Greed And Debt

[Gandalf]

I have been stalking this site for a year now and decided i would finally take the plunge. Trying to figure out all the housing terminology has been hard at times but i think i'm there now.

Personally, i think this country is in for BIG trouble over the next few years driven by 2 main factors, namely 'recession' and 'unsustainable debt'. The fools that have been MEWing up to the eye balls to live the dream have caused this mess and i truely hope they're the only ones that suffer on the way down. All those 4x4 hummers will be back on the market next year when all these irrisponsible people realise they can't service their silly amounts of debt.

There is one thing i am struggling to understand in all this economic talk though, which i was hoping to get an explanation for. I keep reading that high inflation would erode debt. I really don't understand this?! - I can see the obvious link of interest rates on debt but not inflation. As you can tell i'm not from an economics background but willing to learn.

[MarkG]

I keep reading that high inflation would erode debt. I really don't understand this?!

Good, because it's nonsense. High wage inflation erodes debt because you earn a lot more and can pay off debts with a smaller fraction of your wages. High price inflation makes debt worse because you have less money to blow on interest payments after you pay for essentials.

BTLs are betting on high wage inflation while renting out their flats to Polish immigrants who are doing jobs that would previously have paid twice as much to a British worker... not the smartest plan ever.

[London Landlady]

I have been stalking this site for a year now and decided i would finally take the plunge. Trying to figure out all the housing terminology has been hard at times but i think i'm there now.

Personally, i think this country is in for BIG trouble over the next few years driven by 2 main factors, namely 'recession' and 'unsustainable debt'. The fools that have been MEWing up to the eye balls to live the dream have caused this mess and i truely hope they're the only ones that suffer on the way down. All those 4x4 hummers will be back on the market next year when all these irrisponsible people realise they can't service their silly amounts of debt.

There is one thing i am struggling to understand in all this economic talk though, which i was hoping to get an explanation for. I keep reading that high inflation would erode debt. I really don't understand this?! - I can see the obvious link of interest rates on debt but not inflation. As you can tell i'm not from an economics background but willing to learn.

Hobbit?

[Pippa]

I have been stalking this site for a year now and decided i would finally take the plunge. Trying to figure out all the housing terminology has been hard at times but i think i'm there now.

Personally, i think this country is in for BIG trouble over the next few years driven by 2 main factors, namely 'recession' and 'unsustainable debt'. The fools that have been MEWing up to the eye balls to live the dream have caused this mess and i truely hope they're the only ones that suffer on the way down. All those 4x4 hummers will be back on the market next year when all these irrisponsible people realise they can't service their silly amounts of debt.

There is one thing i am struggling to understand in all this economic talk though, which i was hoping to get an explanation for. I keep reading that high inflation would erode debt. I really don't understand this?! - I can see the obvious link of interest rates on debt but not inflation. As you can tell i'm not from an economics background but willing to learn.

The way I explained it to a friend the other day (and I'm not from an economics background either, just getting into it triggered by being on here and reading MoneyWeek!)

You have £100,000 debt and £20,000 savings (assume neither values are paid off/added to), so £80,000 'net debt

2% inflation means after a year that's eaten into both of the above to give

£100k *.98% = £98,000 debt

20k * .98% = £19,600 savings

Total = £78,000 debt

Higher inflation, say 4% would give the following:-

£100k * .96% = £96,000 debt

20k * .96% = £19,200 savings

Total = £76,800

Bad news for savers, good news for those with debts....discouting all the nasty things like living becoming more expensive/salary being worth less/strain on economy etc, etc.

[MarkG]

£100k * .96% = £96,000 debt

Again, that's nonsense. You still have 100k of debt, but the cost of your essential purchases have increased by 4%, so you have maybe 8% less money available to pay it off (assuming you're already spending as much as you earn and 1/3 of your income goes on debt, which seems quite normal these days).

_ONLY_ wage inflation erodes debt in real terms. Any other kind of inflation makes it worse.

Edited November 29, 2005 by MarkG

[Gandalf]

The way I explained it to a friend the other day (and I'm not from an economics background either, just getting into it triggered by being on here and reading MoneyWeek!)

You have £100,000 debt and £20,000 savings (assume neither values are paid off/added to), so £80,000 'net debt

2% inflation means after a year that's eaten into both of the above to give

£100k *.98% = £98,000 debt

20k * .98% = £19,600 savings

Total = £78,000 debt

Higher inflation, say 4% would give the following:-

£100k * .96% = £96,000 debt

20k * .96% = £19,200 savings

Total = £76,800

Bad news for savers, good news for those with debts....discouting all the nasty things like living becoming more expensive/salary being worth less/strain on economy etc, etc.

Ok i think i understand that. So it's the net difference between savings and debt. This raises another thing i've never really understood. Why would someone with say £100k debt and £20k savings, not just pay off £20k of thier debt. Aside from IR's for a mortgage and ISA's for savings, surely the debt is always at a higher interest rate than savings ....

[selkirk]

Good, because it's nonsense. High wage inflation erodes debt because you earn a lot more and can pay off debts with a smaller fraction of your wages. High price inflation makes debt worse because you have less money to blow on interest payments after you pay for essentials.

Gandalf

MarkG is mis-informing you.

During periods of high inflation, prices rise, including house prices. Wages also rise. But if you have mortgage, the debt stays the same (or rather it's paid off slowly over the years just as in a period of low inflation).

So, the value of your property increases, and your wages increase, but your debt stays the same. So in real terms your debt is decreasing. Thus, high inflation erodes debt.

[Pippa]

Again, that's nonsense. You still have 100k of debt, but the cost of your essential purchases have increased by 4%, so you have maybe 8% less money available to pay it off (assuming you're already spending as much as you earn and 1/3 of your income goes on debt, which seems quite normal these days).

_ONLY_ wage inflation erodes debt in real terms. Any other kind of inflation makes it worse.

Hey that's why I added that that is discounting EVERYTHING else, like cost of living and wages! - I was only trying to explain the principal in its simplest form, of course it doesn't just affect your debts. Sadly a lot of people only see that part though, like folks who justify buying a new car because it'll save them on petrol, sod the potential increase in insurance/tax/servicing/depreciation.

[MarkG]

MarkG is mis-informing you.

Interesting. Maybe you can explain why debts will be easier to pay if prices of essential items are 10% higher and you're still earning the same amount as before?

During periods of high inflation, prices rise, including house prices. Wages also rise.

Why will wages increase when more and more jobs are being outsourced to China and India or insourced to Polish immigrants?

[Milkshock]

Gandalf

MarkG is mis-informing you.

During periods of high inflation, prices rise, including house prices. Wages also rise. But if you have mortgage, the debt stays the same (or rather it's paid off slowly over the years just as in a period of low inflation).

So, the value of your property increases, and your wages increase, but your debt stays the same. So in real terms your debt is decreasing. Thus, high inflation erodes debt.

MarkG is drawing the distinction between price inflation and wage inflation. You are not.

Unfortunately in today's society it is perfectly possible (and indeed has been happening) that wages stay the same or fall, while prices rise. Which makes MarkG's explanation perfectly sound.

[Limpet]

Hobbit?

I got it

[Gandalf]

Hobbit?

Well i do have big feet!

[selkirk]

Ask anyone who bought property in the 70's what happened to their mortgage. There are plenty of posters on here (who are older than me) who will testify that what I am saying is what actually happened. Wage increases and house price increases eroded their debt.

[London Landlady]

I got it

Too subtle?

[OnlyMe]

Too many people are thinking that there is a magic money pot that companies can simply pay more wages from. Well they can't, especially when foriegn competition and foreign workers are only too happy to undercut prices in high cost countries.

[MarkG]

Wage increases and house price increases eroded their debt.

No. _WAGE INCREASES_ eroded their debt.

And, in case you haven't noticed, this isn't the 70s. In the 70s Britain was a heavily unionised manufacturing nation where workers had a lot of pricing power for their labour. Today jobs are being shipped to cheaper workers abroad or given to cheaper workers shipped into the UK.

Anyone who's expecting wage inflation to erode their debt is likely to be unpleasantly surprised.

[London Landlady]

Well i do have big feet!

Sorry for the frivolity

It's just that if a new posted comes on who is bullish - everyone shouts Troll - so as you are a new bear............

[OnlyMe]

Ask anyone who bought property in the 70's what happened to their mortgage. There are plenty of posters on here (who are older than me) who will testify that what I am saying is what actually happened. Wage increases and house price increases eroded their debt.

You should be asking what happened to people's wages relative to their costs. There is absolutely no gurantee that the outcome will be the same, none whatsover.

[Milkshock]

Ask anyone who bought property in the 70's what happened to their mortgage. There are plenty of posters on here (who are older than me) who will testify that what I am saying is what actually happened. Wage increases and house price increases eroded their debt.

Yes, but THIS IS NOT HAPPENING TODAY!

[Guest prudence]

high price inflation does not necessarily lead to higher wages particularly if you have a stagflationary situation where prices are rising but economic output is falling. In that case you are likely to have increasing unemployment and that in itself tends to lead to wages rising less sharply than would otherwise be the case as employees have reduced bargaining muscle.

[selkirk]

Yes, but THIS IS NOT HAPPENING TODAY!

I didn't say that it is, and I'm not making any forecasts. I was merely answering Gandalf's question.

[Limpet]

Too subtle?

Probably,.....just got under the radar

[Gandalf]

Sorry for the frivolity

It's just that if a new posted comes on who is bullish - everyone shouts Troll - so as you are a new bear............

If you had to stick a label on me then yes i guess it would be 'bear' however i just react to what i see around me. What i see is a crazy bubble of debt which by it's definaition is not stable. It surely has to pop and when it does many people will be in trouble.

For what it's worth i've read your posts on this site and have no problem with BTL'ers. I say good on you all that had the balls (not literally in your case) to go out there and make some money. I personally will look into this line of business myself WHEN the price of houses are reasonable. What happens between now and then is a matter of building finances in readyness to swoop at the trough.

[London Landlady]

If you had to stick a label on me then yes i guess it would be 'bear' however i just react to what i see around me. What i see is a crazy bubble of debt which by it's definaition is not stable. It surely has to pop and when it does many people will be in trouble.

For what it's worth i've read your posts on this site and have no problem with BTL'ers. I say good on you all that had the balls (not literally in your case) to go out there and make some money. I personally will look into this line of business myself WHEN the price of houses are reasonable. What happens between now and then is a matter of building finances in readyness to swoop at the trough.

Agree - but like all investments, some people will make bad decisions & others will make better ones - the ones who make the better decisions will amke money & vice versa..

[neilrich]

Gandalf

MarkG is mis-informing you.

During periods of high inflation, prices rise, including house prices. Wages also rise. But if you have mortgage, the debt stays the same (or rather it's paid off slowly over the years just as in a period of low inflation).

So, the value of your property increases, and your wages increase, but your debt stays the same. So in real terms your debt is decreasing. Thus, high inflation erodes debt.

This is exactly why Banks should be capping the income/lending multiple, the longterm average is 3.5 times a single persons salary or 2.5 for a couple with their combined salary. In this new era of low inflation and with the prospect of deflation at somepoint these multiples should be falling, NOT increasing by up to x6, back in the 1970's they had not even heard of deflation.

My plan is to limit myself to 1.5 times hence I'm trying to save up a rather large deposit.

If someone should say borrow with a multiple of 5, how are they going to protect themselves in the future, imagine unemployment continues to rise and the ecomomy slips into a recession, it shall happen at some point! What if the goverment also forces them to save and put money into a pension. These poor sods shall not have a leg to stand on.

Edited November 29, 2005 by neilrich