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We are already there
Oct. 20th, 2010 01:30 pmLong-time and long-suffering readers will know that I have been battering on for ages about how there are only two ways that the western world can get out of its crisis of over-borrowing; one is for the borrowers to suffer long and hard as they pay back what they borrowed, and the other is for the magic inflation wand to spirit away the debts that borrowers built up, "wiping the slate clean", with the losers being savers.
I make no moral judgement on borrowers and savers. One group decide to consume today while the other group forgo consumption today because they place a higher value on consumption tomorrow. Although I have a personal distaste for the hedonistic "run-up-the-credit-card" types (nearly all of whom will claim that al of their expenditures were really, really necessary), it's not my task (or right) to say that these are the ones who should "pay the price". And, anyway, even if I did, it wouldn't make one bit of difference. As a general rule, it's the savers who tend to "pay the price".
All of this is a given, and any politician who denies it is not an optimist fighting nasty pessimists, but a full-blown member of the Head-in-the-sand Ostrich Party. The recent debate has mainly been about what way the fates will fall. Will we have Japanese-style deflation for a decade, accompanied by a real fall in the prices of assets (mainly, houses), or will quantitative easing cause rampant stagflation a la the 1970s, meaning that our mortgages will become meaningless in terms of monthly wages, and all of that money that we borrowed will become so much confetti?
But then it struck me that, just as no-one knows for sure that a boom is over or a recession is over until about 18 months after it has ended, so no-one has actually realized that the above debate is pointless, because the borrowers have already won.
Why has no-one noticed this? Because, as is the case with economists, political commentators, journalists and that bloke down the pub who wears a funny hat, people are too fixated with the lessons of history, without realizing that, although history repeats itself, it does so with subtle differences every time.
So, while we have all been sitting here waiting for inflation rates of 15%, zooming interest rates, and the continued fall in the value of investments (see 1972 to 1978) what we have actually had is inflation of about 4%, zero interest rates to investors, and, for borrowers on tracker mortgages, repayments of virtually nothing. That, in effect, is a transfer of wealth from 10 people each saving a grand a month (or living off interest on savings of £200k) to someone with a £200k tracker mortgage, worth about £10k a year. And it's been achieved without headline-grabbing inflation figures.
How many people does this affect/benefit? Perhaps three or four million borrowers and 10 to 15 million savers. Multiply that out conservatively and you get a transfer of wealth from savers to borrowers of about £30bn a year.
That sounds like a lot, but UK borrowers pay nearly £100bn in interest each year, with an average household debt of £57k. Multiplying that out, that makes the net transfer from group S to group B of about £2k to £3k of that average debt, or about 3% to 5% a year.
Still, 20 years isn't too long in the grand scheme of things, and the transfer doesn't need to be total. That would be the equivalent of Germany in 1923 or Hungary in 1945. A 50% transfer would be quite sufficient to restore what we might call "balance". So, if my calculations are correct, we are already 10% of the way to shifting debt to the extent required to put the economy "back the way it was" in terms of borrower-to-saver money ratios.
Unfortunately, "back the way it was" won't be enough, unless we want to head down the same disastrous path again, except this time round people in India and China will own 80% of the countr. What has been combined with the current crisis is a far more strategic problem, the pensions time-bomb. This has been treated as part of the current financial crisis, but it isn't. The current crisis is just a good excuse to do something about pensions.
This is a far bigger problem and involves not the transfer of wealth from borrowers to savers, but from the old to the young. In effect, anyone currently aged 65 or over has been stealing money from today's economically productive population ever since they retired. The amount that they "paid in" was probably taken out by the time they reached 70, and everything else has been gravy. In a sickening irony, the people who are going to have to pay for this are not retirees, but those who are still economically productive. But that's another problem.
Eventually the savers will wake up to the fact that their wealth has been battered at about the same rate as borrowers' obligations have been reduced, even if inflation doesn't soar to 20%. Already the "short-term" period of 0.5% base rates has lasted 18 months. Personally, I've taken the opportunity to pay down debt, but I reckon that those reduced rates (because I am a saver, who is on a fixed-rate mortgage, but not on fixed-rate investments!) have cost me about £40k in the past two and a half years. I'm probably a worse sufferer than most, and I don't resent it, but it's an indication of how the wealth has shifted from people like me to people on tracker mortgages with no savings.
None of this means that inflation won't take hold on a more headline-grabbing basis, but I can see the validity of the arguments against this; there's far less pricing power in both the selling market and in the labour market. There's also spare capacity, and less of the "he's got 'x%', so I should get 'x%' too. But it's interesting that it could be possible for the borrowers to be the "winners" even without double-digit inflation. All you need is another four years of 0.5% base rates.
______________
I make no moral judgement on borrowers and savers. One group decide to consume today while the other group forgo consumption today because they place a higher value on consumption tomorrow. Although I have a personal distaste for the hedonistic "run-up-the-credit-card" types (nearly all of whom will claim that al of their expenditures were really, really necessary), it's not my task (or right) to say that these are the ones who should "pay the price". And, anyway, even if I did, it wouldn't make one bit of difference. As a general rule, it's the savers who tend to "pay the price".
All of this is a given, and any politician who denies it is not an optimist fighting nasty pessimists, but a full-blown member of the Head-in-the-sand Ostrich Party. The recent debate has mainly been about what way the fates will fall. Will we have Japanese-style deflation for a decade, accompanied by a real fall in the prices of assets (mainly, houses), or will quantitative easing cause rampant stagflation a la the 1970s, meaning that our mortgages will become meaningless in terms of monthly wages, and all of that money that we borrowed will become so much confetti?
But then it struck me that, just as no-one knows for sure that a boom is over or a recession is over until about 18 months after it has ended, so no-one has actually realized that the above debate is pointless, because the borrowers have already won.
Why has no-one noticed this? Because, as is the case with economists, political commentators, journalists and that bloke down the pub who wears a funny hat, people are too fixated with the lessons of history, without realizing that, although history repeats itself, it does so with subtle differences every time.
So, while we have all been sitting here waiting for inflation rates of 15%, zooming interest rates, and the continued fall in the value of investments (see 1972 to 1978) what we have actually had is inflation of about 4%, zero interest rates to investors, and, for borrowers on tracker mortgages, repayments of virtually nothing. That, in effect, is a transfer of wealth from 10 people each saving a grand a month (or living off interest on savings of £200k) to someone with a £200k tracker mortgage, worth about £10k a year. And it's been achieved without headline-grabbing inflation figures.
How many people does this affect/benefit? Perhaps three or four million borrowers and 10 to 15 million savers. Multiply that out conservatively and you get a transfer of wealth from savers to borrowers of about £30bn a year.
That sounds like a lot, but UK borrowers pay nearly £100bn in interest each year, with an average household debt of £57k. Multiplying that out, that makes the net transfer from group S to group B of about £2k to £3k of that average debt, or about 3% to 5% a year.
Still, 20 years isn't too long in the grand scheme of things, and the transfer doesn't need to be total. That would be the equivalent of Germany in 1923 or Hungary in 1945. A 50% transfer would be quite sufficient to restore what we might call "balance". So, if my calculations are correct, we are already 10% of the way to shifting debt to the extent required to put the economy "back the way it was" in terms of borrower-to-saver money ratios.
Unfortunately, "back the way it was" won't be enough, unless we want to head down the same disastrous path again, except this time round people in India and China will own 80% of the countr. What has been combined with the current crisis is a far more strategic problem, the pensions time-bomb. This has been treated as part of the current financial crisis, but it isn't. The current crisis is just a good excuse to do something about pensions.
This is a far bigger problem and involves not the transfer of wealth from borrowers to savers, but from the old to the young. In effect, anyone currently aged 65 or over has been stealing money from today's economically productive population ever since they retired. The amount that they "paid in" was probably taken out by the time they reached 70, and everything else has been gravy. In a sickening irony, the people who are going to have to pay for this are not retirees, but those who are still economically productive. But that's another problem.
Eventually the savers will wake up to the fact that their wealth has been battered at about the same rate as borrowers' obligations have been reduced, even if inflation doesn't soar to 20%. Already the "short-term" period of 0.5% base rates has lasted 18 months. Personally, I've taken the opportunity to pay down debt, but I reckon that those reduced rates (because I am a saver, who is on a fixed-rate mortgage, but not on fixed-rate investments!) have cost me about £40k in the past two and a half years. I'm probably a worse sufferer than most, and I don't resent it, but it's an indication of how the wealth has shifted from people like me to people on tracker mortgages with no savings.
None of this means that inflation won't take hold on a more headline-grabbing basis, but I can see the validity of the arguments against this; there's far less pricing power in both the selling market and in the labour market. There's also spare capacity, and less of the "he's got 'x%', so I should get 'x%' too. But it's interesting that it could be possible for the borrowers to be the "winners" even without double-digit inflation. All you need is another four years of 0.5% base rates.
______________
