Friday, 19 December 2008

German "Crass Keynesianism" Lesson

"All this will do is raise Britain's debt to a level that will take a whole generation to work off ... The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking ... When I ask about the origins of the crisis, economists I respect tell me it is the credit-financed growth of recent years and decades ... Isn't this the same mistake everyone is suddenly making again, under all the public pressure?"
Peer Steinbruck, German Finance Minister

It is very rare that economic sense is spoke in the mainstream media. All too often 'experts' are paraded in front of the media circus to explain what needs to be done to amend the current financial crisis. Sloppy Journalism has become all too common, with many of the main newspapers and television companies rarely exposing the truth. Peer Steinbrucks recent comments were a breath of fresh air and comments that expose how many governments of the world are now proceeding to make the crisis worse. Comments like these expose the policies for what they are, short term political popularity contests that have no benefit in the medium to the long term. The particular attack on Britain was fully justified and words that our leaders should take great alarm to. The markets have also begun shorting the UK, as McDonalds debt has become cheaper to insure against default. Peer Steinbruck is not the first German to expose the weaknesses of the UK economy. Back in October of last year, when the Credit Crunch was still in its infancy, a team of German Economists warned that the UK economic miracle was nothing more than a mirage, built on debt and short term consumption. At the time I remember a lot of the 'experts' deriding this report as nonsense, with the politicians ignoring these warning signs, but here we are 12 months down the line the Germans are spot on again. The UK is in dire shape, with Brown and Darling still with their fingers in their ears. Well I suppose Brown apparently saved the World recently.

Gordon Brown's popularity in the polls has perversely gone up recently, and he has begun capturing ground against the Conservatives. Could he be trying to call a Summer election in 2009, before the economy implodes in 2010 and beyond? Brown was originally going to call an election in 2007, as he knew the economy was about to nose dive off a cliff. He backed down in the end and decided to ride out the storm as he didn't want to loose his life's long ambition, of being Prime Minister. Of course these fiscal paternalistic policies are just more smoke and mirrors, eco-matrix policies to confuse the public. Peer Steinbruck views are a minority. Legitimacy is gained when Paul Krugman, a Nobel prize winning economist, praises the central banks and the fiscal polices of governments, stating that we can not repeat the mistakes of the past. A Nobel Prize winning economist who came out saying that during the Great Depression they didn't cut interest rates like we have now - it makes you wonder what history books he reads. These neo-Keynesian economists just know one thing, and that is too inflate, so its no surprise that governments galvanise these economists. Recently, unbelievably the media have begun mentioning the 'helicopter drops' of money, ones that Ben Bernanke remarked about in 2002, just as this bubble was being inflated. Yet no one from what I have seen has come out and said how stupid these ideas are. Printing money has never worked and never will. It has become so bad that for once I am actually worried what our leaders are doing along with the complicity the media and mainstream economists seem to be showing towards such dangerous actions. No currency seems safe these days, with everyone trying to inflate. Yet economics editors, people that you hope have been educated in finance, seem to think this is a good thing.

"It is not inconceivable that banks could start charging customers to hold their money – after all, their business model is predicated on positive interest rates"

Statements like these sum up the delusional state the UK has found itself in. What savings? Do you think the banks are going to start charging people for their money, when they are insolvent? Do you think members of the public will pay banks to store their money, when we get double digit inflation? There still seems to be a propaganda mission among some, that we are are entering a deflationary spiral that will last for years. However once this sell off period has ceased, inventories and stock have been sold off, production has been cut back and the government has printed up more money, can you really see deflation taking hold? The goods and services in the real economy will decrease, capital is running scared therefore there are no productive investments being made, yet the amount of paper money will increase - this is classic stagflation, the phenomenon that smashed Keynesian economics apart during the seventies.

We've been here before of course. Back in 1973-74 the world was in a similar situation we find ourselves in now. There was a commodity bull market, oil price spikes, an expensive war, recently Iraq, back then Vietnam and a serious bust that was occurring during this time. Yet at the time there was no unified economic response to the above as the seventies credit crunch hit. Rates of inflation varied greatly in Europe through 1973-79, the years after the crunch, with the UK, Ireland, Spain and Italy averaging around 16% during this period while West Germany, Holland and the Swiss averaged around 5%. Yet history seems to be repeating. West Germany back then pioneered the monetarist approach and shyed away from reflation, opting instead to control government spending and the money supply, allowing the deflationary forces to amend the market during 1973-74. Meanwhile the UK chose reflation, by implementing the opposite polices to the above. It joined the other Western European basket economies at the time, by experiencing some of the worst inflation in the euro zone. Once again the Bundesbank are stating the principles they undertook in the past, but these policies are not populist polices politicians like to hear. Once again, the interpretations of history they use are inaccurate, thus they fail to see the causes of the Great Depression and the stagflationary seventies. Government intervention and inflationist policies caused the above, not the market, as what is commonly mis-perceived.

If we compare the current German economy to the UK, we see a stark contrast. Germany has a trade surplus, managed to balance the budget (thanks to Peer Steinbruck) before the downturn occurred, has much less personal debt and has savings of around 10% of income. The UK has none of the above and all its macroeconomic indicators are in bad shape. So essentially Germany is a producer nation, while the UK is the unsustainable consumer maxing out every credit card in sight. I'm not saying Germany won't be effected by the current downturn, there are very few economies in the world today who practice autarky in the globalised economy we live in. But the German economy has far better fundamentals than the UK. Don't be fooled by our governments spurious claims that we have 40% GDP public sector debt. It will soon be 50% then 60%, and keep rising further. With off book debts this figure is more like 200%, as just looking at pension liabilities with a conservative estimate, this would be around 100% of GDP alone, not mentioning other liabilities. Yet the UK economy will contract further - thus increasing these percentages. With the pounds recent slump, the worst since it experienced a run and was consequentially removed from its Gold backing back in 1931, external debt has in effect become more expensive (well at least until other currencies fall against the pound as will no doubt occur). To illustrate how bad this is the graph below indicates how exposed the UK is compared with the other G7 nations. This is public and private debt the UK owes to the rest of the world as a proportion of the economy. With the pounds devaluation recently, this has just got a whole lot more expensive to service, as quite substantial amounts are borrowed in other currencies.

Since Otto Von Bismark managed to unify Prussia with the other German states to form what we now know as Germany, Europe and indeed the World has always looked suspiciously at her. Victory in wars against Austria and then France, during the later part of the nineteenth century displayed early remnants of the economic powerhouse, that would become one of the main European powers. France and Britain today still cling to their old superpower status that has long gone, and will not accept Germany as the current European superpower. Germany took in huge numbers of Yugoslav refugees during the ethnic 'cleansing', much more than the UK, but as soon as they tighten their boarders we brand them as Fascists, showing our Deutschtum phobia. It seems that the UK along with other nations are unwilling to listen to the Germans. They ignore this advice at their own peril.

Saturday, 6 December 2008

UK Bubble RIP

"The City of London is pretty much finished ... and if you're alarmed by the recent slump in sterling, you ain't seen nothing yet. In a decade, you're going to be importing oil again - what's going to hold sterling up when you're a net importer of oil? You've already got a balance of trade deficit. I've sold all of my sterling ... there are no fundamentals to support sterling as far as I can see"
Jim Rogers, Chairman Rogers Holdings

"But if investors no longer think the UK's banks are at risk of collapse, they then look at our other vulnerabilities - such as public sector borrowing which is rising very sharply because of the costs of the bank rescues, dwindling tax revenues and the need to spend our way through the economic downturn ... If international investors fear our credit isn't what it was and are selling pounds, we should hardly be surprised."
Robert Preston, BBC Journalist

Since the end of the First World War, Britain had been in a state of terminal decline. Recently, however, the worlds financial markets were loosing confidence in Sterling as the Treasury could no longer balance the books, with ever increasing government spending that could no longer be paid for. By Autumn the pound was plunging, inflation was rampant and the Prime Minister was trying to keep his party together after just recently obtaining the job. The year was 1976. The UK in the end had to go cap in hand to the IMF to avoid economic collapse, the first Western Nation to do so, and only Western nation up until Iceland's recent decline. It ushered in a wave of right wing Thatcherist economic policies which prevailed up until the present day and changed British politics and society forever. The Labour party after the crisis subsequently split between the old left who remained, and the Social Democrats, who later abandoned the Labour party and joined forces with the Liberals to form the Liberal Democrats. Labour also morphed in subsequent years, from the early eighties the 'loony left' politics of Michael Foot, all the way to 'New Labour' a 'Third Way' led by Tony Blair, who won power in 1997 and for the first term emulated Tory spending plans.

Without North Sea Oil and Gas as the seventies came to an end, the UK could have become an economic wreck, and Margret Thatchers monetarist policies in all probability would have failed putting the final nail in the coffin. The UK's trade of balance would have collapsed without the support from the Oil and Gas revenues. In the end, the UK experienced a renaissance and shook itself out of the terminal decline it had found itself in. However in 2008, the UK again showed strains with investors questioning a new generation of Labour Politicians, wondering if history was repeating itself again. Expansive fiscal measures had been announced, with huge government deficits being forecast and the balance of trade in once again, a perilous state. The UK bubble had burst and with it, she resumed her long decline after the illusionary reprieve of the last 25 years.

Over the past 11 years the Labour government has won successive elections, which no other Labour government in history could achieve. Tony Blair won a historic third term and with it, the party had gained the trust of the people regarding economic affairs. It was no surprise that there was a reversal in opinion regarding the economic competence between the Conservatives and Labour which had once favoured the former, now favoured the later. 'New' Labour was nothing more than a Thatcherist project, one that the Iron Lady herself would jokingly remark was her greatest achievement. Labour had increased the Plutocracy that was seen under Thatcher, with little change in the social apparatus of the country. They continued with Tory Policies, such as PFI, the selling of state assets or Privatisation and the push towards the services industry, in particular the over zealous belief in financial services. Yet this 'Third Way' obtained some false perception among the British public, that social responsibility or progress was greatly enhanced under 'New Labour policies', even though it was evidently Thatcherism but under these new false social pretensions. Of course like all socialist governments they were tied to their socialist dogmas, with the incessant need to 'help' people under the guise of the states apparatus. Their spending deficits became more prominent after the honeymoon period, with needless spending and increasing bureaucratic waste. As the global economy began its historic downturn, the government was now exposed for all its true colours. Relative poverty was as bad as ever, hospital deaths from new super bugs had increased with some of the worst standards in Western Europe. The decline in state pensions had not been reversed since Thatcher pegged them to CPI rather than average earnings, which had now become officially the worst in Western Europe. No real social progress had been made, and the economy had become even more imbalanced with government finances in a dire shape with all the one time privatisation cash cows now all but gone. It would soon be 1976 all over again.

So why did the UK have such an extraordinary post 1970's renaissance? The biggest free gift which gave a healthy revenue stream was the North Sea Oil and Gas that had been discovered during the Sixties. This in effect saved the UK from a perilous plight. It enabled Thatcher to follow in the lead of Federal Chairman Paul Volcker and implement Monetarist Policies in order to contract the money supply and cut government spending, suppressing inflation that was causing havoc in the UK's ability to conduct trade. Without the Oil and Gas revenue stream it is very hard to say if she would have been successful, as even with this, there was still huge unemployment and civil unrest. With sound monetary policies Thatcher could then next turn her attention to the Unions who had held successive governments to ransom during the stagflationary seventies. A move towards a more dynamic workforce was critical in positioning Britain for the global challenges that would evolve over the coming decades. The battle against the 'Shock trooper' Union, specifically the miners lead by Arthur Scargill, was subsequently won by Thatcher and meant that the Unions were subdued. The reformation of tax, meant external capital was once again flowing back into Britain, fueling further economic expansion. With tax cuts came the problem of raising sufficient government revenues and Thatchers solution was privatisation, the selling of state assets for dirt cheap prices giving the government a once only large cash flow. Without getting into the flaws or the advantages of privatisation, this is what happened in the UK, but it is a once and once only money machine. The state was slowly selling off its family estate. In 1986 the 'Big Bang' policy deregulated the financial markets and in came the all conquering US Investment Banks, along with further external flows of capital. Thatcher had begun reinvigorating London as the financial center of the World once more, like the bygone age of British hegemony at the turn of the century.

Manufacturing was in solid decline, indeed recession, for the subsequent two decades. The turn towards services was deemed to be Britain's area of strength after the fiasco of Nationalising the Car Industry during the seventies which ended in disaster. An age of retail had begun, consumerism ruled Britannia, with Marks and Spencer becoming the darling of British Retail. Margret Thatcher had a very conservative childhood with strong family values and thrift. Ironically she presided over Britain's largest credit boom of its day, a new consumerism had taken over the nation. Of course all credit induced booms end in bust and this was no different. After unpopular polices such as the Poll tax, and mutiny within the party, Thatcher was ousted and replaced by John Major. As the bust continued Sterling collapsed as it was ejected from the ERM. The subsequent years of 'Tory sleaze' and their old tired public image lead to the publics rediscovery of the opposition. Under Tony Blair Labour had become 'respectable' once more and with amendments to the party manifesto, mainly the abolishment of Clause IV regarding nationalisation, and a pledge not raise income taxes, Labour were voted in on a landslide.

Once in power Labour initially adhered to the policies of Tory tax and spend. They continued with further privatisation of state assets. They ramped up the PFI projects they had once opposed while in opposition, with further increase in off book government debts. During their time North Sea Oil and Gas reached its peak production, with the UK exporting it in ever greater quantities. With the abandonment of Coal during the political clashes of the eighties, the UK drew more of its power now from Gas fired power stations rather than turn to Nuclear options like the French. While in Norway they kept a substantial portion of their Oil and Gas revenues in the Government Pension Fund, for future generations to enjoy and to smooth out the coming decline, Britain in typical Anglo Saxon consumerism spent it all. Debt began its exponential climb upwards as the UK reached its economic peak, as people racked up further debts just at a time the UK would be ill equipped to pay them in the future. More external investors flooded the island with capital, from Russia the Middle East or Asia, London was the nations financial artery, directing more money into a heavy debt laden economy. This further fueled more credit expansion, with the need for less internal savings. The financial liberalisation of the 1980's from the Big Bang came to a pinnacle as British banks expanded more and more, with traditional conservative Building Societies moving into the realm of risk. Northern Rock, with 125% mortgages, or the 'Together Plan', became the dynamic dynamo of London, what would soon be the Enron of the UK.

During this time the Labour government had been increasing spending ever more, running continual budget deficits, with ever more rosy growth projections from the 'prudent' chancellor Gordon Brown. As Oil and Gas production began to decline and with ever increasing reliance on imports, Britains trade of balance deteriorated further. Warning signs were there, but few wanted to acknowledge them. This was after all the new dynamic Britain, who its people believed had become a strong economy with solid foundations. However as the American housing market bubble began to unwind, so did many financial instruments and institutions. Britain had uniquely positioned itself precariously reliant on finance, only Iceland had an even more foolish model. With the global slowdown, came a collapse in the main British Industries, finance, housing and retail. The service economy where we could all become sales people, skills and trades had been outsourced, with everyone getting cuts and no real value being created, was beginning to unwind. Sterling was beginning its decline. Unfunded government borrowing was beginning to occur once more. The UK was not bankrupt, but began on the path towards it.

Just like the seventies where key manufacturing industries were nationalised, the UK government had once again made the same costly errors, this time with the Banking system. RBS, Bradford and Bingley, Northern Rock and further shareholdings in other banks will paralyse the sector for years to come. Without the luxury of being the worlds reserve currency or a major currency such as the Euro, Sterling can't afford to be exposed the way it has. Even with Sterling falling week on week the politicians continue to make more mistakes, recently with the policy of paying the nations mortgages if there is personal loss of income. This will Compound the issues with the battered banks they have nationalised. More money will be needed to pay peoples mortgages and as the banks can't liquidate their assets, will need further government capital injections - a double disaster as the economy tailspins out of control. Indeed, the UK is even beginning on the road to loosing its triple A credit status. It will just be a matter of time before it does. External capital flows are drying up, with Sovereign Wealth Funds questioning their Investment strategy in the once 'dynamic' island. Rather than waiting for the Pound to collapse, Gordon Brown has begun looking for alternatives to try and shelter the UK from the coming decay.

The current government, just like the populace, are in a state of denial. Over optimistic growth forecasts are continually used, with Growth projected to rebound sharply to 2% at the end of 2009. A quite fundamentally flawed figure. I'm not sure the leaders truly appreciate the risks they are currently running with increased government debt, and a further deteriorating economy with no credible plans to reverse these current conditions. The suggestion that they won't be able to balance the books until 2016, shows what a mess we are in, as it uses these optimistic forecasts. With ever decreasing options the Bank of England has begun with suggestions of the nuclear option, namely the printing press, as the options addressed above used by previous governments have all been exhausted. The media are under the illusion a Japan like scenario could occur, however we are not the worlds largest creditor nation like Japan was then, and do not have a trade surplus. Japan tried to inflate like we are now, but failed due to these reasons. We however will succeed and face years of stagflation once again, just like the seventies. The governments are continually propping up the private sector, but no one is asking the real questions. Who will prop up the government? Even mainstream commentators understand the implications, as Robert Preston states just before the Nuclear Option was announced,

"Some analysts see this as the start of the money printing-presses being turned on with a vengeance, a deliberate attempt to stoke up inflation to reduce the real value of all those excess debts. I'm not sure we are there yet - though it's probably only a matter of time."

UK Government debt is set to explode over the next few years, with off book debts being realised as unfunded pension liabilities, Bank Loans, PFI and declining energy revenues further impair Britain's finances. Central Banks and governments have begun explaining the false dangers of deflation, however they know perfectly well they are preparing for inflation, one that will make the seventies mild in comparison. The reduction of interest rates is further evidence of this, by giving no incentives to save, just the further encouragement to spend and upkeep the velocity of money. Victorian thrift has long gone.

Of course there are no economic fundamentals to support the UK, as the quote at the start states. All of the above, PFI, nationalised finance, unfunded government spending, privatisation, pension liabilities and off book debts, will now go into reverse. Just as they exacerbated the boom on the way up, they will exacerbate the bust on the way down, all compounding with one another over the coming decade.

However, when history is examined Britain has a long and successful functioning liberal democratic system, one that was able to survive the excessive debts obtained during the wars with France, and with it rose as the global power. With debts in excess of 200% of GDP, the UK did not default like many other nations did. It instead paid all the bond holders even in a period of extraordinary deflation during the pioneering phase of the Industrial Revolution. She rose to become the greatest creditor nation the world had seen, spearheading what we now associate as modernity. As Europe succumbed to Fascism during the crisis in capitalism throughout the 1930's, Britain maintained its traditional liberal democracy. These historical factors alone won't prevent the decline of Britain. It involves a painful transitionary period, which politicians are notorious for preventing. Even with this there are no guarantee's as Britain is not what it once was in 1815 and the world is a much different place. We may have seen a high in the UK in our lifetimes. We may be witnessing the beginning of terminal decline.

Wednesday, 3 December 2008

A Ringing Endorsement

An article has been published recently on the Internet which I found very interesting. It was a monetary statement published by Dr Gono the Governor of the Bank of Zimbabwe earlier this year in April. I have included snippets from the article below.

"As Monetary Authorities, we have been humbled and have taken heart in the realization that some leading Central Banks, including those in the USA and the UK, are now not just talking of, but also actually implementing flexible and pragmatic central bank support programmes where these are deemed necessary in their National interests."

"That is precisely the path that we began over 4 years ago in pursuit of our own national interest and we have not wavered on that critical path despite the untold misunderstanding, vilification and demonization we have endured from across the political divide."

"Here in Zimbabwe we had our near-bank failures a few years ago and we responded by providing the affected Banks with the Troubled Bank Fund (TBF) for which we were heavily criticized even by some multi-lateral institutions who today are silent when the Central Banks of UK and USA are going the same way and doing the same thing under very similar circumstances thereby continuing the unfortunate hypocrisy that what’s good for goose is not good for the gander."

"Our economy is and has been in trouble for over ten years and our extraordinary interventions by whatever name have helped to keep the wheels of this economy moving."

"Of course, in the short-term such interventions are without doubt inflationary but in the medium to long-term they trigger and propel economic growth and development that everyone craves for."

For those of you not in tune with the modern economic collapse of Zimbabwe, inflation is a big problem over there. Well it's more than a problem so much as the currency is worthless with the rate inflation running in the millions. As the currency has no stability the economy can't function, as prices can't find a stabilisation point, subsequently businesses can't invest as trying to predict future costs is impossible. Add to that disastrous policies such as price controls and you have a recipe for product shortages as retailers actually loose money by trying to sell the products below market value.

This rate of inflation did not happen over night. It happened after years of mismanaged fiscal and monetary policy. Robert Mugabe and his Kleptocratic regime ran up government debts that could not be paid, thus resulting in the use of a printing press to pay the bills.

As we can see in the chart below inflation was in its infancy less than 10 years ago. When the government began printing money to try pay their bills and implemented a lot of disastrous policies inflation began to take off. The problem with inflation, is once it has emerged its very hard to contain, as prices rise, people demand more pay which puts further strains on the governments costs, so they have to print more money, as the vicious cycle continues. Capital Investment collapses as the currency has no stability, in turn a flight of foreign capital ensues.

In the above graph, Inflation also drops briefly as the government implement a host of policies that stifle markets forces such as pricing by having "Price Controls". Of course the deflation effect is short lived as market forces should never be distorted by governments and bureaucratic institutions. From 2005 inflation exploded and now stands in the millions. In the short time of writing this article inflation has probably increased in a magnitude of 10's.

The reason the UK had such a bad recession in the early eighties was not due to Thatcherism, as many populist anti establishment figures proclaimed at the time such as Ben Elton in the Young Ones. It was due to the inflationist policies that were perpetrated by the Labour government in the seventies, as they spent money they didn't have and funded the difference with inflation. Thatcher came to power and inflation was rampant, as she begun to implement her monetarist policies to tame inflation, in effect contracting the money supply. As painful as this was and as high as unemployment became, it was completely necessary as the economy could not progress until currency stabilisation had been achieved. I'm not a Thatcher fan, it was her policies after this that created the divisive nation we now live in and decimated communities, but returning Britain to a more stable footing allowed the eighties boom, and the subsequent boom we have just been through.

Again, just like the seventies, the UK has begun tampering with market forces and running up deficits they can not pay, trying to inflate their way out of the current credit collapse. Like any previous government that has tried this, it will fail in disaster. Don't be fooled by talk of deflation. When you look at the underlying economic picture it is inflation we will get. It might not be next year or in two years, but it will happen at some point in the future and with it the devastating effects that it causes. As one of the quotes mentions above "keep the wheels of the economy moving" has an eerie ring to it, like a statement from Gordon Brown at the present time. We have been told at all costs we must keep the economy moving. Even if it leads to even worse economic hardship for the medium to long term.

Tuesday, 18 November 2008

Interest Rates and Capital

“Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed.”
Mahatma Gandhi

“The highest use of capital is not to make more money, but to make money do more for the betterment of life.”
Henry Ford

"This weak republic throws its pieces of paper about wildly in order to enable its main party functionaries ... to feed at the trough"
Adolf Hitler

The use of paper money has become ubiquitous in modern times and with the introduction of computers in the past few decades, society has become accustomed to the further abstraction of money in the form of pixels, a series of 0's and 1's to represent money. We all use our nations currency either the paper or electronic form, and have complete trust and faith in what it represents and it's intrinsic value. Is this blind faith in pieces of paper justified? As we have only grown up in a society whose main medium of exchange is the use of government currency, should we place an almost religious belief that it will always retain its value? We have recently had a meeting between the G20 countries, to co-ordinate agreements towards a global fiscal stimulus package. The Bank of England cut rates by 1.5% with the base rate now at 3%. The Federal Reserve is down to 1%, with other nations Central Banks following the trend. However if we go back 6 years, weren't the low interest rates the main cause of the monetary problems we are now facing? Why do politicians always seek lower interest rates and why do we have central banks that try and impose a broad monetary policy on all financial institutions in our economy? We have become accustomed to Central Banks, almost conditioned, into the fact that their very presence is essential for a functioning modern economy. Contrary to what Central Bank are supposed to do, that is fight inflation, they are actually a huge inflationary mechanism that create the moral hazard we are now seeing and continually told about.

Central Banks are the Moral Hazard

When Mervin King the Governor of the Bank of England makes statements regarding moral hazards towards banks, its like a drug dealer giving a lecture on drug abuse to a drug addict. Central Banks amplify the effects of the boom, by flooding private banks with cheep money at the beginning of the boom. When the boom turns to bust, Central Banks begin a program of propping up private banks as the private banks always know they can turn to the Central Bank when the bust materialises. If you can't picture a modern economy without a Central Bank, then America had no central bank from the 1830's right up until 1913, just as it was becoming the industrial power of the world. The current central bank is the third America has had in its short history as a nation and is owned and controlled primarily by private banks. It was set up with the intention not in ensuring financial stability but for the purpose of increased profits for the banks, so they could load up even more with peoples debts with less need for capital. In a true free market there wouldn't be need for a Central Bank. Private banks would obtain capital and lend on their own accords. The setting of interest rates is just the supply and demand mechanism banks use in order to encourage people to either save with them, or borrow from them. If a bank has a lot of money in reserve then it lowers interest rates to increase demand for loans. If they have low reserves then they raise interest rates in order to encourage people to save and increase their capital base.

These aggressive cuts that we are witnessing bear no relation to the above supply demand dynamics detailed above. Many countries, in particular western nations, have pitiful low capital levels and huge levels of debts. What needs to be done is at least a stabilisation in interest rates, however an increase is required in order to incentivize people to save thus allowing banks to re-capitalise, capital based on human labour that has already been done. Debt is the modern Political-Monetary illusion of wealth, however its all a magic act with the money being taken from future human labour. Having a Central bank trying to set interest rates for the whole financial system is an crude instrument for influencing private institutions monetary policy, similar to the communist state planned centralised economy. It will always be inefficient.

Marx on Capitalism

Karl Marx, the most famous anti-Capitalist symbol in history, stated that sooner or later Capitalism would drown its markets in goods. It could only survive by continually cutting prices and real wages of the workers to below the point of subsistence. With markets ever expanding the Europeans would eventually branch into Asia, with ever more goods being produced but eventually the people of the world would revolt under these conditions and the global socialist system would emerge. So why has this not happened yet? One of the main flaws of a centralised state planned economy is its neglect of a suitable pricing mechanism.

The Capitalist Pricing Mechanism

Free market economics uses the basic premise of supply and demand to drive markets. This creates a pricing mechanism that is used to divert capital and labour to the required sectors of the economy in order to obtain economic efficiency. I'm not saying that capitalism is a fine tuned, super efficient economic model, far from it, I'm sure there is some economic model that has yet to be invented that is far more socially responsible. However for this reason a free market, operating under the direction of individuals and capital obtained from labour that has already been performed, induces a system of great productivity and material gains. This whole system relies on no monopoly and no centralised institution controlling a specific sector. Central Banks are a monopoly that prevent these very market forces. They prevent capital being used wisely and labour being re-deployed and used efficiently. Interest rates should always be driven by private institutions all in competition with one another, all responsible for their business actions, with no inflationary engine waiting in the background to bail them out or other businesses for their irresponsible decisions. Accountability has all but been ignored within finance recently as the bonuses were rewarded for short term decisions that were never beneficial to the bank and society.

Without a sufficient pricing mechanism Eastern Europe's Communist block collapsed as the planned state economy could not allocate resources efficiently. After the early illusionary productive gains obtained under the Stalinist Regime with the use of forced labour (the infamous Gulag camps) the economy began to collapse. The 1980's saw Mikhail Gorbachev introduce Perestroika, a policy to try and introduce a more efficient pricing mechanism, however it was too late as inflation and product shortages had become widespread.

The Capital of Asia

The IMF have recently begun to show the strain and how little capital they have. A world body that is supposed to ensure stability and provide capital for nations in need of it has now begun turning to the Japanese for money. They are increasingly seeking funds not from Western nations, but from Asian Nation states. The reality of the current situation in the global economy is the G7 and the IMF have very little capital. The real countries that hold the capital are now in Asia. An assumption that the West are the rich is simply not true the way things stand. Asian countries with savings rates of anything between 20% and 40% are now the people with capital, the west with negative savings rates are the ones who are now in poverty, relying on the external capital flows from Asia. It's only our high levels of debt, our old infrastructure that gives the illusion of wealth. Why do you think people were given 125% mortgages? Why do you think everything was on credit with no one saving? Why did you think people could buy a whole street of houses, with no money down, just the supposed capital gains of previous acquisitions? It wasn't because we had entered a new frontier of Western superiority. Asians were giving us their Capital. Capital that they obtained by expending human effort to produce goods for us to consume. They gave us more capital so that we could continue loading up with more debt and buy more goods from them and they further increased their capital reserves, buying bigger stakes in our economies. Now the global downturn has come, Asian economies are being hit more and more, and this 'agreement' above is beginning to break down. Capital, instead of going West is now in retreat back to China or Japan. This is what happens when you rely too much on foreign capital to fund your consumption. This is why in particular the US and the UK need savings. Tomorrow always comes and with it real problems.

Sterling Collapse?

One such country who was greatly reliant on external capital was Britain. It tapped foreigners for their capital and used London as the driver for this financial utopia. Britain has the second largest external liabilities behind the US. Recently the Shadow Chancellor George Osbourne has come out and said a future sterling collapse could occur due to the unfunded borrowing of the Labour government. What became interesting was the reaction his comments evoked. Rather than dismiss it, opposition politicians have labelled it as "irresponsible" or "dangerous". I thought our politicians were supposed to challenge and offer conflicting views. If there is a run on the pound, there will be a run on the pound not because of what one man said, but because of fundamentals relating to the UK economy. If they continue with inflationary policies, deficits continue rising with little internal savings as foreigners sell their pounds then a run seems likely.

Helicopter Ben

Ben Bernanke the current Chairman of Americas Central Bank has dedicated an academic life to the study on the causes of the Great Depression. Two of his economic heroes are Milton Friedman and the latters wife, Anna Schwartz, who some four decades ago co-authored a landmark book entitled "A Monetary History of the United States", on which he based a lot of his ideas regarding the Great Depression. In a recent interview that Anna Schwartz gave she said Ben Bernanke was getting Fed policy wrong and the problem does not lie with liquidity or money supply. It lies with the toxic securities that Wall Street has created. Her comments regarding these were,

"Because you cannot sell them, you don't know what they're worth, your balance sheet is not credible, and the whole market seizes up."

She went on and said that Paulson and Bernanke have now prolonged the crisis,

"They should not be recapitalizing firms that should be shut down ... Firms that made wrong decisions should fail."

Central Banks are just a monopoly, and just like any other monopoly are desperately inefficient. They create huge distortions during the boom and prolong the bust, punishing the prudent among us and propping up institutions that should be liquidated to create a more efficient economy. Capitalism's "Creative Destruction" has been replaced with "Monetary Creation". He still believes we had the Great Depression because the Central Bank didn't print enough money. The reason we had the Great Depression are the reasons given in the quotes above.

Weimar Germany

"I do not believe a word of the silly stories that the German Government could be so bold or so mad as to engineer on purpose what will in the end be a great catastrophe for their own people."

The most recent example in modern Western history of a nation experiencing serious inflation and its destructive effects was Weimar Germany just after the First World War. After incurring substantial debts during the war and the imposition of further debts by the victor nations, the Reichbank pursued inflationary policies through persistent trade and budget deficits and the increase of government spending. All the European countries incurred substantial debts during the First World War, Britain had debts amounting to 136% of GDP but Britain avoided hyperinflation. Inflation was high, running at around 22% but nothing like Germany which witnessed people wheelbarrowing worthless Marks to burn as a source of fuel. The currency was destroyed by irresponsible fiscal and monetary policies, Britain chose debt service, while Germany ramped up the printing presses. Just before hyperinflation became evident Germany experienced deflation, with inflation dropping to 2% with the Mark rallying, just before its spectacular collapse. I warned in one of my previous posts that the media and institutions would begin warning about the misconceived notion of the dangers of deflation, and we are beginning to hear more about it with Gordon Brown now mentioning it. Deflation is a natural function of a free market. We are not going to get a true deflationary bust that would happen in a truly free market as governments and Central Banks are now pursuing inflationist policies similar to the above, with economies that ill equipped to weather the storm.

One of the main causes for the rise of National Socialism and Adolf Hitler was the hyperinflation caused by Weimar Republic contrary to the conventional emphasis placed towards anti-semitism and First World War grievances. It destroyed peoples savings, capital that people had laboured for their whole life vanished in a matter of months. Whether any Western nation will experience hyperinflation remains to be seen and one hopes not, but as economies shrink, debt increases, trade collapses, deficits rise and more people claim benefits, we have the conditions for at best, mild inflation.

The quote given above is a comment made by economist John Maynard Keynes in November 1921, who was an advisor and influential figure towards German economic policy during those fateful post war years. A person whose inflationary economic theories have become biblical in recent decades.

The Last Bubble?

Western Government Bonds are shaping up to be the next bubble in a very long line of bubbles, from the Dot Com Stock Market bubble, to the Real Estate bubble now government debt is beginning its exponential climb upwards. However if this does become a bubble and bursts, its effects will be felt very quickly and violently in the nations it occurs in. If there are no buyers for government debt, then interest rate will have to rise in order to attract capital, how high it all depends on if investors think the government is solvent. For years the US has abused the Dollars status of world reserve currency, building up many enemies throughout the world through its Imperialist policies. From the teachings of Sun Tzu in China, to the chess culture of Russia, they are all waiting for their opponent to self destruct or make continued mistakes.

A Sound Currency

Money is not a new concept, it has been around for millennium used as a means of exchange between people, a store of human labour or something people value. Empires have come and gone along with currencies too, but there is one that has withstood the test of time. Gold. In our modern western culture it has been associated with extravagance with no intrinsic value, however when we step outside our conditioned frame of mind that has been shaped by the environment we have grown up in it becomes something different. If you took an ounce of gold a thousand years ago, to an ounce of gold now its purchasing power would be more or less the same. Gold is a rare metal that can't be printed out of thin air like banknotes can. That's why it has always held its value throughout time, throughout the world. Older generations always remark that a penny today isn't worth what it was 50 years ago, however people don't seem to realise that this is due to the inflationist policies of the people who regulate our currencies. The reason why we have more money then we did at any other time in history, is not due to the fact that everyone has become richer, its because more of it has been printed. This is why we always experience inflationary periods throughout life, market forces are always deflationary as economic efficiencies are made from capital that is re-invested. Its politically popular to increase the money supply, to give a short term illusion of wealth or to try and pay off excessive debts. People make statements asking why value is placed in an archaic metal such as Gold or Silver, but never ask the right question, why a set value is placed in a piece of paper with pictures on it. History has always shown precious metals to uphold their value as a store of human labour. All modern fiat currencies have shown persistent devaluation over time, especially when debt is as high as now.

Will it Work?

The favourite phrase in the media over the past year has been "Will it Work?". New policies are implemented with the same question repeated over and over again, now with interest rates falling we are told this is the latest silver bullet. The real question should be what are we trying to solve? The Credit Crunch isn't the problem, its the cure. Its brought about an end to reckless lending, a recapitalisation of banks, a break on consumption, the re-balancing of the economy, yet "remedies" to the credit crunch are formulated as though it is the problem. The patient is sick and just as the doctor was about to administer the medicine the "I know better" parent with no medical training stepped in to provide the "real cure". By delaying the treatment the patient becomes worse, until eventually the patient is no longer ill but becomes terminally ill, beyond help. The pricing mechanism for capital has been distorted by the Central Banks and Governments. The end result could be disaster for nations with little or no capital.

Friday, 24 October 2008

Taxes and OPEC

"The hardest thing in the world to understand is the income tax."
Albert Einstein

"In this world nothing can be said to be certain, except death and taxes."
Benjamin Franklin

As the world descends into the synchronised Global recession, Keynesian fiscal policies are being used to try and counter market forces. Like pushing on a piece of string, our institutions and leaders will still not admit that we have been living in a bubble, and continue trying to spend money they don't have. Deficit spending has never worked and never will and government intervention has never worked either, but yet this is exactly what we are doing. Governments are increasing their debts, meaning more interest payments are being made to just cover the debt repayments. Money is being poured into overpriced assets such as finance and houses, rather than being spent on infrastructure, hospitals and schools. All this extra debt leads to one thing as time goes on - higher taxes. In my opinion this will happen. With the US presidential election taking place in a matter of days, both candidates are as clueless as each other of how to solve the current problems. Barack Obama is on a mission of change, one of redistributing wealth or to put it bluntly, he seems to be edging towards raising income taxes. In the UK, the pound is sinking and capital is fleeing, with the worst deficits since the Second World War, and coinciding with declining Oil and Gas revenues. The government should be cutting spending at times like these, however this is never a politically popular policy so they borrow. With further borrowing comes further taxation later.

One policy that made the Great Depression so Great, was when Hoover raised income taxes to try and fund the governments deficits. In my opinion we will see this again in the not too distant future. If we take the US for example, they have over $10 trillion of debt on the books, and around $50-$60 trillion of future liabilities, which will more likely increase as time goes on. You can't pay these vast numbers without tax increases, and this will put further strains on Western economies. Ireland and Spain boomed when they joined the EU as they benefited from the generous EU subsidies. Ireland in fact had their first housing boom in their history due to this extra income, but it was all a short term illusion. The Celtic tiger is due for a long decline, with emigration rather than immigration, occurring again. Spain too has issues, reliant on selling foreigners overpriced holiday homes. As air travel becomes more expensive over the years to come there will be further collapse. Italy has huge debts and is in complete denial. With a retirement age of 58, and a lethargic economy it is only being protected by its membership of the Euro. The UK after amounting huge debts, the biggest seen in the west proportionally per head, and with huge external liabilities seems to have run out of time. The plug could be pulled at any moment on any of these. IMF bailout talks have begun. Pakistan, Hungary and Iceland are a few, that have become unwound.

Increasing taxes are the worst thing a government can do during a downturn. This further compounds the problem, taking money out peoples pockets and thus the economy so the government can use it for their own inefficient consumption. If more taxes are implemented then expect very hard times indeed. I feel we have boxed ourselves into this position due to all the waste that has occurred over the previous years and we will have to pay more taxes, and I've been saying this for some time. They will either be taken from income or other indirect forms, or maybe a combination of the two. Governments will look to this to try and re-balance the books, rather than admitting the social system is too extended and cutting spending.

Income tax - Do we need it?

There are some people who feel that we shouldn't need to pay income tax at all. I always find this an interesting concept. Can you imagine getting all your salary with no tax deductions? We used to have no income tax in the UK a long time ago. It was in 1798 when William Pitt introduced income taxes in order to pay for the wars with France. This is essentially how it began. By Governments running up debts that they needed to fund, so turned to the working people to take some of their pay to subsidise their spending. So how could we survive without income taxes? Well we would use our newly untaxed income to pay for stuff ourselves, rather than the government spending our money for us. Schools and hospitals, for example, can function without the need for state systems. The best schools and hospitals are already private institutions. This system would in fact be incredibly efficient despite what people tell you that we need government. Income could be raised by taxing consumption, land etc. The working people who produce wealth for the economy, by expending energy should be the least taxed sector of the economy.

There is a problem with the above. It relies on people making the right decisions and being in control of their own lives. I and many others could manage our own affairs and ensure we had medical insurance and paid for schools etc. However a lot of people can't manage themselves, thus making the wrong decisions and taking the incorrect measures. A lot of people still need to be spoon fed and can not take responsibility for the actions.

OPEC and the Oil Barron's

OPEC have announced that they are going to cut supply and surprise, surprise, the uninformed governments and media have repeated the common mantra that the greedy cartel are responsible for high oil prices and they want the price to remain as high as possible. Nothing could be further from the truth. OPEC are simply trying to keep supply in line with demand and ensure a greater longevity in their oil fields. If they kept forcefully pumping their oil fields the way they have been, oil supplies would collapse within the next decade inducing worldwide collapse and a breakdown of society worse than anyone could imagine. Over pumping a field leads to a steeper decline, the best examples are the Russia's fields which during the eighties the Russians began overproducing them as it was the only way to get hard currency to support the collapsing Communist system. The curve of these fields is a very sharp increase in production, followed by an equally sharp decrease in decline as the field becomes depleted. Contrast that with the fields in Norway that have been well maintained and gradually extracted, the production gradually ramps up and peaks but the decline is gradual and thus the field yields more oil in the long run.

Saudi Arabia the worlds biggest oil producer have already damaged their oil fields, with various technical issues being reported by the Saudi Aramco engineers over time, as early as the sixties and seventies. During the oil spikes in the seventies Saudi Arabia ramped up production to cover the short term shortfall to ensure the west didn't enter a terrible depression, or try and find alternatives. Oil fuels Saudi Arabia's economy along with other OPEC members economies. The last thing they want to do is send the price sky high, thus destroying world economies with economic collapse and destroying their number one export industry. They are simply hinting to the world that this once abundant resource has ceased to be cheep and abundant. It is becoming increasingly hard to extract and more energy is required to get the remaining oil. High hydrocarbon prices are here to stay and countries need to adapt and accept this fact.

It's also amusing when the media mentions that the oil companies are making obscene profits, at the expense of the public. Again its all uninformed dribble, something that has become common in modern journalism (read any of John Pilgers work as he details the decline of journalism, I would personally recommend Heroes as a starting point). For a start oil companies are public listed companies. If they make huge profits profits, compared with other stocks then buy shares in them and reap the dividends. However there is nothing stellar in that aspect and they are like any other tradable company. Profits for big oil companies seem huge, but this is only because they work in huge volumes of the product they sell. Compared with other industries, oil companies actually work on lower margins. Oil company share prices are based more on their oil reserves rather than their profits, as a company without oil has a pretty weak business model, hence the fairly recent fiasco with Shell. The fact that oil is so volatile in price compounds their problem, which brings me onto the next issue of the recent oil price collapse.

This price collapse was to be expected. As with all markets, speculators got involved and drove the price of oil too high and subsequently as oil is bought in 6 month futures contracts these positions were unwound as the delivery date got closer. I predicted to my dad a few months ago that I thought they would fall to around $70-$80 a barrel, with them now around $67 so a tad below. I don't know how low they will fall or when they will begin to rise again, I'll leave that to the technical analysts amongst us. I like to focus on the fundamentals as short term markets behave irrationally, and $67 is cheap. While the public think this is great news, this is in fact setting up a future disaster in the next few years. Future oil projects are being cancelled as the price has collapsed, which means lower oil production for the future which will lead to a greater oil price spike. Projects that were producing, are now being shut down as the oil price has dropped below economic viability recently. It's not like setting up an Internet company. Getting oil projects set up along with the distribution network takes time, years in fact. That's why the looming crisis has the potential to be catastrophic. When it will hit I don't no. If the world collapses then never, but I think the world will go on and continue to grow. The above applies to all commodities. Similar projects are being cancelled as prices drop and projects become less commercially viable. The lack of credit compounds the problem too as money is not available to finance these projects.

I will end with a graph that I found regarding world oil production and projected demand. As can be seen, there's been no substantial increase for the past few years. If the predictions are to be followed as detailed on the graph have a look at how the population demand increases as supply keeps declining. It looks pretty scary 5-10 years from now, just when the next boom should begin. We may be looking at a complete disruption of the business cycle for years to come until we adapt the way we use energy.

Sunday, 12 October 2008

The Run on the Global Financial System

The systematic liquidation of the financial system has truly gripped the worlds attention this week, as fear has spread to all facets of society. Global Stock markets have been crashing. As prices fall, margin calls are being made ensuring further deleveraging of positions. Comparisons with the Great Depression have become widespread in the mainstream media. World leaders and Central Banks have been meeting to try solve the issues, with co-ordinated interest rate cuts and monetary packages. Iceland, a whole country, is on the verge of collapse. Citizens everywhere have been withdrawing savings from banks, feeling safer holding cash themselves. Physical precious metal dealers are running out of gold and silver. The American mint has stopped issuing certain gold coins. All assets are in free fall with no place to go, apart from cash. Libor is rising, the Fed's balance sheet has exploded, talk of the CDS meltdown has begun as positions at Lehman, the recently collapsed investment bank, are unwound. The US debt clock in New York has run out of digits. The UK has part nationalised it's remaining banking system, after the full nationalisations of Bradford and Bingley and Northern Rock. If the general public didn't realise the severity of the situation before, they do now, after a week of paralysis and sheer terror caused by decades of high finance prominence, as savings and production were side lined for the new age. The public will pay dearly for the misallocation of capital, the loss of private savings and the end of cheap energy in the years to come. To illustrate what an unusual week it was, we saw Gordon Brown making banking jokes. It was a week of many surprises.

The years to come will be more of the same with many mini crisis to come. And in times of crisis, history has always shown there is great change. Politicians and governments always intervene in a panic stricken manner when all around them seems to be crashing and failing. Emergency laws are enacted for the 'good' of the nation. Normality of the past, has been replaced with the normality of the foreseeable future. This brings me to the point of what could possibly happen over the next decade. There are many interesting and viable possibilities that could occur and I will explain my thoughts on what actions could be taken, in order to try and stem the future crisis that will take place.

  • Confiscation of gold is more than plausible or the suspension of moving from paper assets into gold and silver. Precious metals are always seen as a safe haven when finance is in trouble. As the mistrust of paper based money becomes more prevalent after years of financial incompetence, people will start looking for tangible assets, ones outside the system. It would be an irrational decision and make no sense, but our leaders always seem to endorse those types of ideas.

  • I still believe in inflation in medium to long term. Prices may be falling currently but this is deleveraging not deflation. The governments and authorities are embarking on the great reflation, slashing interest rates, pumping future earnings into the system. Therefore I can see certain key commodities becoming very expensive and price controls at some point seem likely. Of course an idiotic policy, but they did it in the seventies.

  • Rationing is also a policy I can see been implemented at some point in the future. Food and energy rationing may become standard.

  • Further nationalisation of the system. The banks are gradually relying heavily on governments, but it won't stop in the finance sector. You will probably see airlines, car makers, other key industries handing out the begging bowl for government intervention. If we begin drinking vodka and producing fine cigars, then we know we really are in trouble.

  • Higher taxes sometime in the future are inevitable in my opinion. We are accumulating huge amounts of debt, more future promises to pay based on future earnings, with no current capital now. Western governments can't manage the books, and were running deficits well before the slowdown in the global economy. All of these future earnings may be severely impeded by our ageing populations and the end of cheap energy. I think Colin Campbell, a prominent proponent on the peaking of Oil, summarises it well in a speech he gave to Parliament in 2004 about the coming oil depletion, where only 3 MEPs bothered turning up.

    "The perception of looming decline may be worse than the decline itself. There will be panic. The market over-reacts to even small imbalances. Prices are set to soar in the absense of spare capacity until demand is cut by recessions. We will enter a volatile epoch of price shocks and recessions in increasingly vicious circles. A stock market crash is inevitable."

    And this from a geologist, someone not specialised in the details of economics and finance.

  • Further government borrowing will have further consequences on how much money our governments can keep borrowing, and if they can find a buyer. As Robert Preston, a mainstream journalist states:

    "Possibly the biggest risk for the US is that in bailing out the finances of the private sector, Paulson would dent international investors' confidence in the American government's balance sheet - which could ultimately undermine the dollar, push up inflation even more and raise the cost of servicing debt for the US authorities."

    What happens if the Saudis, Japanese and Chinese don't want to keep lending money to the West? We have little capital in our own societies. The prices of government bonds will go up, as investors suddenly realise certain institutions have no intent on making good on their promises as the currency devalues further.

  • Interest rate cuts have been used progressively over the past year. The trend will continue. They will fight the inflationary boom, that has just occurred, with more inflationist policies during the bust. Don't expect to be living on easy street though. Debt is far too high and the last thing banks are thinking about are more risky loans, just as defaults are rising and capital is being destroyed at a rapid rate.

  • I heard recently that bonuses in the city this year are due to decline 60-70% this year. As I have said in a previous post, finance will be in big decline for years to come. The age of excessive rewards are over, and in my opinion finance will become a middle earning job, with places like New York and London, that were heavily reliant on high finance to be in a state of terminal decline. For how long who knows. We may have seen a top, for the rest of our life times.

  • It may be all hands to the pump, co-ordinated action, on the current events, but this may turn as time goes on. Protectionist policies and the hoarding of certain assets will become more and more common between countries.

  • Regarding the above, if the flight of investors from certain countries does occur then governments may freeze assets to try and keep them within their borders, enacting emergency laws.

  • Wars regarding resources are bound to become more prominent. We have already had the invasion of Iraq and Afghanistan, which was the establishment of a middle east police station for the West. With more shortages to come, these areas will be of critical importance to many economies, with countries organising themselves into coalitions. China has already been in agreements with Venezuela regarding Oil supplies to name one of many relationships that are being formed. Water will become more important, with the potential for conflict between Israel and Palestine, Pakistan and India to name a couple. The Twentieth Century was the most bloody Century in human history, with the second half involving more deaths. I expect the first half of the twenty first century to continue this trend and be even more bloody, although I do hope I'm wrong on this point.
I suspect there will be a rally in the markets next week. The governments should be able to calm investors fears in the short term. More runs and panics will happen over the following years. With these events will come great changes. We are all in uncharted waters. Governments have the buckets at hand, but will it be enough to save the sinking ship? Or is the ship destined to sink as the damage done so far, is irreversible?

Saturday, 4 October 2008

Buying is Dead Money

It has been widely assumed for years now that renting a property is a waste of money, or what has become known as dead money. For years now I have rented, moving from property to property, one end of the country to another, and I have never understood the saying of 'dead money'. How can paying for a living space be dead money? I mean, I pay rent to the owner of the property, who then provides me with a house to live in. He maintains all the upkeep, insurance, wear and tear and I get to live in a fully furnished property. Now that property prices are completely collapsing, along with the overinflated UK economy, I can view the events occurring with no worry or stress, in fact with enjoyment as I watch an interesting chapter in human history unfold. I have no huge debt. If I need to move for another job I can relocate within a month or two. If I wish to move into a larger place I can do so. Renting, during a downturn like the one we are about to go through is anything but dead money. It's money well spent and let me break down some of the 'home ownership' myths that have been falsely put forward in the age of stupidity.

  • The first one, and I always enjoy hearing this, which reveals the majority of peoples financial illiteracy, is rental payments are dead money as opposed to paying a mortgage. For the type of properties I rent in order to buy them in the past couple of years the interest payments on the mortgage would have been larger than the rent I paid. Now if I actually wanted some sort of payment plan, then it would have obviously cost a lot more, in fact all my wages pretty much. Then of course if I miss payments on a mortgage persistently I risk having the property repossessed and of course obtaining a terrible credit rating, with the bank chasing me for years to come. If I miss a rental payment persistently, the landlord will eventually be able to evict me, but I have no bad credit rating, no legal proceedings. I just have a bad reference, in which case you just don't use for your next property as most landlords are desperate for tenants.

  • Rents will rise and mortgage costs will drop. This is the complete opposite of what will happen over the next few years. As credit becomes tighter and banks try to repair their balance sheets they will seek to deter borrowing and encourage saving. Therefore mortgages will be more more expensive. If I did buy in the last couple of years I would have needed to get a huge adjustable mortgage which would have been in negative equity by the time re-mortgaging came around therefore I would be paying the much higher adjusted rate. I feel sorry for a lot of people in this position who will have to pay a lot more in the years to come, especially when they see rents falling. Despite what the 'experts' say (the same people that were telling you the sound fundamentals of the economy, when I was telling you they were lying), rents will come down, in fact they already are. People are emigrating, moving back in with relatives as jobs are lost and so on, meaning less demand for rentals. This is how it always works in economic downturns.

  • I have no upkeep costs of the properties I live in. If the boiler breaks down, I don't pay a penny, and its the landlord who is responsible. Washing machine breaks? No worries, my landlords wallet can pick that one up. Fancy a change of decor? Rather than buy a load of tat with the stress of getting it and building it, I can go find a house that is furnished to more of my tastes (if I was interested in that kind of thing).

  • In the event I loose my job, I simply give my landlord two months notice and leave. Go back with the parents what ever I want. I can walk away, intact and with money still in the bank.

  • The savings I have acquired so far I can put into savings accounts that will earn interest. If this money was put into a deposit a couple of years ago, it would have long been eaten away by the price drops of the past year.
Point is, I'm comfortable and happy renting, and for some reason for the past decade, in particular in the UK and the US if you rent you are almost seen as a second class citizen. The sad thing is, people are still trying to buy property now, thinking because it has dropped 10-20% it is somehow a bargain. People are still viewing property through the tinted glasses of a way to get rich. In reality the equity they will have will be shortly wiped out in the next few years and will not be recovered for decades. The collapse of Bradford and Bingley should completely topple BTL owners and it will bring about even more drops to come, along with the rising unemployment and government budget deficits. Despite the deteriorating state of the economy people are still talking about a bottom on property. A bottom will appear when everyone stops talking about a bottom. It will happen when people have become weary of debt, governments and banks. It will happen when mortgages are far cheaper than rents, and sizable deposits are required, with banks lending to prudent standards once more. It will happen when people have lost their 'pensions' in BTL and say there is no money in property and only a fool would buy now. It will happen when people say, buying is dead money.

Turning to the Bailout

The situation is quite clearly going from bad to worse. I said that the governments and institutions of the world would try and prop the economy up, and this would only make things worse. It's no suprise that the $700 Billion Bailout package has passed on the second attempt. Since the post war period, Western economists and leaders have become drilled in Keynesian economics, a tragic and false theory whereby governments should become active in fiscal stimulus activities during recessionary periods, with the discouragement of saving and encouragment of consumption. I mean it defies logic when you think about it, and its what is occurring at this very moment. We've just had the biggest consumer boom and spending spree, well ever. According to John Maynard Keynes whose theories our leaders are trying to follow, we should be increasing spending and government intervention, trying to prop up the very excesses that were caused during the boom. House prices are too expensive, therefore we throw money at the problem, which is a waste of resources and goes against the very market forces that demand the correction. What the market at the moment is saying, is that we have too much debt in society too little savings and are not producing any real value in the economy due to all the mal investment that has occurred. Therefore prices in certain areas need to fall and fall fast in order to bring about a normalisation to the economy. All good economists recognise the recession is the good part of the business cycle, and at the end of one the economy is returned to a state of optimal efficiency. The media and mainstream 'experts' however, have made economic contractions into something that should be avoided at all costs, even if it induces a worse recession in the end. Its all scaremongering, just like terrorism, rather than looking at causes and reasoning as to why the terrorism was created in the first place. It's how institutions always control people. Religion, for example Christianity, does this by giving the concept of 'hell', a place where people go if they don't conform with convention and ask questions.

This bailout package won't be the last. It's just the foot in the door. There will be more, with politicians proclaiming it needs to be carried out in order to save the system from collapse, when in reality the problems are compounding further, with the endgame of a worse collapse. Government deficits are increasing along with debts, while savings are being depleted further, thus the fundamentals are continually getting worse. I was hopeful we may let the bust proceed but as ever the powers that be have decided to prolong the bust and ensure that we experience the worst recession any of us have ever seen. We are entering a period of great change, as we pass the opening chapter of many chapters to come.