5 per cent. Real interest rates would then be zero by far the lowest in the globe.

Very serious. Worse still, after EMU, Irish borrowers will face no constraint on the amount of money they want to borrow. Punters here can borrow all the money in Europe if they want.

Now let's look at the property market. By the most conservative estimate, house prices are forecast to increase by 15 per cent this year. So a potential 15 per cent price increase when interest rates are 5 per cent implies a free 10 per cent. In fact, for property investors, the real interest rate will actually be minus 10 per cent. Punters will fall over themselves for mortgages this year and next year. If there is any more potent recipe for an unsustainable property-price bubble, please tell me.

Finally, the long-term impact of the Asian crisis may be, as most are predicting, that some of our higher paid, hi-tech, multinational jobs disappear to the likes of Malaysia. If this comes to pass, the ability of highly leveraged punters to pay their mortgages comes under pressure. You do not need to be Einstein to figure out what could happen next.

At the moment, we appear to be seeing little or no concern from the authorities. In fact, the last bulletin from the Central Bank reveals an institution in denial.

Meanwhile, the latest tax breaks, although welcome for other reasons, will give borrowing an extra kick. All told, the authorities appear to be adopting a head-in-the-sand attitude to oncoming problems, ranting on about impeccable fundamentals, happy simply to put all their eggs in the one EMU basket.

As the Asian crisis taught us, fundamentals count for nothing if your house is built on a bubble.

David McWilliams is Senior Economist at Banque Nationale de Paris, Emerging Mar- kets, London. (dmcwilliams@bnp.co.uk). The views expressed are personal.