The credit crisis and the recession that followed happened because of a collective suspension of belief in economic reality. It was assumed that low income related inflation could be coupled with high asset price inflation fuelled by the issue of new money in the form of credit by banks and that this imbalance between incomes and asset prices could continue ad infinitum without strain arising. That was wrong. It was always going to be wrong. The crash was inevitable, even if it took a few false starts for it to happen.
What is extraordinary is that this sleep walking to disaster as a result of collective denial of the truth is continuing. It has, for example, been reported that:
Every household in the UK will have to face a 'fiscal squeeze' of over £5000 a year — through tax increases and spending cuts — if the government is to get public debt back under control and meet the costs of an ageing population, PricewaterhouseCoopers (PwC) has said.
Let’s put this ion context. First this assumes we have to get back to national debt of less than 40% of GDP: there is no reason why that is true. Second, it is written deliberately, I suggest, to promote the idea that massive cuts in public services are required — an agenda PWC pursues with some enthusiasm. You can be sure it does not believe in the alternative prescription it offers of tax increases.
But whichever scenario is offered the reality is that when average household incomes in the UK are around £30,000 this cost burden of £,5,000 is not going to be imposed: as a simple matter of fact that cost could not be borne by those households without collapse of the underlying economy, not least due to the lack of demand for other goods and services it would precipitate which would leave the economy spiralling into massive depression.
So what will happen? The answer has to be that we will inflate our way out of this situation. No other option is possible. The inflation will be in incomes, not asset prices. Asset prices are what have been over-inflated to date. The benefit of this inflation will be that it will restore the relative balance between incomes and asset worth. Ordinary people — those outside the top 10% of asset owners in society — will benefit as a consequence. They will be able to afford houses once more. Those currently crippled with debt to repay obligations to the asset owners in that top tier will have their burden lifted. And the rotten money that the banks flooded into the system to allow asset price inflation will be washed out of it through the simple process of devaluation.
It’s time to be realistic: this is the only option we have. We can’t raise taxes enough to pay for the bank’s folly. We cannot impose a burden of £5,000 a year on every household in the UK to ensure that the current, post asset price inflated disorder in society that has meant the wealthy have got considerably more wealthy compared to all others in society is maintained. We would face complete economic ruin if we were to try to do so — though be sure the Conservatives, backed by the likes of PC (who have close links with them) will argue this is exactly what should be done.
Just stand back and use common sense: there is no way earth we can get out of this mess without inflation. It creates all its own problems, I know, but when in a hole you have to use the only ladder available to get out.
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richard i dont know whether you had seen this one
THE Reserve Bank of Australia company under federal police investigation over its use of foreign agents to win contracts has paid millions of dollars into offshore tax-haven accounts — including some linked to those same middlemen.
http://www.theage.com.au/national/rba-link-to-taxhaven-payments-20090524-bji4.html
Absolutely spot on ad well done for being the first to put this case so clearly. Unfortunately, it’s a message very few want or are prepared to acknowledge even though it is, as you say in other words, blindingly obvious.
You’ve also given me the perfect argument to make against someone who wants my blessing for a small local body to take on significant borrowing without either an asset to secure the loan or income with which to service it, ie continued belief in ever rising property prices, despite all the evidence, to cover any financial problem. Thank you.
Hoorah for common sense. Let’s have an increase in the minimum wage for a start – the opposite of what the Tories plan to do.
Richard, I do not believe inflation is the only way out of this. If the burden was placed fairly on the broadest backs the debt could be repaid without inflation but I doubt if the government or civil service would am inclined to agree with you but what percentage inflation do you expect before this is over?
Bearing in mind that annual rates of inflation of more than about 12% give rise to social and industrial unrest, what do you think will be the likely outcome?
I am not aware of any period in the history of any economy where income inflation has not been accompanied by asset inflation (perhaps you could direct me to one?). Indeed, I do not see how it is possible to have income inflation without asset inflation. The fact that asset prices have become wildly inflated in recent times, whilst true, is wholly irrelevant – not least because, as I suspect you’ve noticed, prices for assets such as housing have collapsed by 20,25,30% in the past year. If people’s incomes go up, as sure as night follows day you’re going to see the demand for these assets increase just like they have in the past. And in this case the effect will be quite the reverse of what you say: the beneficiaries will be the top 10% who hold these assets and whose wealth will shoot upwards, for the rest of your “ordinary people”, like pensioners on fixed incomes it will be a disaster. The historical facts don’t change, Richard – the only countries who’ve tried this are Nazi Germany, Zimbabwe and South America.
The only way to stop this mess happening again is to ensure that the inflation target tracked asset prices such as housing and financial derivatives, and not packets of frozen peas. But that isn’t going to happen because that would require higher long term interest rates and thus higher unemployment.
Peter, by “assets”, you mean LAND. House prices have not bubbled up. There has been little increase in the price of bricks, cement, timber or glass, etc, nor in builders’ pay. It is the price of the underlying land that bubbled up. It is essential that this is understood or the problem cannot be correctly analysed and cured, and the same thing will keep on happening.
What made land prices bubble up? Easy lending policies by the banks, and a belief that land prices could continue to rise indefinitely and that land was therefore a safe collateral for further lending eg Northern Rock’s 125% mortgages. This made the land price bubble, mistakenly identified as a house price bubble, self-feeding.
There is a simple way to prevent this from happening again and also to pay off the debt with tax increases which will not nip recovery in the bud, but vested interests will not allow it and nobody has the gumption to face them down.
Peter
If the main asset we’re concerned about is land regulation can deal with the issue: it is very obvious that the availability of credit is the key issue.
Limit that for loans and we solve the problem.
And of course we can do that. Son’t doubt it. It just requires political will: the will needed to solve this problem and rebalance the economy for the benefit of the vast majority i.e. those who cannot afford to live in their own house now (owned or rented) or their parents who worry (as far as I can tell) extraordinarily about the fact that their children will never do what they did
Which is absurd: someone is going to have to buy their houses one day – and that will only happen when the price of property re-equates with earnings through their relative revaluation and the revaluation of money itself.
How can you deny that obvious truth? What else can happen? And what better way is there to do it?
Richard
Richard, regulation has a history of failing when most needed. We used to have regulation. Until the mid-1960s loans for house purchase were restricted to a single salary. Then wives’ incomes were taken into account and that helped to fuel the bubble of the late 1970s. We inflated ourselves out of that one and there was heavy social disruption, and in the end, Thatcher, who persuaded us successfully that there was no such thing as society and we are even now paying the price.
Then we got more deregulation and the bubble-bust of the late 1980s. Then new Labour persuaded us that we had beat boom-and-bust and the banks went mad with lending, same in the US. Which brought us to where we are now.
Note that these catastrophic events are a generation apart. People grow over confident and take down the safety measures just as they are about to be needed in earnest.
Since the problem is one of lending money for land purchase, the solution is to draw off the income stream from land, via the tax system. If this is done consistently over time, then there can be no boombust from that cause.
Richard, please tell me how you regulate land? What Henry says is true. There is a very simple solution which would kill house price inflation permanently, without having to ratchet up interest rates beyond what the rest of the economy needs, which would reduce the capital value of houses and make them affordable for the younger generation and without leaving glaring loopholes which clever accountants will always find ways through. Most importantly it will destroy the main source of unearned accumulated wealth in this horribly unequal state we live in.
Hoorah for common sense. Let’s have an increase in the minimum wage for a start – the opposite of what the Tories plan to do.
PB – increase in minimum wage will add to unemployment, not good in a recession. But there is another way of increasing minimum take-home pay, which is what really counts. Increase tax thresholds instead so low-paid workers actually end up with more in their pay packet. It is absurd that workers on minimum wage should be paying any tax.
Any loss in tax can be made up by having a higher standard rate of income tax – which as those who know me will know, should in any case be arranged so that most people in ordinary jobs don’t pay any income tax at all, as used to be the case before WW2. There is another fairer and avoidance-proof way of raising public revenue, withouth the present deadweight loss.
I just hate the fact they are just hiding behind rules that are obviously aload of crap!