Monday, 11 October 2010

Why Charlie Bean Could Be Disappointed

A week or so ago, Bank of England Deputy Governor, Charlie Bean, appeared on TV to say that one reason the Bank was keeping interest rates so low was to punish savers, and to persuade them to spend their savings. The economy was depending on them spending, he said in order to boost consumer demand in the economy. Of course, given that private sector investment is low, and the other part of aggregate demand - Government Spending is being cut, which will also negatively impact investment and consumer spending - that is important.

The problem that Charlie and policy makers have is that the economy is bifurcated. Different parts of it are not just doing different things, but doing opposite things. Demand and economic activity is declining along with consumer and business confidence, because of Government policy. That creates pressure to keep interest rates low, and along with every otehr country in the world to engage in Monetary Easing in a hope to encourage economic activity, and to devalue the currency as part of the growing international currency war, as each economy goes into protectionist mode trying to keep imports out, and to boost its own exports. But, on the other inflation is rising, and has kept rising for nearly two years despite repeated assurances from the Bank that it was about to fall. A Lower pound means that Britain's import dependency - we have to import many raw materials and foodstuffs, and since the devastation of manufacturing brought about by the Tories in the 1980's, we are also reliant on large amounts of cheap manufactured goods from China and elsewhere, without which the cost of living would be much higher - results in the already rising prices of those imports rising even faster.

As I've said before, the State is not too unhappy about that. Debt is measured in nominal terms. The more inflation rises, the more nominal GDP increases, and so debt to GDP falls. In effect, creditors are paid back in funny money, devalued currency. It also has another postive effect related to Charlie's hopes. If inflation is rising, then people think that all those things they were intending to buy, they had better buy now, before the price goes up.

But, there is that other side of the economy. The reduced level of economic activity, and uncertainty means that shops and factories with unsold stocks may want to get rid of them quickly to avoid the possibility that in a recession they might not be able to sell them. That will mean that bargains will be there to be had. Moreover, workers in both the Public sector, and in the Private Sector dependent on the Public Sector, will be worried that they might not have a job in a few weeks time. Phillip Green's report out today will strengthen that beleif. It showed what most of us have known for a long time. Inefficiency in the Public Sector is not the fault of lazy workers, but of bad top management, and the fact that the private sector rips off the Public Sector. If his report is acted upon then private sector firms can expect to get much fewer lucrative contracts, and to get paid much less for what it does supply. Somehow I doubt that will happen! But, workers in general may well decide in such uncertain times, not to follow Charlie's advice. Instead, they might think that any savings they have would be well used to pay off the credit cards which charge them usurous rates of interest, to pay off their mortgage rather than risk it being foreclosed on them etc.

But, there is another reason they might decide to save rather than spend despite the high consumer inflation and the low interest rates. That is that a much bigger part of potential spending is moving in the opposite direction. Over the last 20-30 years, many workers, particularly in parts of the country like London and the South-East, have been priced out of the housing market, by a bubble in property prices. I have been arguing for the last few months that that bubble was due to burst, and the latest figures show that it is probably bursting in dramatic style.

Figures from the Halifax show that in September - which is the strongest month of the year for hosue sales - house asking prices fell 3.6%. That is the biggest monthly decline since current records began in 1983. It is bigger than any monthly decline during the house price crash of 1990, when house prices fell by 40%. That is the measure of how dramatic the collapse is likely to be. Moreover, as i've pointed out previously the decline is being restrained so far by the measures introduced in 2008/9 to counteract the financial meltdown, the historically low interest rates, the fact that banks have been holding off repossessions, in the hope of an economic upturn, and so on. When those things are removed, a trully massive collapse is likely. A graph produced by Left Foot Forward shows how much.

Just to go back to 2000 prices would mean a 50% fall. In 1997, when Japan's Bubble burst again property prices fell almost 90%. As an indication of how high prices are, and how much they could fall consider this. My sister bought her semi-detached house in 1972 for £2,000. Today, it would sell for around £120,000. If prices fell 90% as they did in Japan, that would mean a price of £12,000, or still 6 times what it originally cost!

This has huge consequences. For all those people who have been priced out of the housing market over the last 30 years, such a fall would be a massive windfall. Imagine you were thinking of buying even a £100,000 house. In the last month alone, the 3.6% fall in prices means you have gained £3,600 in real terms for doing nothing. That is a hell of a return for sitting on your hands, and a very strong motive given that house prices are likely to continue to collapse for putting aside as much cash as you can. Even consider someone like my sister who was able to pay off the £2,000 Capital sum on their mortgage long ago, as inflation reduced its real value. Yes, you might have lost £108,000 in the nominal value of your house, but the other consequence is that if you had been thinking about buying a £240,000 house, you could now buy it for just £24,000 or only £12,000 more than you would get for your existing house, a saving of £108,000!!!

The huge savings that could be made for people in such circumstances - and there are still 30% of people in rented accommodation, plus those who might be wanting to move to more expensive properties - far outweigh the losses from higher consumer inflation. That is a strong reason that the authorities might not get the consumer spending they want. There is a strong reason to beleive that. Its basically what has been happening in Japan for the last 20 years.

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