Bill Totten's Weblog

Saturday, September 25, 2010

Making the Case 1

Why Debt is Bad

by Frank Taylor

Prosperity (April 2007)

Repetition is so often a prime symptom of stagnation.

As a relative newcomer to Monetary Reform I find myself reading an endless succession of books and articles, along with reports of meetings and seminars, all saying more or less the same thing. It is natural for an idea which finds itself unable to break out of a small circle of the converted, to twirl in circles. But that serves only to underline the present and increasingly urgent necessity to stop preaching to the converted and convert the unbeliever on a far wider scale than hitherto.

How is this to be done?

Most works on Monetary Reform are at least extremely vague as to how such a political transformation is to be brought about. At least it can be said that we are most unlikely to instantly leap from where we are now to 100% money, like some Zebedee on his magic spring.

The world doesn't work in that way.

Like the bemused traveller, if we wanted to get there we wouldn't be starting from here!

Calls for 'more education' is usually a pretty good sign that someone has a problem, yet with little clue as to what to do. Thus efforts to promote Monetary Reform by 'educating' a mass public into the intricacies of the financial system are likely to continue to fall on stony ground.

Not only are such intricacies of little wider interest, most people would view Monetary Reform as an abstraction, even if they could be induced to assent to its basic propositions.

Not only this, we have an uphill battle against a public sozzled and somatized by the credit-driven housing and consumer boom.

Joe Soap might admit that he has a tidy six figure sum out on the mortgage, and a good four or even five figure sum out on the plastic. Even though he will admit that this makes life tight he will shrug. So what?

Interest rates and inflation are low, as is unemployment; and all this credit drives the economy and keeps the price of his house high and growing. He has instant availability to a range of consumer merchandise. He will perceive debt not merely as an abstraction, but as a benefit.

It is at this point that Monetary Reformists, if they played their cards right, might be able to scratch at Joe Soap's Achilles heel.

For does Joe Soap have the slightest idea of the hidden, indirect and externalised costs of the bounty that he thinks he enjoys?

Has he any clue that the gains that he thinks he is making are largely illusory?

Has he bought into the toxic fiction of a Retail Price Index (RPI) which excludes house prices?

Since Labour came to power the economy has 'grown' by around thirty per cent in real terms. Yet the level of debt has doubled. On this reckoning we are not 'growing' at all, but declining.

But there is more to it than that.

During that time average house prices have increased from almost GBP 70,000 to more than GBP 180,000.

On that figure we can do a rough macroeconomic calculation, as follows: If we take an average house price increase of GBP 100,000 over ten years and spread it over a notional average 25-year mortgage term we arrive at a sum of GBP 4,000 per annum. Thus the annual cost to the average household of house price inflation in the past decade is a least GBP 4,000.

That might make Joe Soap's jaw drop a little.

Expressed in another, simpler, macroeconomic equation, if we have an increase in debt of GBP 700 billion over twenty million households over ten years, then we get to a cost of around GBP 3,500 per household per annum, net of interest charges, or nearer GBP 4,000 with interest.

But what are the likely microeconomic components of these externalised costs?

The prime candidates are as follows:

1. Higher taxation

Although there are complex leads and lags in the way in which house values feed through into rental levels, rent will rise over time according to those values. So will the cost of housing benefit and thus the bill to the taxpayer.

In addition, the upwards displacement of wealth caused by land price inflation, and the consequent widening of the gap between rich and poor, will place greater stress on welfare budgets generally. More social housing will be needed.

As the price of land rises so will the cost of building schools, hospitals, roads, and indeed all public infrastructural projects. Again the taxpayer foots the bill.

2. Higher retail price levels

Virtually all human activities take place on land. Even ships and aircraft are built on land. If land values rise, company accountants will be telling their directors that if their site value is x then it should be yielding a profit of y. In consequence agricultural, manufacturing and retail prices will naturally rise in concert with land values. The apparent 'low inflation' of recent years is due largely to the self-deluding mirage induced by globalisation and the exploitation of third world labour, as well as by the exclusion of house prices from the RPI. If we had not had such severe land price inflation prices would be lower.

3. Higher mortgage and debt repayment

These should be a direct rather than an externalised cost, except that land prices have been largely decoupled from the RPI. Indeed the RPI, not only takes virtually no account of house prices, but pays no heed to any difference between luxuries and necessities, to product durability, or to debt levels, and is thus all but meaningless. If house prices were included we would have inflation nearer twelve per cent than two per cent.

More than that the audacious success of the Great Lie that inflation has gone away - whereas it has been displaced into asset values - is a worrying reflection on the collective sanity of the human race.

4. Lost pensions and savings

It stands to reason that if Joe Soap spends much of his adult life up to his eyeballs in mortgage and consumer debt he is unlikely to have much spare to save.

It is for others to speculate why such a factor is so rarely mentioned during debates about the pensions crisis. In truth Joe Soap's debts will be costing him dearly in lost saving opportunities.

Yet the government is caught in a cleft. Whilst it may fret about pensions, if indeed more money were to be switched from consumption to savings - and given that so much production has now been off-shored - the bubble of this shallow-rooted cappuccino economy may well burst sooner rather than later.

Such microeconomic costs should equate closely to the macroeconomic calculation outlined earlier. Monetary Reformers should begin proselytising by making the case as to why debt is bad.

Events may well prove that anyway, and if so, we must be ready for the bubble to burst. We should also be loudly underlining the inherent absurdity of the belief that inflating the price of a fixed non-productive asset such as housing creates new wealth. It doesn't. It moves old value around and does so in a fiercely regressive manner.

To make the case we should now concentrate on finding reputable economists to undertake such microeconomic research. Whilst this is a task beyond the resources of a private individual it is work perhaps for at least a doctoral thesis, if not an entire university department.

We must be able to prove the real cost of debt and land price inflation to the average person.

In doing so, we should also be asking the question of the Treasury as to the nature of its own research and economic modelling on the externalised costs and regressive nature of land price inflation. Does it even have any?

Armed with a strong case of how debt affects the pockets of the average household, Monetary Reformers may then be able to start the process of prizing open the door into a wider public awareness.

Bill Totten


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