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.

The Children's Budget

"I shake my head in despair. As the Chancellor faces a terrible fiscal position no one outside the Treasury will believe the forecasts. When I saw the public spending plans I nearly fell off my chair"
Michael Saunders, chief UK economist at Citigroup

"The increase in debt servicing costs alone will be between £35bn and £47bn per year in 2008 money. That is more than the annual transport budget. It is about the same as the entire annual defence budget, and about half the annual education budget."
Danny Gabay, head of Fathom Consulting


In 1909 David Lloyd George, Chancellor of the Exchequer, delivered what became known as the Peoples Budget. It's primary aim was to raise taxes on the rich in an attempt to redistribute wealth within society, which in its day was a historical and radical set of measures. One Hundred years later, Alistair Darling delivered another historic budget, however it was under quite different circumstances. With finances spiralling out of control and a country heading for the worst post war recession, there was no room for social justice. Again a Labour government had spent too much. History will judge it as the Children's Budget.

The repetition of all the budgets figures are not required here, suffice to say the numbers are truly horrendous given the optimistic forecasts the government has used. Some of the areas of worry are:

Future Economic Growth
We are in the midst of the worst recession any living person would have experienced. Looking back at history when events like this happen, economies take years or a decade or more to recover from these credit excesses. The growth projections given yesterday were lies. Not even Mr Darling believed them. The idea that the economy will grow at the end of the year, and be in the thick of a new boom within a couple of years is nonsense. The economy will continue its decline for this year and the next. If there is any recovery after - which this author does not believe - it will be weak at best. Not 3.5% growth. The IMF have recently projected -4.1% and -0.6% growth for the next two years, however they are still playing catch up and their projections have always been wrong. Expect further revisions to these numbers.

Peaking of Debt levels
The government claims that debt will peak at around 80% and again it is more lies, and the markets know it too. It will go much higher. For readers of this blog you will also be aware that this is only the official debt figure. There's many off book debts to come, just at the time they claim debt will peak.

Deficits turning to surpluses?
In order to try and pay the debt back the government needs to be running budget surpluses. Estimates again, state that the deficit will drop below the £100B mark around 2013/2014 with the admission that it may take a decade to balance the books - to just break even. Then we get to the point where we need to be running surpluses to pay for all this debt. We can let our children worry about that. Whose going to fund all this? Isn't global capital low, with the high saving nations in Asia enacting their own stimulus plans? The main buyers of Government bonds have been foreign buyers but for how long?

All of the above is based on government estimates. Estimates that will prove to be as wrong as the estimates of 2008, or the ones in 2007 and so on. There were no proposals to try and balance these figures, which is to be expected as the election looms with unpopular decisions being put back. However the longer the government postpone action, the worse the hardship will be. By not creating a credible framework for balancing the books the risk of further gilt strikes are inevitable. David Cameron again had no polices that would attempt to rectify the perilous position as he follows the focus group discussions not wishing to disturb his poll leads, sending signals to investors that Britain has no intention of paying its creditors back.

The budget was full of contradictions. We had the various environment measures for wind power and then there were incentives to build more Coal power plants along with tax breaks for Oil and Gas. They announced they will pay people to buy new cars, which is in effect throwing money away. We may as well employ some people to dig holes and another set of people to fill them in, rather than subsidise car purchases - at least it will keep the unemployment figures down. If double glazing sales start dropping is the government going to pay people to smash windows in order to create artificial demand? There was extra money for the Job Centre network, when the job market is shrinking. A scheme to back mortgage backed securities, dead assets, further preventing liquidation that is needed in order to bring about the recovery Darling mentions. However the biggest move was an introduction of a new high income tax.

The 50% rate of tax was welcomed by many - "get the rich, they got us in this mess" as many will say. However readers of this blog will be aware it is government that got us in this mess. Unsound money, central planning price stability created huge distortions in the economy. However this tax increase is just a foot in the door. We will all be paying much more in tax in the coming years like I have previously mentioned - crushing any recovery for a generation or more. It was the increase in income tax by Herbert Hoover and then Franklin Roosevelt that assisted in the prolongation of the great depression. By hitting wealth we are also sending a signal to the rest of the world, that if you work hard in the UK we will confiscate your earnings. Suggestions of a brain drain has begun before any of the real hardship has even started. Before our boomers begin to retire. Before we run out of cheap energy. Before printing money has had its full ruiness effects and so on. It also marks a further nail in the coffin for the city of London as a financial center of the world.

With the above there is no hope of retaining quick growth again. By taxing the entrepreneurs who create jobs and wealth for us all we are further impoverishing ourselves. Then there's the point will they pay? There could be a negative effect with more people looking to avoid the tax. Tax revenues could actually fall, as less jobs are created as successful business leaders and entrepreneurs wonder what will happen next. The IFS has recently supported this claim, however I don't think they appreciate the full damage of a policy such as this.

Healy or Howe?

There were discussions about if the increase in income taxes represents a return to Old Labour, or if the cuts to come in spending represent a return to Thatcherite economics. We are a long way from Old Labour 83% high tax brackets, but we are heading in the same dangerous direction. Then there's the myth of the supposed Thatcher Monetarism economics that prevailed during the eighties. Government spending barely moved during her time as prime minister. Standing at around 42.5% in 1977/78, it was 41.7% ten years later. She actually spent more than Ted Heath and Harold Wilson as spending on government rose 32% in real terms through the eighties credit boom. Thatcher kept this fact quiet as she prided herself on the illusion of getting government out of the way, controlling the money supply, the Milton Friedman philosophy. In Milton Friedman's later life he would be critical of the governments and central banks who inflated in his name, rejecting his original ideas that they could be trusted to control the money supply. The Austrian Economists always told him governments could never be trusted. Nevertheless taxes and unprecedented public spending cuts will be required - both of which we have never experienced in tandem. We will need more substantial cuts then just "savings efficiencies" to balance the books and tax rises that can actually make an impact on the deficit.

The government are also starting to admit they may have to take losses on the bank bailouts they carried out, rather than the profit many believed. As I have said before I will be happy to get half the money back. Wait until the losses really start stacking up. There will be an incredible strain in the gilts market for years to come, with further money printing to cover the shortfall as investors appetite for our debt wanes. Indeed questions of Britain's AAA rating has become mainstream news now, as a ten year old could do the sums and realise they don't add up.

Green Shoots?
Before the budget there had been more discussions of green shoots of recovery or the bottom of this and that. These green shoots will be mentioned for years to come as I have mentioned before, many will be fooled by the bull moves in this bear market we find ourselves in. I started this blog around this time last year and everyone was saying the same. The 'worst is behind us', 'the credit crunch won't effect us', 'the UK has sound fundamentals' with everyone having an almost religious belief in the state of the economy. There is plenty more pain to come. Mistakes of history are being repeated which are once again impoverishing society. Unemployment has only just begun its climb. The next bubble, government debt has yet to pop and cause havoc. Energy prices and commodities are historically low. Retirement has yet to set in. As the year goes on the FTSE will hit new lows possibly hitting levels around the mid 1990's in a best case situation.

So the Children's Budget has been announced. A decade of deficits, and a generation of hardship. These were the debts I have been talking about. The debts I knew were in the system, waiting to hatch out and there's much more to come. The debts that are now staring my generation and future generations in the face. Many Western Governments will find themselves in a similar situation, but Britain has managed to come up with the largest deficits of the developed world, even without the substantial stimulus packages other nations are putting in place. The greatest asset we have is a long history of democracy and peoples individual rights, but we have a government that is continuing along the path towards bankruptcy. It's all unsustainable and must be stopped, immediately, if not for our sake then for future generations sake.

Dr. Doom

As the worlds leaders continue to make mistakes and economies continue their decline I found the following video of particular interest.



For people not aware of who Marc Faber is, he is known for his bearish views on Western economies and how the problems began with Black Monday of 1987 from which point the Central banks embarked on expansive monetary policies and would not let the free market function. You could dismiss the above video as economic thespian commentary. After all high inflation only happens in distant lands, with historically weak economies. Argentina and Zimbabwe used to be economic giants in their respective regions, with prosperous living standards for their people, yet economic crisis came and ruined their peoples way of life. Some of the points in the video are very interesting:

• "The Fed will never raise interest rates to real levels" - Meaning they will give up on their currency. In the event of inflation running at 10% they will have rates at 1%. They won't even bother trying to bring the money supply under control and will just give up on the currency to keep inflating to pay government and societies debts. Of course this isn't free. It ruins the economy, but still this is what Central banks think will solve the credit crunch. When something goes wrong print (tech bubble pops - interest rates to 1%), when something else goes wrong print (housing bubble pops - interest rates to 0% and QE implemented).
  
• "We are a while from high inflation" - Dr Faber is precisely correct on this point. Inflation doesn't happen immediately. It's a gradual process. All examples of serious inflation have taken time to work through, even while calls about deflation were being made. The final chapter of fiat money is always destruction. There are still many chapters to go, but we are getting through the book at an alarming rate.
  
• "Totalitarian State?" - More state control along with less individual decisions in the economy signals the beginning of government control as it crowds out the private sector. Further Government debts are being imposed on its citizens without their consent. We still have the ballot box, so are a long way from succumbing to totalitarianism although it is perfectly plausible in the long run.
  

The video sums up the irresponsible stance institutions and Governments have taken in recent years. The debt burden can not be paid. The only way to not default physically on the debt is default by the printing press - the governments most dangerous weapon. Not 'A Step into the unknown' or 'will it work?' or 'Just enough to move the credit markets' - just plain debasement. Destroying genuine capital and saving that is so desperately needed at this current time to assist with the recovery.

It really was a historic week. The Federal Reserve have announced they plan to buy Treasuries by printing money, not real savings, but with fictitious money. The history books of the future will illustrate this event as a milestone, a turning point where the great credit crunch of 2007 got a whole lot worse. Ben Bernanke has now openly admitted that they are printing money, no swapping of assets, parking of securities just printing new money, to buy government debt. This is always how it begins. As public speakers continue talking of moral hazards they miss the biggest moral hazard of all, that of fiat money. A money with unlimited supply means governments can inflate and bail out everything, with no immediate cost. Perpetuating the irresponsible behaviour from reckless individuals, squandering societies scarce resources.

Budget Deficits are rising, seemingly by the week. A latest forecast for Britain has come in at 12.5% for next year, with the IMF saying Britain has the worst fiscal position in the Western World. Unemployment relentlessly carries on rising, with forecasts of 3.3 million or even as high as 4 million people out of work, putting further downward pressure on economic activity and increasing public spending to cover those out of work. As the private sector reacts to the market forces correctly by reducing pay and redeploying labor, public jobs are sheltered in the governments own wonderland, thus further crippling the private sector, the real engine of human prosperity. As state spending increases it is not only consuming scarce capital that could be used by the productive private sector, but labor. Private sector talent heads into the public sector as conditions worsen, thus stifling innovation and future economic growth. Trade figures deepen as international markets further dry up, meaning more firms cutting jobs.

It will be interesting to witness the coming budget report form Alistair Darling. Will he have a credible fiscal framework (as though there is one now, as the BoE buys government bonds with printed money)? People are still not with the program. The public are still talking about property, stocks, a recovery, the bottom of this market, the bottom of that. The inevitable bull moves in these great bear markets will no doubt fool many into a false bottom. People still don't appreciate the severity of the issues we face.

The FSA has recently begun to look into setting limits against income multiples to be lent against houses. 3.5x salary is being proposed, with suggestions of a 15% minimum deposit. If the above is the case, I can't see many people buying homes. Most British people don't have the discipline to save, never mind save the huge sums required for a house. Why do we have regulators? Why do we have regulatory institutions such as the FSA and the ratings agencies? So after the crisis has hit, they can come up with the regulatory framework. It's similar to a civil engineer not putting supports into a bridge that gets used by the public, and when a disaster occurs admitting that they should have put supports in place as the bridge never stood a chance. Will the new framework work? Of course it won't. The market is smarter than any bureaucratic institution. Regulation doesn't get to the root problem, as true free markets regulate themselves.

Religion was seen for centuries as an institution of wisdom, a beacon of light, defending people against invisible evil forces. As time passed, the enlightenment, the progression of science, slowly religion became exposed for what it was, a mass cult following of stories passed down from generation to generation with no real rational basis. Rather than religion being the saviour, it was indeed part of the problem. Catholic and Protestant divisions in Ireland, Hindu and Muslim tensions in India, centuries of pogroms in central and eastern Europe against the Jews. It became a convenient means to segregate and persecute people. When Fascism rose, Catholicism praised it for its opposition towards Communist and Socialist parties. Movements that believed in equality. Just like religion, Central Banks are just an institution run by a select few, who are not the solution to 'market failure' but are part of the problem. Dr Doom may be viewed as a 'non-believer', just like atheism was demonised during religions dominance. Dr Faber knows the cause of the problems we see, and thus what problems these policies will create further down the road. Back in 2002 Ben Bernanke made a speech entitled "Deflation: Making Sure "It" Doesn't Happen Here", in which he now seems to be implementing the very policies he proposed 7 years ago.

"The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt ... Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. "
Ben Bernanke, Deflation: Making Sure "It" Doesn't Happen Here, 2002