Sunday, 18 July 2010

UK Housing Market Crash, Its a Marathon not a sprint

"PricewaterhouseCoopers said there was a 70pc chance that British house prices would be below peak 2007 levels in 2015 in real terms, despite a continued expected recovery in prices in cash terms – in other words any rise in property prices won't keep pace with inflation. ... Even in 2020, after five years of predicted relatively steady growth, the accountants warned there is a 50pc chance that "real" house prices would be below 2007 levels."
A recent PwC report on UK House Prices

The beloved British property bubble has recently looked shaky once more. QE has come to a short term end, political talk of fiscal austerity, interest rates with only one way to go and a Government who are fast running out of money. There are no fundamentals supporting the recent dead cat bounce in the UK's property market. Many still believe that you can't go wrong with property, that its business as usual with never ending positive returns from the value of their land, but the coming decade will smash all those myths with a bear market that will endure for a whole generation. If market forces were allowed to play out we would have had the housing market crash, we would have had the 50-60% falls but with modern Government its never a quick sprint, it always becomes a drawn out marathon.

Over the long term as I have mentioned the value of the land (or houses as people commonly mistake) goes nowhere (Of course the free markets lowering of many consumer goods means assets can indeed buy more consumable goods in the future. It's one of the reasons the rich always get richer with our current monetary system). Its the depreciation of the value of our currency that provides this illusion. Don't believe me? Take a look at the chart of gold to house price ratio in the UK. 

The target area is not my illustration but obviously someone who predicts rising gold prices relative to houses. The chart is probably not quite up to date, but it displays the important historical ratio of how many ounces of gold it takes to buy a house. The chart illustrate some important historical changes notably 1971 when Bretton Woods - the fixing of many Western currencies to the dollar which in turn was pegged to gold - collapsed. Through the 50's and 60's house prices seemed to rise relative to gold, but this is because the fixed price masked the real price a free market would have determined for Gold. After 1971 when the price was liberated the value of houses to gold indeed fell greatly. This is during a time of great inflation, generally rising house prices in Sterling - but the key thing is they may have been rising but not in real terms. Then came the 80's, 90's and 00's - a historical unprecedented credit boom based on pure fiat money with no restraint. Free markets did their job and lowered prices of consumer goods, the authorities reaction - expand the money supply to counteract this based on their flawed central planning metrics. It reached a peak of over 500 ounces of gold to buy the average house, but this is where the illusion stopped and gravity would take hold once more.

Record low interest rates, huge private debt levels, trade and budget deficits, a Government fast running out of money and bullets there is only one way for this asset and thats down. 

The bigger problem I see is - we haven't liquidated any this debt - we haven't de-leveraged! Politicians like to proclaim that our public sector debt is low (however its now exceeding and growing at a faster rate than our peer nations) but forget to mention our private debt levels. They are astronomical compared with other Western Nations. We borrow huge amounts of money from the Russians, the Saudis, the Chinese, or owe it to ourselves and we dig further into debt to buy overpriced assets such as houses in order to fund short term consumption. We kid ourselves into thinking we can do this by becoming a financial centre but in reality it's just a ponzi scheme under the hood. We borrow huge amounts of money, spend this money through the economy, which in turn drives the City of London which packages all this money up and in turn we kid ourselves into thinking we have a sound economy. Of course it will all come crashing down with disastrous consequences. The world will not look kindly on us when we can't pay our way without turning to the printing press. 

These private debts are weighing down on the economy and will stagnate growth for many years to come. Unlike other nations who are in the Euro we have our own currency. Worryingly 99.9% of economists seem to think devaluation and money printing are the way out, but this will only compound the troubles. This will in turn drive interest rates ever higher over the long term, ultimately making it harder to service our debts, that the Government are obsessed with not liquidating just like Japan's politicians 20 years ago. 

People naively think inflation is great for high debts, but again they forget that goods and services rise under such conditions. Serving debt may become more expensive but what happens when the price of energy or food rises beyond pay inflation like what is happening now here in the UK? People struggle further opting for present consumption or living costs over future investments. Inflation erodes our existing capital and savings or drives it out of the country, just like what is happening now with negative saving rates. Society doesn't invest in capital goods (tools, for example computers, machines, roads) as it needs ever more resources in the present time to stand still. Societies prosperity relies on the capital structure, put simply the access each generation has to tools. I have higher living standard than my grandfather as I have more tools at my disposal. University, the Internet, a computer and so forth. When Governments inflate they give people pay cuts instead of allowing the capital structure to adjust. Companies accept this as a solution but in reality we get less productive as tools or innovation are deemed surplus to requirements over the short term. To an Austrian economist all of this makes perfect sense, but to the many it will only become clear once the process occurs. Then it will make perfect sense to all.

The Spanish are another country with similar issues to the UK. They also have a lower public debt compared to others, but their private debts are relatively large. They also try and prop up their zombie banks and prevent liquidation. The US on the other hand leads the western world in this aspect. Who was the nation writing off all these bed debts? People viewed the sub-prime fiasco that the US was becoming the basket case of the world but in fact they are ahead of the curve, indeed ahead of Europe that's for sure. The value of their houses have already fallen around 25-30% but their bubble was no where near as bad as others such as the UK. They don't have as much private debt as the UK. And despite talk of manufacturing decline, who produces some of the most innovative and high tech products in the World? The US. I'm bullish on the US relative to other nations. I'm wouldn't invest there, which tells you the trouble the world is in.

For example Apple is a marketing machine, with a whole fanatical legion of followers. They make their hardware in China buts its in their product design, software, marketing - the creative economy - that provides the real income. The UK would be lucky to have the same clout, but we don't. Sure we have small to mid size innovative companies which I take my hat off to who do a great job, but we have no Googles or Microsofts. All US based with their profits going back to their home country. 

My employment record is great illustration of the UK's problem. I currently work for a large Japanese based firm, prior to that a large American Services Company. I've worked for 3 UK based organisations. A UK government backed learning centre called the Open University, a car sales company called Reg Vardy who sell cars made by companies based in France, Germany, Japan the US - basically anywhere but the UK and a telecommunications company who sold German telephone equipment made by Siemens and photocopying products made by Cannon a Japanese imaging specialist.

Where are the large British companies? This is the problem - I agree with letting foreign companies and expertise come in - this increases all of our living standards. But it can only do so much. We will never be able to maintain the illusion we have made for ourselves under the current framework of more debt, more sales, more jobs based on this debt, rising assets based on this 'prosperity' with the cycle going full loop. It doesn't matter if its tangible or intangible - we only seem to be able to sell others products to ourselves by increasing our short term consumption debts. We make an excellent nation of salesman and people who get into huge debts but at some point in the future others will demand payment and stop lending at which point we will come short. 

The values of these such debts are tied in many places to assets such as houses. The government can not dampen or assist in this rebalancing process, all they can do is make the imbalances worse like they are doing now. By enforcing the cycle listed above. People like to think this is different to the seventies.

Back in the seventies we propped up manufacturing, car makers, our steal works etc. This was despite the fact that others around the globe were doing it cheaper and better. Then Thatcher came in and changed all this. She stopped propping up these type of jobs. Of course unemployment went through the roof as it takes time for the private sector to create sustainable jobs that were competitive in the global marketplace. In our present time replace factory worker or coalminers with estate agents or beauty therapists. Same problems just different unsustainable lines of work.  Sure we may have a need for such people but not on the sheer scale we have them now. That's the simple fact why for example estate agents haven't been hit as hard as they should have been. Low interest rates and printed money have supported the assets that they sell. The government has in fact given many of these lines of work a bailout, by ensuring the debt economy and imbalances can continue. 

People don't understand when you try and put all this into context - the unsustainablity of the debt we amass. Business as usual, I don't know how you will afford to buy if you don't buy now and so forth - as though this exponential debt boom can continue. "Surely the Government will turn to negative interest rates or the Government won't allow the prices to fall". Everyone misses the real crisis to come when the Government has no more bullets, they will no longer have control of circumstances and events will dictate policy. Greece may have been removed from red alert but the solution was just more of the same - more debt for all to bail the Greeks out. Economic gravity will take hold - you can't escape it. 

The illusion still seems real to people. Like a magician Derren Brown or David Blaine who kid people into believe that they are performing an art form or something that is indeed beyond the realms of magic but they are just the same as Paul Daniels - it's a trick that has been handed down through the generations only with their modern twists on such acts. The Gold ratio of house prices illustrates that house prices are just an illusion over history. Its the decline of the purchasing power of our governments monopoly over our money that provides the magic trick. The magic act has many more years to run.

Saturday, 3 July 2010

Cuts, its never that easy

Margaret Thatcher, Conservative party Conference, 1980

The subsequent 5 years resulted in unemployment doubling in the UK after this speech. After years of kicking the can a politician eventually got a grip making Britain competitive in the global market place once more. It wasn't easy. It wasn't pretty. It wasn't sadistic. In fact it was political suicide but Maggie held her nerve. 

Talks about public sector cuts with Prime Minister Cameron claiming that not only will the private sector take up the slack within his term - but actually there will be more jobs is ludicrous. Just as I expected, within a month of power I can see David Cameron is no Maggie. The Tories talk the talk, declare swaggering budget cuts but its all soundbites. Clegg, his coalition buddy, meanwhile states that "this won't be like Thatcher, we will do it differently", contradicting the recent budget given by George Osbourne which is much worse than anything Geoffrey Howe had to administer. 

There is no chance the Conservatives will be able to do what they state - they don't even have a majority government which is based on a shaky coalition. Even if they did it will take longer than a term. Back when Thatcher was in office, at the 1983 election unemployment was still rising (setting post war records), the pound was dropping like a rock and the economy was still in taters. It took well into her second term to see the effects of her earlier policies. 

The idea that the private sector will take up the slack is just political wordplay. Its takes years for these things to change, a change in peoples will, a change in peoples expectations. People expect the UK bubble to carry on. So until reality kicks in, people will want the politicians to maintain the mirage which will mean its the market that has to force the people into the correct line of thinking, just like it did with Thatcher. We are a way off this so Mr Cameron will play kick the can down the road until this moment.

What factors are different this time? For one Cameron has to contend with a stronger opposition, and competent at that. People didn't necessarily like Thatcher back in the early eighties, but they couldn't stand Michael Foot and Labour who had increasingly moved so far left they were within touching distance of Joe Stalin and Mao. It was the oppositions weakness that helped Thatcher pursue what she did. Labour was so broken, the party splintered creating the SDP which ripped its support base in two. Thatcher could have campaigned with Adolf Hitler as her minister for for Justice - she still would have won a landslide back in '83. 

Thatcher also had a majority from 1979 unlike the current government. You try and reduce public spending you have another recession. We've only just emerged from the worst depression since the all-mighty one back in the 1930's. People won't warm to this. Then the budget deficit gets bigger. It did with Thatcher - it will do the same for Cameron if this is the path he takes. This would bring into question with the public the competence of the Tories with the economic policies they are pursuing. I know and you probably know that its the right path to take but many who are told the Keynesian way of thinking will not see it that way. 

The Unions are coming, North Sea Oil and Gas is running drier by the day and higher interest rates are inevitable over the next decade. We haven't liquidated anything - just like the Japanese during their lost decade we have propped up the banks and ensured zombie loans are kept afloat. Like a junkie we tell everyone we are good for it - we just need more time. But time is our worst enemy.

The problem with the current coalition is how long will it last with cuts on the agenda? The Tories may be historically comfortable in this setting but how many grass root Lib Dem supporters are going to swallow the medicine? Defection of many to Labour is inevitable. And remember - "things were going 'well' under Brown". This could cast the Tories in the wilderness for a decade if they practice what they preach. There's only so long you came blame the previous government for the mess. Give it a year and people won't be seeing Labour mess but will instead switch their view to Tory mess. Just like Thatcher. People forgot the Labour mess in the 70's, they just remember the early eighties.

The G8 or now the more relevant force the G20, have been putting austerity on the agenda. I think a basic illustration of economics is required to contrast spend and stimulus versus austerity, using the classic economic Crusoe example (there has been many takes on this over the years). Peter Schiff gives an excellent example in his latest book which I will list below. 

If we imagine a desert island with three people. These people all catch fish in order to survive and feed themselves. The problem is they have to use their hands, which is very time consuming so they spend all their time catching fish to live. However one day, one person decides to build a net. He spends a day constructing this, therefore foregoing current consumption and going with no food for that day. He is the entrepreneur within this small community and doesn't know if his endeavour will succeed. For the sake of argument his net is a success and he is now able to catch more fish in less time. So much so that he now has more leisure time and can eat more, thus consuming more. 

A simple example but it perfectly illustrates elementary economics. The current Keynesian thinking is that postponement of consumption is a bad thing but yet as we saw above this was in fact good. It is how society accumulates capital goods, tools, that enable us to enhance our productivity. Savings - the foregoing consumption should be embraced not deterred. The entrepreneurs risk taking has also benefited everyone. We should reward those who figure our how to do things more productively or cost effective, we all benefit over the long term. 

You see our recent solution was for the government to spend more, to destroy capital, to expropriate wealth from individuals. Raising taxes, printing money, raising deficits will never solve the economic question. Just like state planning never did. All it does is take away the net from the individual, remove incentives for innovations such as the net and encourage us to consume more rather than increase our productive capabilities. If the net breaks we can leave it and continue consuming our way out of trouble. That's why no amount of Paul Krugman stimulus will ever be enough because its the wrong thinking in the first place. He is saying we need to run faster just to stay still. I say we need to be leaner and think smarter to run just as fast only this time at a stroll.

The video of Thatcher at the start was right. However the left always like to use slogans of themselves such as compassionate, open, fairness, yet when an individual states they support the Conservatives they are ironically labelled Tory scum - and for what? Thatcher put us back in the global marketplace. She embraced Asia's awakening which enables us to buy many consumer goods for practically nothing. We moved out of mines with many of us into flexible workplaces, hours that suit us, working from home in relative luxury compared to how our ancestors had to work. The fact is the left still can't swallow the reality that Thatcher destroyed their ideological way of thinking in this country. John McDonnell's unwise words regarding wishing to assassinate her was not for her policies but rather that people like himself have no place in politics where 30 years ago they were everywhere in parliament. Was it nice that people had no jobs back during the early eighties? No, but this is the problem with statist elites. They cause the problems, blame markets, then ironically when things get that bad look to markets once more to solve the mess they made in the first instance. We still seem to be looking for state solutions. We have recently had hard talk, yes. But talk is cheap, when action is taken then the backtracking towards Keynes once more will commence.