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Inflation's Moral Hazard

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some more lessons from history

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Nevertheless, I can attest to a prolonged era of price stability from evidence in my own lifetime. When I was born, it cost one and a half times as much to send a letter as it did 100 years earlier. In my childhood, during the fifties, we still used the same coins, with the same denominations, that people had used during the Victorian era. The silver coins were still made of silver, not a worthless silvery metal. Occasionally, we would even come across pre-Victorian coins. Their continued use was not absurd: though prices had risen, they still bore some resemblance to what they had been in the earlier time. When my grandmother gave me a florin—one-tenth of a pound—I felt rich. It was enough, in any case, to buy a paperback book; between 50 and 60 times as much would be required now.

I also remember the vast white five-pound notes, as grandiose and almost as large as professional diplomas or nineteenth-century share certificates, that my father kept in a roll in his pocket, only 100 or 200 of which would have been needed in those days to buy a decent house. And it was still possible for a boy like me to buy something—albeit only a stick of gum—with the smallest coin of the realm, a farthing, worth one-960th of a pound. That something could be sold for such a tiny fraction of money might seem a sign of general poverty. But though the Britain of my youth lagged economically, it was far from poor.

The regime of relative price stability soon collapsed. During the sixties and seventies, the sums of money of which everyone spoke increased, first by a little and then by a lot (and how nonchalantly we now speak of trillions of dollars or euros!). All that had seemed solid, to paraphrase Marx, melted into air.

At the time, I gave no thought to the effects of this inflation, which tended to be discussed in purely economic terms—experts would ask, say, whether inflation was compatible with satisfactory economic growth. In a naive way, I assumed that since most people’s income tended to rise with inflation, there was nothing to worry about. I did not suffer personally because of it, nor did most of the people I knew. If a product once cost y and now cost 10y, what did it matter, so long as your income had gone up by ten times, too? Since people seemed better off, at least measured by what they could consume, one could even assume that incomes had risen faster than inflation.

Yet this was a crude way of looking at things, as my father’s fate should have instructed me. He sold his business in the sixties, at the end of the period of price stability that had reigned throughout his life, for what then seemed a large amount of money. He was a man who, for both temperamental and ideological reasons, held a deep contempt for financial speculation and wheeling and dealing, with the result that he did nothing as inflation inexorably eroded his savings. He grew poorer and poorer through the remaining 30 years of his life, and might have sunk into poverty had he not moved into a house that I owned. And this after reaching a level of wealth that, relatively speaking, was greater than I shall probably ever know.

For a while, I was angry about what seemed my father’s improvidence and lack of foresight. As the current financial crisis has conclusively demonstrated, however, not everyone is blessed with foresight, not even those whose livelihood depends primarily on the claim of possessing it. My father was born of a generation that saw money as a store of value, a far from dishonorable notion—and one that, when it reflected reality, helped give a lot of people peace of mind. And as I reach the age when inflation might cause me some embarrassment, even hardship, my sympathy with my father’s plight has grown. I am no longer young enough to fight another day, economically speaking: the destruction of my wealth by inflation would be final. In an aging population, more and more people are in my position, which helps explain why an age of prosperity can be an age of anxiety, even without a financial crisis.

Like my father, I am not particularly avaricious; on the other hand, I have no vocation for poverty and share the prejudice of most of mankind that a loss of capital and a sharp decline of income are much to be feared. In an era of price stability, a man of my disposition could judge with a degree of certainty how much money he would need for each year of his retirement. The calculation of how much principal he would require now, in order to yield that amount of money in interest each year in the future, was relatively simple and would yield financial tranquillity.

That kind of tranquillity about one’s financial future is more difficult for most of us to achieve now. President Reagan and Prime Minister Thatcher brought raging inflation under control in the U.S. and Britain during the eighties—at the cost of great short-term economic pain and considerable political and social strain—but they could not reverse the public’s loss of confidence in money as a store of value. People must today try to foresee not only how long they will live but also what is even less predictable: the reigning economic conditions of the next 40 years, assuming this to be the upper limit of their retirement period. And this, to quote Doctor Johnson in another context, “requires faculties which it has not pleased our Creator to give us.â€

There seems to be no choice, then, but for everyone to have constant regard to his own pile, and to try to outwit the economic moth and rust that threaten to erode all but the largest fortunes: in short, he must speculate, or risk losing nearly everything. The question of whether it is best to hold shares, or bonds, or property, or gold, or some combination of them, is constantly before him. Further, as many who have taken tips from their brokers or bank will attest, funds’ managers and investors do not always have the same interests. A man trying to preserve a competence learns to trust neither himself nor others.

Inflation has overturned centuries of economic wisdom, or at least prejudice. When Polonius conferred his parting platitudes on Laertes, one was to “neither a lender nor a borrower be,†and this because a “loan oft loses both itself and friend.†A quarter of a millennium later, Mr. Micawber famously asserted that the secret of happiness was to live within one’s means; and while credit is obviously essential for economic growth, an intuitive difference exists between borrowing to consume beyond one’s means and borrowing to increase one’s means.

Inflation has blurred that intuitive difference. Many times I have received advice, from friends and banks, to borrow as much as I could so that I might buy the best and most expensive house possible. And for many years it seemed good advice, for what could be more advantageous than to buy an appreciating asset with depreciating currency, especially when my income was likely to appreciate faster than the currency depreciated? It was a painless way to become rich.

I did not take the advice—not entirely, anyway. I remained sufficiently a child of the regime of constant prices that I found it difficult to imagine how a sum that seemed vast now would seem trifling in just a few years: caution seemed wiser. Even so, I borrowed within what I thought to be my means, and thereby accumulated assets of a value that I could not have obtained by the steady buildup of savings. The curious result has been that at no point in my career could I have afforded to buy the real estate that I now own, whose value—even now, after a precipitate post-financial-crisis decline—greatly exceeds my cumulative income over the years. If my borrowing had been bolder, the value would exceed my earnings even more.

My situation is no different from that of millions of others, of course. And since we are all richer than we should otherwise be, is there anything, really, to complain about? The problem is that this “richer†represents a curious kind of wealth. I must live somewhere, after all, and everywhere else has appreciated in value, too. I don’t live any better in my house than I did before simply because it is worth three times what I paid for it. Its increase in value is thus of no use to me, unless I want to sell it to live in a less valuable house and invest the difference. An increase in the value of one’s house is therefore a bit like fool’s gold.

But for many years, people—in Britain, especially—have treated rising property values as if they were the real thing, and the government has supported this belief by allowing extremely easy credit. My bank gave me some good examples not long before the crunch.

I still remember the letter that the bank sent me when I was a student, pointing out with considerable asperity that I was almost three pounds overdrawn and asking when I would correct this serious irregularity. Nearly 40 years later, I briefly overdrew my account again—this time by much more—and wrote to the bank, explaining that I would clear the balance in a few days. Unusually, the bank called me: a banker wanted to see me, and would like to come to my house. I made an appointment and expected him with some trepidation.

When he arrived, I repeated that I would pay off the overdraft, and more, in less than a week’s time. “Oh, we don’t want you to do that,†he said. “I’ve come here to ask whether you want to borrow more money.â€

“What for?â€

“Well, a nice new car, or perhaps the holiday you’ve always dreamed of.â€

I was astonished. The bank was encouraging me to indebt myself for an asset whose value would swiftly melt away—or for one of no resale value whatsoever. After rejecting this offer, I soon found myself receiving others—of large loans that would be advanced to me, as if by right, by a simple telephone call. Apart from home improvements, whose enduring monetary value would depend on the state of the property market, all the suggested uses to which I might want to put the lent money were for consumption in the here and now. It all suggested a giant pyramid scheme.

Some time later, I was thinking about buying another house, for which I would need a short-term loan. Passing my bank, and having a few minutes to spare, I entered and inquired about how I would arrange such a loan. Within five minutes, the bank had offered me a sum that was 20 percent larger than the single asset that it had evidence that I owned (another house)—whose value, in any case, was subject to fluctuation, including downward. I came away feeling that the bank was careless to the point of frivolity; it was treating money as if it were playing Monopoly, not exercising due diligence on behalf of its shareholders and depositors. Sure enough, the bank was nationalized two years later, in 2009, and its 3 million shareholders, who had enjoyed several fat years before the collapse, wound up virtually expropriated.

During those fat years, a man could sit at home watching television and imagine that he was growing richer thereby. I remember an eminent professor’s telling me, with a barely concealed exultation, that he was making nearly $1,000 per day, week after week, merely by owning a very large house in a fashionable area: an amount that, needless to say, dwarfed any savings he might salt away from his salary. The government could not have been better pleased, for the majority of the population, who owned their own homes, felt prosperous as never before and attributed their affluence to the government’s wise economic guidance.

But asset inflation—ultimately, the debasement of the currency—as the principal source of wealth corrodes the character of people. It not only undermines the traditional bourgeois virtues but makes them ridiculous and even reverses them. Prudence becomes imprudence, thrift becomes improvidence, sobriety becomes mean-spiritedness, modesty becomes lack of ambition, self-control becomes betrayal of the inner self, patience becomes lack of foresight, steadiness becomes inflexibility: all that was wisdom becomes foolishness. And circumstances force almost everyone to join in the dance.

Except in one circumstance, that is: the possession of a salary and a pension that the government promises, implicitly or explicitly, to index against inflation. This is the situation of public-sector workers and is a pyramid scheme, too, perhaps the biggest of the lot, since events may require the government to renege on its obligations. But meantime, such employment will seem a safe haven, and the temptation will be for government to expand it, with the happy consequence—for itself—of increasing dependence. And dependence, too, undermines character.

It is no coincidence that the Western leader most worried about a new bout of inflation is German chancellor Angela Merkel. If there is one thing that Germans agree about, it is the necessity—social and political as much as economic—of a sound currency. The hyperinflation of the 1920s brought about a German change in mentality as great as, or greater than, the one caused by World War I, with what disastrous consequences 50 million dead might attest if they had voice. The solidity of the deutsche mark was the great German achievement of the second half of the twentieth century.

Inflation is not a bogey for everyone—not for those who wish to restructure society, for example, or for those who want government control of ever more aspects of people’s lives. But for the rest of us, the consequences of its full-blown return are not likely to be good: for inflation is not an economic problem only, or even mainly, but one that afflicts the human soul.

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Guest The Relaxation Suite
This was posted the other day, but it's well worth reading again and giving a bump!

Yeah it was me - definitely worth a read because it describes the effects of inflation in a personal way.

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The stand out line to me is:

at no point in my career could I have afforded to buy the real estate that I now own, whose value—even now, after a precipitate post-financial-crisis decline—greatly exceeds my cumulative income over the years

I have heard my father say much the same.

To me, it is a clear indication that something is wrong with 'the system', although it is not clear to me whether the problem is the use of fiat currency, the increasing availability of credit or both.

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It is a combination of fiat, bank credit and land rationing.

If land was freely available, we wouldn't have to fight over the crumbs of land. If the crumbs of land weren't so expensive, we wouldn't have to borrow so much bank credit. If so much fiat wasn't created, there wouldn't be the bank credit to borrow.

We need monetary reform to stop the government creating too much fiat. We need monetary reform to stop the banks creating too much credit, unless it is at the expense of debasing their own currency. We need land value tax* to stop the minority holding the majority of the land.

If we fix the above, we have a hope of living a life which isn't dominated by debt and oppression. If we don't, we will live life as debt slaves.

*There maybe other solutions, but this seems an obvious one.

EDIT: To add, as we don't have enough land to feed ourselves, we need tougher immigration policies too. Cheap houses, but no food isn't a great solution either.

Edited by Traktion

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It is a combination of fiat, bank credit and land rationing.

If land was freely available, we wouldn't have to fight over the crumbs of land. If the crumbs of land weren't so expensive, we wouldn't have to borrow so much bank credit. If so much fiat wasn't created, there wouldn't be the bank credit to borrow.

We need monetary reform to stop the government creating too much fiat. We need monetary reform to stop the banks creating too much credit, unless it is at the expense of debasing their own currency. We need land value tax* to stop the minority holding the majority of the land.

If we fix the above, we have a hope of living a life which isn't dominated by debt and oppression. If we don't, we will live life as debt slaves.

*There maybe other solutions, but this seems an obvious one.

EDIT: To add, as we don't have enough land to feed ourselves, we need tougher immigration policies too. Cheap houses, but no food isn't a great solution either.

The rental streams from land have been privatised. This is what is causing 90% of the problems IMO as government then needs to find an altenative source to fund their operation; so they have to damage and tax the productive part of the economy. A Land value tax would deal with this problem which if implemented properly would drastically cut the financial 'services' sector too.

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I like the idea of a land value tax, not only for the reasons given, but also because it is a very easy tax to administer: you cannot hide land or take it off-shore, and it is relatively easy to value.

If revaluations were regular, it would give the government a rather volatile source of revenue, but it would also stabilise prices.

Another fairly minor (in terms of the land area needed as a percentage of the size of the country) change that would have huge effects would be to slightly relax planning laws to allow more land to be urbanised - ii.e. land in residential use is a small percentage of the total land area, so changing the use of a very small percentage of total land area would lead to a large percentage increase in the amount of land in residential use.

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In the whole of the 20th century there were only 2 or 3 years when prices fell and these were during the demand-led slump of the Great Depression.....

In the latter half of the 19th century prices fell with improved productivity and incomes remained more or less the same.........

which begs the question, what is wrong with deflation.....?

the old chestnut that people would defer their spending in anticipation of lower prices is hogwash...as food and clothing or anything else dropping only 1 or 2 or 3% per annum in price would not affect consumption patterns..............

the exception is new-fangled electrical devices whose prices can fall dramatically after they first appear....

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its funny, but even with all this wonderful information about bubbles money as unstable as it is, and a clear view of the future laid out before me, I still dont know what to do for the best.

persuade the cash holder to buy silver or gold?

buy a house with a large loan and be damned?

hold cash in the expectation that it will, as it should, be worth more next year than this?

Each solution is valid as a protection....but each solution could be fatally wrong.

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its funny, but even with all this wonderful information about bubbles money as unstable as it is, and a clear view of the future laid out before me, I still dont know what to do for the best.

persuade the cash holder to buy silver or gold?

buy a house with a large loan and be damned?

hold cash in the expectation that it will, as it should, be worth more next year than this?

Each solution is valid as a protection....but each solution could be fatally wrong.

Couldn't agree more.

I've been sat on the fence of the deflation/inflation debate for so long now the splinters are hurting...

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The stand out line to me is:

I have heard my father say much the same.

To me, it is a clear indication that something is wrong with 'the system', although it is not clear to me whether the problem is the use of fiat currency, the increasing availability of credit or both.

The problem is that wealth is an illusion.

He can't feed himself by exchanging a roof tile per week for bread.

The only way he can access that wealth is to sell it to someone else, in effect he can only have that wealth by agreeing to lay on the next generation his shackles of debt slavery.

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some more lessons from history

link

in keeping with the above

http://www.housepricecrash.co.uk/forum/ind...t&p=2103203

In 1969 I was No 1 cashier at Nat West (in a small place around Manchester). We had the local bus company pay in huge amounts of coin (especially after weekend). I saw an advert offering 106 quid for every 100 of pre-47 coin. What a time-I could do 200 quid a week-no kiddin. I even got the manager on it in his spare time. I would just put the 100 sorted coin in to reserve-have the bullion guys come in and pay me and I would do the necessary "currency swap" pocket the difference and balance my till. I remember I was making my salary at least again by way of this bonus scheme so decimal currency and the rise of the silver price wasn't all bad for everybody. Yep ten quid was my "salary"When I left the bank (at twenty years old) I was called crazy because I was considered a "high flyer" and would be on scale to earn the magical "twenty quid a week" at age 31 (that's 1982 BTW).
Edited by p.p.

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its funny, but even with all this wonderful information about bubbles money as unstable as it is, and a clear view of the future laid out before me, I still dont know what to do for the best.

persuade the cash holder to buy silver or gold?

buy a house with a large loan and be damned?

hold cash in the expectation that it will, as it should, be worth more next year than this?

Each solution is valid as a protection....but each solution could be fatally wrong.

yep one big casino

link

THE CASINO OF PAPER MONEY

Our present economy is best understood as a casino. In the casino, house chips in varying denominations, e.g. dollars, euros, pounds, pesetas, pesos, yuan, yen, krona, drachma, won, etc have been substituted for gold and silver.

This is because the casino is run solely for the profit of the bankers; and through control and issuance of their paper chips, the bankers are able to control much of what happens on the casino floor.

The bankers make sure that the governments who issue the paper chips do so at the direction of central banks. Through their influence over the central banks, the bankers control the flow of chips without which the patrons cannot play.

Question: Who are the patrons and what role do they play in the casino?

Answer: The patrons are the producers, savers, and entrepreneurs without whose activities the casino would come to a halt. In the casino, they are known as marks, suckers who provide the on-going profits of the casino.

The casino’s hidden skim: Through the constant issuance of paper chips, governments insure the value of previously issued paper chips will fall thereby forcing patrons to gamble their earnings at the casino tables in order to preserve their paper savings and to perhaps gain by so doing.

The casino’s hidden advantage; While the casino patrons, sic marks, can only bet their earnings and savings on a 1:1 basis, in the private gaming rooms upstairs, the casino owners are able to draw on house credit and leverage their bets by 20, 30, or even 40 times their original sum.

What went wrong: After 1999, the casino owners began betting the savings of the downstairs patrons (bank savings deposits and insurance investments allowed by the repeal of Glass-Steagall) and bet this money on subprime CDOs, credit-default swaps, derivatives, emerging market equities, commodities, etc. and used house credit to leverage their bets far beyond the original amounts.

At first, winnings skyrocketed driven by the vast amounts of leveraged money available from the repeal of Glass-Steagall, providing even more incentive for the casino owners to borrow and wager even more. But, in 2007, the luck of the house changed

Even in rigged games, if the sums bet are large enough, the losses can be staggering and can break the bank, sic the house/casino. With bets leveraged 40:1, a fall of only 2.5 % completely wipes out the bettor. A fall of 100 % takes out not only the bettor but the enormous amount of credit extended to the bettor by the house.

Some of the losses incurred by subprime CDOs are as high as 90 %. The losses on Lehman’s bonds are over 90 %. The reason why financial markets are in such trouble is the trillions of dollars in credit extended by the banks is now gone and, as a consequence, almost all banks are bankrupt.

With the casino now broke, governments have announced that they will guarantee the value of all paper chips issued by the casino. Governments do not want bettors to cash in their paper chips because they know the banks are broke and do not have the cash to cover either their bets and/or the chips they issued.

Now the casino patrons are being forced to subsidize the casino while their governments are frantically issuing more chips hoping that by so doing the now terrified patrons will return to the now empty tables and continue to bet what little they have left.

Good luck.

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its funny, but even with all this wonderful information about bubbles money as unstable as it is, and a clear view of the future laid out before me, I still dont know what to do for the best.

persuade the cash holder to buy silver or gold?

buy a house with a large loan and be damned?

hold cash in the expectation that it will, as it should, be worth more next year than this?

Each solution is valid as a protection....but each solution could be fatally wrong.

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Chinese tell their Citizens to buy gold...suppose its easy to confiscate if they know whose bought it.....amd the more bought the more they will have .....I think Ill get some more.

price will deffo fall then.

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