Category Archives: economics

Back to the future

An article in the FT caught my eye this morning (Banker fury over tax witch-hunt). For the first time in weeks I have had the luxury of catching up on the papers and not having to fit it into a never long enough gap between getting up and getting out.

The article highlighted the backlash in the US banking industry to a punitive tax on bonus payments paid to bankers whose employers have received state bail-outs. It seems there is much wailing and gnashing of teeth along with warnings that the best and brightest will leave the industry and we will all go back to the stone age.

I have to admit to being somewhat underwhelmed. There are two issues here, and on both, the direction we seem to be moving in appears more attractive than a year ago.

The first complaint of the bankers is that the brightest minds will be attracted away from the banking industry by other offers. Good. Other industries have suffered from a drain of talent attracted by the prospect of unimaginable wealth. Engineering and science are two areas in particular which would benefit from the best thinkers.

Secondly, after twenty years of the market-driven, profit-orientated, short-term profiteering that has become the foundation of many people’s lives, a return to the stone age sounds like a very attractive idea. Of course the wails of the bankers are hyperbole. We won’t go back to the stone age but perhaps we might go back to a place where values are based on something other than money.

I dream of a future where we do things, not because there is profit or even personal gain to be had, but because those acts are worth doing for their own sake. Our lives should be driven by a value system that is based on something other than money and profit. When we choose a career, be it banking, engineering or science, we should do so because it provides a benefit to others. Profit will never benefit society. It will only ever benefit the owners of whatever is being traded.The most valuable things we have, from the air we breath to friends and love cannot be bought with any amount of money.

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Some disturbing figures

An article in the FT caught my eye this week: Why dealing with the huge debt overhang is so hard by Martin Wolf. Wolf presented a number of charts analysing both US and UK debt over a number of years.

What was alarming was that in the UK, non-government debt has grown from roughly 80% of GDP in 1987 to over 400% today. This in itself is not new. The vast bulk of the growth has been down to the increase in borrowing by banks and other financial institutions. I have this comic Laurel and Hardy image in my head – “Another fine mess you’ve got us into!”

The fact that the banks have been borrowing like there was no tomorrow, to lend to customers who wanted to spend like there was no tomorrow, is no longer news. What did strike me though, was the figure for household debt. In 1987 this was less than 20% of GDP. Now it is 100%, comparable to the proportion of debt owed by the non-financial corporate sector. In other words, household debt is equivalent in value to the total national output in a year. Put another way: on average, households have spent in excess of their incomes as much as a year’s salary.

Think about this. Some people have little or no debt. That means that the average debt for those who do owe money is more than 100%. Arithmetically, this means that if those people were to reduce their expenditure to nothing (not practical, but let’s assume) then it would take more than a year to repay the outstanding loans they have run up. Granted, some of this debt will be mortgages spread over 25 or 30 years. Still, the implications for lifestyles and the economy in general are not bright.

It will take some effort for many people to reduce their standard of living to a point where they are living within their means, and this is assuming they still have an income. This alone will reduce demand from current levels. The negative feedback is being felt already as people are laid off from previously secure jobs. It will require a further effort to continue reducing living standards to a point where a regular surplus is being generated with which to repay outstanding loans. This will have a further negative effect on output and employment, with several years passing before balance is restored.

There are two issues here. One is that it is questionable that the consensus strategy for tackling the credit crunch (increase liquidity and expenditure) will be effective. Liquidity is not the problem any more so much as our ability to generate sufficient surplus with which to offset previous profligacy. Secondly, a change of attitude to wealth is both necessary and painful. The economy has been increasingly driven by a vast advertising budget, itself driven by a quest for ever-increasing corporate profits. Somewhere along the way we have forgotten that ultimately, we cannot consume more than we produce – at least, not without borrowing. If we ever, either as individuals or as an economy, spend moreĀ  in a year than we produce, then sooner or later we must produce without spending in order to repay the debt. Unfortunately, the consequences of this can only be economic contraction and an adjustment of lifestyles to less than we have become accustomed. Hold on to your hats.

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On consumption, banks and Christianity

I have to confess to a certain smugness of late which I am making a serious effort to throw off. As a Christian who also happens to be a practicing accountant with a training in economics, the current economic climate is providing abundant food for thought.

For a number of years it has been clear to me, and I am sure others, that things could not continue as they were going. I remember discussions with friends and colleagues back in the 1980’s, concluding that the only way to make money out of one’s house is to trade down. This of course was out of the question for anyone with a family. As the 1990’s rolled on we talked about the spiralling cost of mortgages with young couples on anything less than two professional salaries effectively being priced out of the market in many parts of the country. Hindsight is easy, but as the new century turned it was increasingly evident that the more expensive houses and mortgages became, the less would be available out of household incomes for spending in the shops. Ultimately, there had to come a point where consumers could no longer afford to buy the goods necessary to keep their employer’s in business.

Except that consumers had found a way out of the problem – credit cards. After they had borrowed from their mortgage on the back of ever rising property values, consumers reached for their wallets and flexed their flexible friends. Once the limit on one card was used up, out came another to take on the increasing debt burden. Let’s not mention the banks just yet in this sorry tale. We can come to them later.

At this point in the plot, the Christian in me cannot help but observe that in the space of 20-30 years there has been a subtle but significant change in perceptions of wealth. There was once a time (remember Granny?) when if you wanted something, you saved for it. If you couldn’t afford to save, you did without. In economic terms, consumption was a function of historic income and savings. Somehow along the way that has changed. There is now an expectation, particularly among the young, that whatever is desired can be had, and had right now. Current income isn’t a problem other than in providing sufficient surplus each month to pay something towards the credit card balance. In other words, consumption is now a function of some multiple of current income.

Again, acknowledging the wonderful value of hindsight, it was still possible to recognise that the consuming population couldn’t continue growing their debt forever. Some might, by increasing their incomes, but this was never an option for the population as a whole. Arithmetically there has to come a point for any borrower where the amount of surplus income available to repay a mounting debt is less than the interest added each month. Beyond that point, the debt simply runs out of control.

So where do the banks fit into this? In the good old days when banks had managers in them, they took deposits and out of those deposits made loans. (This is slightly simplistic, but only slightly). Then the banks cottoned on to a wizard wheeze. If they could borrow money, they could lend even more and make even bigger profits. And what better opportunity to lend than to a nation of consumers with inflating house values and an appetite to consume like there was no tomorrow? Now, it has always been recognised that any bank which lends money will face bad debts at some point. Therefore, prudence (and banking regulations) dictate that the banks maintain a level of easily liquidated assets on their balance sheets. These can be cashed in if needed. Call it a rainy day fund. They all did this but ended up holding assets worth less than face value and possibly worth as little as nothing. Lets not go into sub-prime lending and collateralised debt obligations just now. So when the wheel comes off the cart and banks can no longer borrow the funds they need to lend to people that need to consume – the bubble that has been expanding for two decades suddenly explodes.

Banks stop lending to businesses because they don’t have the funds to lend. Businesses lay off their workforce because they have gone bust or fear doing so. Employees stop flexing those credit cards in the shops, leading to more businesses going bust and round we go again.

So who was it got us into this fine mess? Here is a Christian answer. If consumers had listened to their Grannies and learnt to distinguish between need and want, they would not be saddled with crippling debt and the possibility of losing their home. If banks had understood the folly of lending to individuals for spending on holidays and restaurants, then their balance sheets would not have been so vulnerable to a global setback. True, in this ‘if only’ world economic activity would have been a lot less than we have seen. We would have fewer cars, smaller televisions and only one winter coat instead of four. But perhaps, like Granny, we might see value in things other than material possessions. Money is useful but that is all. Once it becomes our God then we are lost.

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