"A man's errors are his portals of discovery."
-- James Joyce
Even in the summer, the city of Dublin is often blanketed with clouds. When I visited the top of the Guinness factory in 2007, I could only see the long arms of construction cranes scattered across a sea of gray. The cranes symbolized the Dublin real estate boom, which coincided with the surging Irish economy. In my mind, Dublin resembled a European version of Dubai, and the Celtic Tiger showed no signs of slowing.
My prediction could not have been more wrong. Following 12 years of 6.9% average GDP growth, Ireland's economy tanked in 2008 and has yet to recover. My timing was impeccably terrible, but such a misguided forecast can provide a valuable lesson for investors.
Why I was long the Celtic Tiger
A decade ago, Irish leaders and economists alike were clamoring to take credit for the triumph of the Celtic Tiger, otherwise known as the "Irish Economic Miracle." Numerous theories could explain Ireland's rise from the backwaters of Europe to the second-richest nation in terms of GDP per capita. Among the most frequently cited factors were low corporate tax rates, an educated, English-speaking workforce, and increased access to international trade through the euro.
As a former Dell (Nasdaq: DELL) employee, I had witnessed firsthand how technology companies were capitalizing on all of these advantages. Dell constructed its major European manufacturing plant in Limerick, the once-impoverished city immortalized in Frank McCourt's novel Angela's Ashes. Competitors like IBM (NYSE: IBM), Apple (Nasdaq: AAPL), and Microsoft (Nasdaq: MSFT) were providing jobs in cities that had been stagnant for decades. In 1999, Ireland was producing 33% of all European personal computers. Meanwhile, pharmaceutical, financial service, and dot-com companies were establishing operations on the Emerald Isle as well.
Looking back, if Ireland were a publicly traded stock, I probably would have loaded up on shares. I could see the influx of foreign investment, witness the construction boom, and even talk to immigrants flocking to Dublin for work. In investing lingo, capital was readily available, management seemed focused on the future, and customers were satisfied. All of this pointed to an economic miracle that seemed to have legs.
Of course, things aren't always as they seem.
How the Celtic Tiger sold me short After stumbling upon the proverbial pot of gold, the Irish let greed and regulatory failure sink the entire economy. This sounds like so many get-rich-quick stories I've heard before. But who am I to judge? I was cheering the Celtic Tiger all along. Let's take a look at where I went wrong and what we can learn.
- Banking shenanigans -- Around the same time American banks were loading up on toxic assets, Irish banks were following suit. Given my current place of employment, I'm all about tomfoolery, but not when it comes to managing a balance sheet. When foreign borrowing by Irish banks grew from 10% to 60% of GDP in five years, I should have known something was amiss.
- A real estate bubble -- The bank's lenient lending practices pushed real estate's share of the Irish economy from 5% to 14%, the highest in Europe. As Michael Lewis noted in his excellent essay on the topic, the Irish were constructing half as many homes as the U.K. for a country that had one-fifteenth of the population. Considering the flow of foreigners into this tiny nation, I assumed (as did the Irish developers) that foreign buyers would fill the void in this market. Unfortunately, rampant speculation drove supply through the roof, significantly outpacing foreign demand.
- A lack of organic growth -- By October 2004, Ireland had become the world's most profitable country for U.S. corporations. Was Ireland's tax-haven status a sound strategy? In hindsight, perhaps not. Ireland had shed its protectionist history and was allegedly thriving in the age of globalization. But its economic growth was due to mercurial profits for Irish banks, real estate developers, and multinational corporations. I failed to realize then that banks were doomed and foreign investors could flee in an instant. Similar to management at a company, a country's government needs to invest in organic growth for long-term prosperity.
Essentially, the Celtic Tiger emerged in two phases. Foreign investment led to increased exports and job growth in the first phase, a positive trend that subsided in the early 2000s. In the second phase, the Irish economy was boosted by low interest rates, superficial property prices, and an influx of European speculators. At the time, it was incredibly difficult to distinguish between these two periods.
After centuries of devastation and emigration, the Irish embraced prosperity and suppressed any anxiety over a potential collapse. Michael Lewis noted that the real estate boom "was sustainable so long as it went unquestioned, and it went unquestioned so long as it appeared sustainable." Similar to the Irish, many of us have been caught red-handed when we refuse to question things that seem too good to be true.
What we can learn from Ireland's woes
Ireland's real estate boom was built on a sinking bog, and I was completely oblivious. Going forward, however, investors can learn from this experience and better equip themselves for the future. Here are two things to watch out for.
- The OECD recently commented on rising real estate inventory levels that could limit work for migrant workers. Sound familiar? China's real estate market could follow a path similar to Ireland's, and investors should keep an eye on any property fire sales.
- In addition, pharmaceutical companies manufacturing drugs in Ireland face a wave of patent expirations in the near future. Ireland's reliance on multinationals left it vulnerable before. Could this deliver another devastating blow?
Again and again these types of scenarios will play out, and we'll be better investors for having learned from our mistakes. As we so often preach at the Fool, short-term mistakes should not deter an investor from focusing on long-term success.
Ireland might not be the next international growth story, but investors can still tap into the economic rebound overseas. For starters, read The Motley Fool report "3 ETFs Set to Soar During the Recovery." Inside you'll find investing ideas that can instantly diversify your portfolio -- and, best of all, it's free.
