Thursday, January 22, 2009

The importance of ability to service debt.....

I have just been reading a Times columnist, the Business Editor, who is seeking to explain why it is that the UK will not be the next Iceland. The reason why I highlight this article is that it seems to express the profound denial of the reality of the situation.

In his introduction he has the following to say:
The economy is in a bad way and government finances are in an awful state, but let's get a sense of perspective. The City is not Reykjavik on Thames. Britain is not Iceland. Sterling has fallen a long way and may fall further. But Britain is not bankrupt.
The first thing to consider is that the idea that the UK is bankrupt has now gathered enough traction that the subject is now being considered and discussed in the mainstream media. Even six months ago, this would not have been a topic for 'serious' discussion (I have been discussing this for a long while, and this would not have been considered 'serious').

The columnist goes on to point out that, whilst there are some serious problems in the UK economy, they are not as dramatic as Iceland. He then makes the following comparison:

The housing market here may be in a worse state than in America, as claimed by Jim Rogers, the US investor and former partner of George Soros. But the outlook is nothing like as dire as in Spain or Ireland.

The City will go through a terrible time, but the prospects for the German car industry look just as bad.

In this case what we are seeing is something that I have seen through several reports, and even some comments on this blog. This is the idea that country x, country y, country z, are is a worse state than the UK on factor a, or factor b, or factor c.

This is a non-argument. It is a bit like going to a casualty room in a hospital, taking a look at the patients, and saying patient 'a' is okay with his broken arms, because patient 'b' has broken legs. In both cases the patients are not in a good condition. The only way that a reasonable comparison can be made is to compare them to the notion of a healthy patient (i.e. a patient with no broken bones at all).

The columnist goes on to offer this rather extraordinary statement:
By international standards, Britain's government debt is not that high compared with the size of the economy, although the picture does change if all corporate and household debts are included.
In saying this, he is hitting the nail on the head, as the debts of corporations and households in conjunction with large government debts is exactly the point. Every section of the UK economy has been running large deficits. As for government borrowing, one of the oft cited examples is the state of the Japanese governments debt, but the people who cite this forget that much of that debt is funded from within Japan. The problem in the case of the UK is that large tracts of the debt is funded externally, including government borrowing.

We then come to another non-argument as follows:
Standard & Poor's recently reaffirmed Britain's triple A credit rating, just as it was downgrading Spain. And after the mauling the rating agencies have received, they are not in the business of giving anyone the benefit of the doubt.
This is a non-argument on the basis that Standard & Poor, and all of the other ratings organisations have got so much so very wrong, that they should be given very little credence.

Having so far given not a single good argument for the UK not being bankrupt, the commentator then goes on to a complete distraction from the subject at hand. In this case he discusses the problems within the Euro area. The interesting thing is that he should think that the woes of Euro area economies have a bearing on whether the UK is bankrupt. However, he throws in some figures, makes it all look well grounded, and so it all looks very credible.

The only trouble is that it is completely irrelevant to the state of the UK economy. From discussing the troubles of Europe, he jumps into his conclusion as follows:
Britain does not have that alternative to the IMF, but it is hard to believe that we will need it. The hard to believe does happen a lot these days, though.
I strongly recommend that, if you have not done so, you read the article in full. The reason why I am doing so is that this article is fairly typical of the kind of article that can be found claiming that the UK is not bankrupt. When you examine all of the arguments, they always come back to the same method, which is to propose that country 'x' is worse on factor 'a', and figures are then trotted out to support the case.

These arguments are quite simply missing the point. For example, there seems to be a grim satisfaction underlying the collapse in the exports of Germany, and the contraction of the German economy. Last week's Economist was highlighting how quickly manufacturing turned down in comparison to services. In another article (which I can not seem to find) they mentioned how much more resilient services were in a downturn.

What they are all missing is that these economies may suffer now, but they have the means to repay their debts when the global economy starts to recover. As I have been saying for a long time, the UK does not produce enough of value to ever repay the debts that it has rapidly accumulated, let alone the debts that it is adding.

As Jim Rogers, who is now quoted all over the media, has said:

He says his view reflects the UK's dire economic situation: "It's simple. The UK has nothing to sell."

Mr Rogers says the two main pillars of support for sterling have been North Sea oil and the strength of the UK financial services sector, in particular, the City of London's role.

But Mr Rogers says just as North Sea oil is running out, so London's standing as a financial centre is set to suffer: "I don't think there is a sound UK bank now. At least, if there is one I don't know about it."

"The City of London is finished, the financial centre of the world is moving east. All the money is in Asia. Why would it go back to the west?" says Mr Rogers.

This has been one of the central themes of this blog from the very posting. In other words, it is not just a question of comparison of country 'x' on factor 'a', which is always about relative levels of debt, relative state of housing markets and similar arguments. It is also about the ability to pay off debts. What matters is the ability to generate income with which to pay the debts.

As an analogy, we can imagine a person with a £100,000 a year salary job who holds debts of £200,000 and person with a £50,000 salary with debts of £160,000. To look at the absolute debt level would considered to be an unusual method of making a comparison. The only way to look at the debt is to consider the ability to repay the debt, and in the case of the UK that is a very poor prospect.

As a summary, I have yet to see an argument that persuades me that the UK is not in reality structurally bankrupt. Whilst the arguments presented all look very plausible on the surface, they are either comparing basket cases with a basket case, or they are not offering a serious consideration of debt in relation to income.

Note 1: I have had a large number of comments on my last post, and will therefore just have time to answer a few of the comments and questions.

Note 2: Lord Sidcup has the following question:
If the government is printing money and giving it to the banks, but the banks don't circulate it (won't lend) isn't this money irrelevant in causing inflation?
This is a perfectly reasonable point, which is actually quite challenging. Yes, if the government is lending to the banks and the banks are not lending, it would appear that the money will not have an impact. However, the banks do not sit on that money, but are using it to buy government bonds and other so called 'safe' investments to restore their base of capital.

The government then uses the money lent to it by the banks to lend into the banks, and it appears that the money goes in merry-go-round, albeit with the supply of money steadily inflating. This is why the government needs to print more money, to break this cycle, and create a greater impetus to get money into activity in the economy. They are literally going to deluge the banks with so much liquidity that there will not be enough government debt to buy with the money.

The only trouble with this plan is that so many other countries are also selling huge amounts of debt into world markets. As fast as the government might print money, the amount of debt being issued by governments across the OECD will be able to mop up that money. The bottom line is that the banks do not want to lend to business and consumers because they rightly recognise that there are considerable risks in doing so. This is why the government is considering measures to 'force'/encourage the banks to lend into the UK economy, such as reductions in capital adequacy requirements and so forth.

As I have pointed out many times, the problem with government borrowing is that it crowds out lending to the private sector.

In this circumstance, how will the money printing lead to inflation? The printed money is still going to be used but, instead of being used by business and consumers, it will now go through the intermediary of the government, as the printed money eventually ends up back on the government's books through their borrowing. This creates a time lag, as the government must find ways of using that money in various guises of 'stimuli'. There is also a time lag as the money goes through the lending / borrowing merry-go-round.

Within this rather odd scenario is a possibility that the banks in the UK will start to worry about the solvency of the government, and will therefore stop lending to the government. They might instead use the borrowed money only to finance debt of other governments. This is, in principle, possible, but is also highly unlikely. The banks are now effectively clients of the state, so I believe that they will be expected/forced to support the state with continued lending. I do not know this, but I think it is a reasonable assumption.

What we have in total is a situation where some of the printed money will be returned to the government, and some of the printed money will be used to finance the governments of other countries, and some will eventually find its way into private lending in the UK. In all cases, the money will appear in the market place.

If, for example, the banks use money to finance borrowing of overseas governments, this is a net outflow of currency, which will further weaken the £GB. If the money remains in the UK, it will eventually reach the economy in the form of loan guarantees, and various other government stimuli measures. In all cases, the money does eventually reach the market. The important point in all of this is that there is a significant buffer in all of this, which is the ability of the government to actually utilise the money such that it reaches both businesses and consumers in the UK.

The most disturbing part of this scenario is the impact of the government which acts as a buffer for some of the money that is created. In acting as a buffer it is possible in principle that the effects of the increase in supply will not be immediately apparent, encouraging a belief that the government can 'get away' with printing money, thereby further encouraging an acceleration of the speed of the printing presses.

What can not be hidden is that there will eventually be an increase in the quantity of £GB in the market. As I have often stressed, printing money just transfers the value of the existing money to the new money, which dilutes the value of money. This is inflation.

However, I do not think that that people are quite foolish enough to believe that printing money can be a solution to the underlying problems of the UK. This is why I believe that the £GB will collapse sooner rather than later. I do not believe that holders of the £GB will hold on to the currency, as they will start to price in the effects of both the underlying weakness of the £GB and the impact of money printing. At that point, there will be inflationary surges due to substantial increases in the costs of imports.

This brings me to another point. In my original post I pointed out that a collapse in the currency would result in hyper-inflation. I should clarify this, as I have noted comments (not made on this blog) which have imagined that the moment the currency collapses is the moment at which hyper-inflation appears. This was not my intended meaning. There will be a time lag, as existing contracts are fulfilled and so forth. Some products will see price inflation very quickly, such as imported foodstuffs, whilst other products may take a while for prices to inflate. However, the process will still be surprisingly rapid, just not immediate.

It seems that a very short question has demanded a very long answer. It is not a simple answer but I hope I have managed to be clear and consistent. Please let me know if I have been either unclear, or missed any key points.

Note 2: I have had several questions regarding the impact of hyper-inflation on ordinary people. Steve Tierney, for example, asks about the social effects, but that goes beyond the remit I have given myself in this blog. I will let others consider such impacts. However, with regards to the economic position of individuals, this is more within my scope. The problem here is that the question becomes huge, and is not suitable for a brief answer. As such, I will apologise for not addressing this question at this time, and may discuss it later. I also need to look at a few case studies of inflation to have a better understanding, as my concern to date has been where and how we are getting there, rather than what happens when we arrive.

Note 3: ChasH asks the following:
'One thing continues to puzzle me though, and perhaps you can see your way to explaining it. China is our major creditor, but they have been lending us the money to buy that which they have produced. As we cannot repay the money, they have effectively given us the fruits of their labour. Moreover as we (i.e. the west) are their main market they have no one else at present to sell to. Is China then in just as dire straits as we are?'
The answer is both 'yes' and 'no'. China has particular problems, which is the potential for instability, which could see the country fall into chaos.

However, a good way of looking at this is to think of yourself in the position of Hu Jintao. He is seeing that his exporters are collapsing, and that the growth necessary for stability is dropping away. Set against this, he has huge piles of foreign currency, a strong position to spend to support his economy. However, he has a difficult problem.

All the while his economy has been growing, it has accumulated massive reserves of foreign currency. In order to enact a stimulus, he really needs to utilise some of these reserves in order to prop up his economy. However, in order to utilise those reserves, they need to be sold into the market place to buy, for example, the commodities that will be required in support of infrastructure projects. If China starts trying to sell those reserves, he is in a position where there will be a flood of the currencies onto the markets. That flood of currency will depreciate the currency, as there are not enough goods to be purchased in the currency, and likely little demand at this time to use the currency as a reserve. During the downturn, others will equally want to use their reserves to finance their way through the trouble, rather than accumulating greater reserves.

If we look at the $US, if this is sold into the market, and sees the resultant depreciation, then there will be further troubles for exporters. Although the RMB is not a free floating currency, if the $US depreciates, and the RMB does not appreciate, the US will (quite reasonably) howl with rage, and will take protectionist measures. If that is the case, China can say goodbye to one of the major export markets.

In other words, what China has done is accumulate currency that it dare not use as, if it uses the currency, it will destroy the currency. The only solution available will be to try to discreetly sell as much of the currency as it can without 'spooking' the markets.

The trouble is that, with so many countries holding these $US reserves, most of whom have their own economic problems, it is likely that everyone is having the same thoughts, and confronting similar problems. What you have is a situation in which there is something like a Mexican stand-off. As soon as one starts selling, then everybody must start selling. They are all, at the same time, terrified of selling, because in doing so, they destroy the value of what they are selling. It is a time bomb just waiting to go off.

As such, the answer to ChasH is that 'yes', China is in potentially deep trouble, as their best route out of their own problems will create a whole set of new problems. On the other hand, they are also in a position where, if they manage the situation well, they might be able to at least use some of the value in their reserves to ameliorate their internal problems. The question is how much, and whether they can pull off this fine balancing act - using the reserves without destroying them.

Like so much in the current situation, it is apparent that there are real contradictions, and that the situation overall might be described as a mess.

Note 4: I am afraid I have run out of time, so that will have to be the end of this post for today. The answers to the comments are a little rushed, so I hope they make sense.

Note 5: I note no comment from Lemming on my last post, which is a surprise - are you not in agreement with the post? If so, your comments are always welcome, even if critical. Also, I have not seen a comment from Matt in Shanghai for a while. As a person actually located in China, the subject of so much discussion, your thoughts on the situation would be welcomed.

23 comments:

  1. Am I right in saying UK gilts are only issued and priced in sterling?

    Japans debt you say is internal financed? is this a result of the QE they undertook some years ago, and are in effect shuffling bits of paper between govt depts?

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  2. Mark, sorry I didn't make a comment to your last post (and thanks for noticing!). I had been devouring the economic news that day, and your post confirmed the sudden downwards lurch in the UK economy that I thought I had detected. I was also involved in negotiating my own redundancy from my job - the economic situation is very real! - but fortunately I think I've found another job in a slightly less precarious industry than the previous one, for now.

    I, too, read the article in the Times you refer to in your latest post, and I was partly taken in by the writer's apparent confidence in his 'arguments'. Thinking about it - and it's very easy to fall into this trap - I was probably persuaded by the fact that as he is highly paid, and a product of the free market he must, by definition, be good at his job..!

    Having read your blog for the last year or so, your arguments are embedded in my mind so deeply that it comes as a shock to me when I talk to 'innocents' who just have no clue. I had such a conversation tonight with a supposedly sophisticated graduate professional, and it was so obvious that he had never considered how the economy works at all - I felt sorry for the poor lad as I began to explain to him the consequences of China pegging its currency. But do you think it is the case that the economy can only work if most of the wealth-generating participants in it (as opposed to bankers and traders etc.) are ignorant of how it works? Even in more normal times can the economy be "talked into a recession"?

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  3. Interesting blog.
    Seems that as long as no-one actually lives in reality, everything will be fine, or maybe everything will sort of continue as it has been.

    Its not as if printing money is a new thing - we abandoned the Gold Standard a long time ago, so money is now not real, its just digits on a screen.

    Perhaps the smart thing to do is grow vegetables - ie start producing all the food that the UK needs within the country.

    Then look at fuel - figure out how to be self-sufficient in fuel, at least for heating and production, if not cars.

    I see the coalmines opening again, and 'global warming' to disappear from the lexicon...

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  4. The Times has another punt at the same story today, in a slightly more sophisticated - but equally flawed - manner:

    http://www.timesonline.co.uk/tol/comment/columnists/camilla_cavendish/article5569343.ece

    I particularly liked this bit:

    "But Britain is not Iceland. Iceland is the size of Coventry. Britain is the fifth-largest economy in the world (although it also has the third-largest current account deficit). The pound is still a reserve currency that people want to buy, despite the efforts of the speculators. We are bankrupt only in the sense that we could not pay if all debts were called in right now - which is true of many countries. A falling pound will be good for exports, assuming there is someone to buy them."

    I've noticed a similar thing with financial journalist at the moment: they make wildly optimistic assertions and then can't help themselves providing a contradictory rejoinder. It's almost as if the truth is spilling out despite their instructions from the newspaper's owner..!

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  5. A SOLUTION

    The UK may have serious problems with its current account deficit, but the European Union itself has a relatively healthy current account: it is often in surplus and when in deficit is never more than 2% of total Eurozone GDP.

    In fact in 2007, the European Union (which is not quite the same thing yet as the Eurozone, all the EU countries that use the Euro) became the world’s biggest economy. According to the IMF figures for 2007, the European Union's GDP (measured by PPP) is 14.712 trillion. The GDP of the US was 13.807 trillion.

    See http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)

    http://www.reuters.com/article/idUSL1491971920080314

    And this is GDP by using purchasing power parity (PPP) as a measure, not simply the cruder nominal GDP measured by exchange rate values (which are subject to appreciating and depreciating currencies, either by government or market forces).

    So, if you think of the European Union as one big economic entity, then its economy is in a fairly healthy state. It tends to have current account balance, just like a single country that has economically disparate regions (e.g., Italy’s industrial north and the relatively poor south).

    The solution for the UK: join the Eurozone!

    Note particularly this fact:

    “the euro is shielding member states in this time of economic turmoil, preventing a currency crisis in addition to the credit crunch. “The euro is sheltering businesses from the exchange rate volatility, which has battered them in previous downturns,” [European Commission president] Barroso said on Monday …
    Before the euro, a financial crisis in Europe went hand in hand with currency woes: a run on weaker currencies, heavy intervention by central banks and finally a collapse of the parity system. "I've lived through currency devaluations, and they are fraught with anxieties," says Hans Martens, chief executive of the European Policy Centre. "But the way the euro coped with the financial crisis was absolutely great. You have a big island of stability, with small nations protected when the big waves became rough." ….
    And the biggest prize of all, Britain, is said to be warming to the euro. Barroso recently claimed that London is "closer than ever before" to euro-zone entry and that "the people who matter in Britain" think it should join ... as the euro zone grows, the U.K. risks being excluded from "deeper intra-E.U. economic consultation and coordination, including in areas of significant national interest, such as financial market regulation."


    See Leo Cendrowicz, “Is the Euro the New Dollar?” January 1, 2009
    http://www.time.com/time/business/article/0,8599,1869159,00.html

    Furthermore, media commentators in Britain are increasingly acknowledging that joining the Eurozone is one of the best policy options left.

    http://www.guardian.co.uk/commentisfree/2008/nov/16/comment-will-hutton-euro


    N.B. In 2006, these European countries (though not all of them Eurozone countries) were in current account surplus (surpluses given as a percentage of GDP):

    Norway (25.7%), Switzerland (24.2%), Netherlands (7.9%), Germany (6.58%), Finland (6.07%), Belgium (3.89%), Austria (3.1%), Denmark (1.69%); Sweden (11.35%).

    Note particularly Norway, Finland and Sweden. Good old social democratic Scandinavia is alive and well!

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  6. Thanks for the entry, which was top notch (if as gloomy as ever).

    I've got a challenge for you, which you should feel free to ignore of course, but since you are often responsive I thought you might enjoy it.

    Perhaps you could imagine, for a moment, you are Prime Minister of the UK and you must choose five 'bullet points' to begin to turn the situation around. What would they be?

    The reason I ask is that it is my opinion that alongside predictions of doom and recriminations of bad policy (most of which I agree with you on) an argument is stronger when coupled with suggestions of alternatives.

    I am aware you've written several long essays on reform strategies (all of which are excellent and should be read by anybody who has not yet done so) the 'bullet point' method is more direct and more in keeping with the way modern politics is announced (whether you agree that's a good thing or not.)

    Just to show I'm not shy, here's my own five bullet points.

    (1) Dramatic Cut In Public Sector spending
    -particularly on wage levels of public sector staff and pensions.

    (2) No Money Printing.
    -If the cash isn't there, you have to find ways to cut the bills until you can afford them.

    (3) Protection from House Repossession.
    -(Complicated, this one, with pitfalls. But worth the risk in my opinion.)

    (4) Encourage saving
    -through targetted tax cuts and slow raise of interest rates again.

    (5) Deregulation & Investment (via tax cuts) in industry, agriculture and manufacturing.

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  7. Thanks.
    Very illuminating. I appreciate the lengths you go to answering questions (I guess as your blog becomes more popular this will be less likely).

    The mainstream media really does seem to aligning it's outlook to your predictions.

    I also read that Times piece mentioned above. I have long been aware of the idea of groupthink, but to see it exposed as so prevalent in the MSM is worrying for human prospects. A friend of mine asked for some links to blogs with cheerful information.

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  8. On the European Union and Protectionism

    With the financial and economic crisis becoming worse very day, it looks as though there could be a turn to outright state intervention and protectionism in the EU.

    French President Nicolas Sarkozy has called for a European industrial policy:

    “In a speech before the European Parliament on Tuesday, … Nicolas Sarkozy suggested that European countries establish their own sovereign wealth funds to take ownership stakes in key industries. He went on to suggest that European states should coordinate their industrial policies with each other …. He also lamented the absence of an administrative vehicle for coordinating industrial and economic policies within the euro zone. "We don't have any economic government worthy of the name. We can't go on like this," implored Sarkozy. Such an "economic government," he noted, would have to work closely with the European Central Bank (ECB). "The ECB must be independent but must also be able to hold discussions with an economic government," he said. The euro zone's 15 member states would work alongside the central bank in coordinating economic policy. He emphasized that such coordination would not have to interfere with an independent monetary policy.”

    The EU has an economy bigger than the US, and a current account that is often in surplus: in short, it is still an economy with a powerful overall industrial base that can export more than the EU as a whole imports.

    Sarkozy's New Dirigisme, October 22, 2008,
    http://www.businessweek.com/globalbiz/content/oct2008/gb20081022_266237.htm


    Furthermore,

    “Mr Sarkozy said the state would take dramatic action in all fields of economic management … "We will intervene massively whenever a strategic enterprise needs our money," he said. The fund managed by Caisse des Depots – the investment arm of the French state – will be used to buy shares in any company falling prey to sovereign wealth funds from Asia and the Middle East, hoping to snap up Europe's crown jewels on the cheap after the stock market crash. "We mustn't be naive and leave companies at the mercy of predators. Europe must not be the only one not to defend its interests. There is no reason why we shouldn't do what the Chinese do, and the Russians do. There is no reason why France can't have an industrial policy worthy of the name," he said.”


    Ambrose Evans-Pritchard, “Sarkozy lays out radical state intervention,” Telegraph 24 Oct 2008
    http://www.telegraph.co.uk/news/worldnews/europe/france/3248982/Sarkozy-lays-out-radical-state-intervention.html

    As the largest economy in the world, a coordinated turn to industrial policy and protectionism in the EU could hardly be stopped by other countries. The Euro is already taking on a reserve currency role, and has a manufacturing sector that can still produce a trade surplus.

    In America, Sarkozy is admired and praised by the US paleoconservative protectionist Pat Buchanan.
    http://www.vdare.com/buchanan/070402_eu.htm

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  9. There's another way out of this. I note that the UK's two most fragile banks are the Royal Bank of Scotland and the Halifax Bank of Scotland.

    Note the repeated word "Scotland".

    Note also that the inhabitants of Scotland have long professed a desire for independence, a desire that has come strongly to the fore in recent years, to the extent that they are now casually beating up English people who happen to stray over the border.

    Note also that Scotland has whole districts inhabited by the economically inactive, and whose only source of income is sucking on the public teet.

    Note also that they don't have much oil left.

    So is it now time to give the Scots the freedom they have so long coveted? Is it now time, like a pair of Alpine climbers hanging over a crevace, that we cut the cord and let the dead weight fall?

    I mean, it's not as though they haven't been asking for it.....

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  10. I should add that there is a silver lining to every dark cloud.

    For years I have been jealous of immigrants who can come to a place like the UK, work their rear ends off and return home as relative kings, perhaps even guy a house or almost a whole house, have an adventure and secure their future.

    This opportunity has been denied to people in the UK so far.

    So not only will my US dollar sourced income rise in value if our currency devalues (so long as the USD doesn't follow suit which I can't see happening as I believe we are in a worse position and have a worse future) but it will also be worth it to go work elsewhere in the EU and send money home! Have you ever heard of Brits sending money home? We may now have the chance!

    Of course, any prospect of civil unrest or huge rises in crime will make things very bad here. But I plan to be gone in June to live overseas so hopefully the worst can be delayed until after then!

    Chris
    My Twitter Page

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  11. Mark,

    I've been back in the UK since before Xmas (curtesy of Chinese tax laws) and I'm flying back to China in a few hours. I've been following your blog throughout all this time, but honestly haven't had anything intelligent to add to your comments.

    The situation is so weird, that all terms have lost their frames of reference. What does it mean for the GBP to "collapse"? Against what? The USD, the Euro, the yen, the RMB? All these currencies seem to be f***ed also. Will all money "collapse"? Will people with the most AK47s be the "winners"?

    One thing the media never talks about, are the current (and potentially future) winners of the chaos that seems to be upon us. Last year, at the top of the market, a friend of mine, traded his 95K house ("bought" in 1993, which appreciated in value to about 400K last year) for an 800K house. His monthly payments for a 500K mortgage are only about 200 quid more than his payments on the 95K mortgage (thanks to "financial engineering"(some "tracker" interest-only mortgage) and the interest rate cuts triggered by the "credit crunch"). He has no chance in hell to pay off his current borrowing in a "normal" economic environment. But low interest rates followed by a collapse in the GBP just might make him a winner. The low (approaching zero) interest rates allow him to stay afloat with his current monthly payments, whereas hyperinflation will make his (principal) debt disappear. At the end of the day, he (and his heirs) will be left with a very nice property in an attractive part of London, whereas idiots (like myself) will be reduced to being paupers. Now, if people like my friend can become accidental "winners", think what "people in the know" might be up to. But I leave it up to your more conspiratorily minded commentators...

    All the best
    Matt

    P.S. When I talk about "last year" I mean 2007.

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  12. 1.
    Whilst I understand the logic of hyperinflation decreasing the value of existing debts and see how people could benefit in the medium term (as long as their debt is fixed because at some point interest rates would spike), I struggle to see how people would benefit in the short term; indeed, they could suffer terribly.

    I do not know if all salaries are adjusted for inflation only once a year, but I know pensions (and perhaps benefits) are annually assessed and adjusted for the following year in October.

    If someone's income is only assessed once a year then until the adjustment occurs that person has to survive on a fixed income whilst prices of everything around them are soaring.

    Sure, after that year they might be able to pay off a huge chunk of their mortgage, assuming that person's income is index linked (sadly one of my family members' incomes is not).

    But there could come a time before salaries are adjusted when a person wouldn't have enough money to meet their monthly outgoings, perhaps even necessities such as food! Obviously this depends on how severe the hyperinflation turns out to be.

    Furthermore with regard to Matt in Shanghai's friend who traded up to a bigger house, his friend would be in this situation unless they are paid in a different currency.

    One way I can see a situation like that working would be if your friend used a portion of the money from the sale of their 400k house to buy a modest amount of gold bullion and then take out the biggest mortgage they qualify for fixed for 2 or 3 years. Once hyperinflation kicks in and the price of gold has soared (which it inevitably would in a hyper inflationary environment), they could sell the gold piecemeal to help them meet their monthly outgoings until their salary is adjusted and then could benefit by paying off a large portion of the mortgage.

    The way I would determine how much bullion to buy would be to look at your current monthly outgoings (eg £1000) and buy enough Sovereigns to meet them at current (pre-hyper inflation) prices (eg £1000/£175 per sovereign (currently) = 6 sovereigns per month, x 12 months = 36 Sovereigns to last a year).

    So by buying six and a half grands worth of Sovereigns your friend would not risk the initial pain of not being able to meet their outgoings in the short term.

    Incidentally the beauty of Sovereigns is they are exempt from capital gains tax as they are considered legal tender.

    As Cynicus has previously noted the rich are buying gold, perhaps this is why?

    Whilst I think one has to be careful when reading articles predicting gold prices as they are often written by people with vested interests, I found this interesting article on the upcoming depression and gold price.

    http://marketoracle.co.uk/Article7923.html

    2.
    Am I to understand that once hyperinflation kicks in house prices will stop falling in nominal terms and could in fact rise in nominal terms? So if you have money set aside now to buy a house, if you leave it too long you won't benefit from falling prices as they will be falling in real terms and not nominal terms?

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  13. Just spotted my error - would be 72 Sovereigns to last the year at a cost of £12,960.

    ReplyDelete
  14. Third time lucky: 175 x6 x12 = 12,600

    Note to self, don't attempt mental arithmetic with a hang over!

    ReplyDelete
  15. Matthew Parris has been reading Cynicus Economicus!:

    http://www.timesonline.co.uk/tol/comment/columnists/matthew_parris/article5576222.ece

    ReplyDelete
  16. proposed new U.S. Treasury secretary Timothy Geithner accuses China of manipulating its currency.

    http://www.forbes.com/2009/01/23/china-currency-row-markets-economy-cx_pm_0123yuan.html

    Not the best way of starting Diplomatic relations really.

    Especially if the analysis in the following link is correct.

    http://www.marketoracle.co.uk/Article8361.html

    Rather hypocritical if the Fed has been manipulating Gold Oil and Bonds in the way that is described.

    A very interesting read, and the link to the recently discovered Federal Reserve paper is worth a read in itself, Being a blueprint for the Fiat currency in the US and just how much they wanted to suppress information.

    http://www.gata.org/node/7095

    ReplyDelete
  17. This might be of interest:
    http://www.guardian.co.uk/business/2009/jan/24/nouriel-roubini-credit-crunch

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  18. With reference to the Anonymous post dated January 23, 2009 5:14 AM

    I don't think that's a particularly useful or pleasant thing to say and I don't see how it advances any understanding of the current 'interesting' financial and economic sitation.

    It's presumptive of the anonymous commenter to write 'we' as if everyone reading this excellent blog is English and xenophobic.

    Jonny, your suggestion looks good but how likely is it that there is no hyperinflation, and gold is in a bubble just now? That would make Matt's friend look awkward...

    Cynicus regarding note 5, its good to see you keeping us all on our toes!

    ReplyDelete
  19. The Collapse Of Capitalism and the Gold Safety Net
    http://www.marketoracle.co.uk/Article8374.html

    Another good read on the economic ponzi scheme that the markets have become (Hell Charles Ponzi was an amateur compared to what the bankers with a capital W have dreamed up)

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  20. Anonymous said the following:

    'Matthew Parris has been reading Cynicus Economicus!'

    I too read the article by Matthew Parris, and the same thought crossed my mind. However, I think it may just be that more and more people are just starting to come to the same conclusions as me. However, it would be nice to think that I was influencing such thinking. Who knows?

    ReplyDelete
  21. Hey pocmloc,

    Perhaps there will be no hyperinflation, although I feel Cynicus' arguments present a strong case. But you're absolutely right, nothing is certain.

    At the very least I'm convinced high inflation is the real worry in the near term and for that I would rather hold gold than a collapsing currency.

    By way of an anecdote my brother asked a well placed friend what he felt lay ahead and he started his email with the following:

    Big boss man visiting us from our head office in the US wandered into our morning meeting and said "so, has anyone else been looking up how to buy gold coins then?". This is a guy who has been intimately involved with the Bear Stearns rescue, the Lehman collapse, the managing of billions of assets for the Fed (part of the TARP) and has had tens of insolvent hedge funds and dubious financial companies offered for sale to him - he knows what's going on.

    His recommendations on what to do with your cash:

    at this stage, if you have money to invest - it's inflation linked bonds, gold, and short duration investment grade corporate credit (if you want to take any risk on. I'd stick it under the mattress to be honest)

    ReplyDelete
  22. Josiah Stamp's GhostJanuary 25, 2009 at 1:09 AM

    This article deserves a read:

    http://www.marketoracle.co.uk/Article8389.html

    ReplyDelete
  23. A more light-hearted view of the situation.

    Fiscal Insanity Virus, the Irrational Fear of Deflation
    http://www.marketoracle.co.uk/Article7912.html

    ReplyDelete

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