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iiblack

Property, Pensions and the Great British Ponzi (and when and why it will unwind)

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The simple mathematical reality is that after many decades where global change bestowed great fortune on the UK, its long-ignored balance of payments problem is now set to cause immense chaos and societal change in coming years.

In my career in hedge funds I traded mortgage bonds, including through the credit crisis of 07/08 and this gives me great insight into the nature of what is now afoot in the UK. The UK economy is like no other I know. It simply doesn’t work like other economies which is why so few understand it. Most leading economists (alongside politicians and journalists) choose to ignore its terrifying and ever spiraling balance of payments crisis because they can’t incorporate this unpredictable ticking time-bomb into their short-term outlook or forecasts.

Many countries, including Japan and much of southern Europe, have horrific balance sheets. From most perspectives (though not all), the UK has a better balance sheet. The problem the UK has is cashflow and this is what makes it so unusual amongst leading economies. Cashflow is ultimately what takes you down, whatever your credit rating, life gets difficult when you can’t find the money for the rent and can’t afford food for your family…..In the case of the UK a vast torrent of money leaves the country every day – mainly in the form of interest, dividends, rent (on British assets owned by foreigners) and payment for imports. Far less of these things comes back – this is our vast balance of payments crisis which means a big chunk of the economy, over 5% of GDP in recent years, is lost to the rest of the world every year. You don’t need to be an economist to realise this isn’t sustainable

What balances this immense outflow and keeps the UK solvent and able to ‘pay the rent’? Inflows of money from foreigners abroad, what else? Mainly purchases of British assets – such as giant swathes of London property. Also loans from foreigners – such as the purchase of government Gilts. What matters is that these immense inflows are not being invested productively in the British economy, they are simply being used to fund the cash pouring out.  In this way more and more of the economy becomes owned by foreigners and more and more return must be paid out of the economy to these foreigners every year. Look at the British Office for National Statistics graph of Britain’s balance of payments deficit from 1955 to the present and you see it spiralling exponentially (See ONS graphs), not just in absolute ₤ terms but crucially also as a percentage of GDP. This illustrates graphically the catastrophic scale of the cancer growing at the heart of the British economy. If nothing changes then within ten years the UK will have transferred ownership equivalent to over 50% of its economy to foreigners – well before then it will have failed at the futile game of selling ever-greater pieces of itself off to service its debts. The consequences of this for the economy and the currency are grave

What led to this situation? In many ways it is the innate attractiveness of Britain that allowed this imbalance to grow for decades when in other countries it simply never could have. The uniquely respected British legal system and the stability of British politics provide enormous security to foreign investors that they struggle to find elsewhere. Since the mid-1980s and the abolition of capital controls, capital has been on the move and the world loves the UK brand. Thatcher’s monetarism raised interest rates long and hard to control inflation and the vast bonanza of North Sea oil began to flow, together keeping Sterling at levels which made much of British industry uncompetitive and laid waste vast tracts of formerly industrial northern England (since when England simply doesn’t make all that much). Ever since the millenium a vast influx of foreign investment, from Russia, the Middle East and beyond, poured into London property. And even gilts became a haven as Europe entered its (first) decade of crisis. Before the 1980s small balance of payment deficits would frequently lead to sterling crises. But from the 1980s onwards the world has financed the cancer to grow unchecked, to now monstrous proportions. But North sea oil production has now collapsed, can the UK keep selling London houses forever to keep the cash flowing?

As for Brexit, it may mean the point at which world is no longer able or inclined to support this British Ponzi scheme is coming far sooner. If that is the case then my view is better that the Ponzi ends now rather than later when it will have grown exponentially

Ultimately sterling has to weaken dramatically until the point arrives when the world wants to invest in productive capacity in the UK (rather than simply buy UK assets). This means, amongst other things, investment to build companies that pay employees, pay taxes and which may generate exports –  and a UK that no longer haemorrhages so much into payments for imports. This would be a rebalancing of the current account deficit. Given the stability of the UK and its institutions, its fairly well educated population and relatively low tax economy, this rebalancing should be forthcoming when sterling remains low enough for long enough. Those vast tracts of indsutrial wasteland in northern England might then see new industrial businesses sprouting up

But there are great risks that the transition from Ponzi to real economy might be brutally hard. Above all else a huge property bubble has engulfed London and the south of England (home of the majority of UK GDP) with affordability falling to record lows as house prices reach nose-bleed valuations and house-price-to-earnings ratios reach levels never seen before. A culture has arisen similar to that seen in the US before the 2007 housing crash with a certainty that house prices can only rise and people wishing to throw every penny of their investment at the market. Who can blame them when even the Bank of England chief economist tells people not to bother with pensions but to buy houses instead. Whilst a lack of housing supply is often cited, low interest and mortgage rates are driving the bubble. As Albert Edwards explains, were lack of supply the primary driver, rents like house prices, would be rising well in excess of CPI, whereas they have broadly risen in line over the last ten years. When the UK loses control of its current account it will lose control of interest rates and will need to raise these to protect its currency and maintain basic living standards. At this point the floating mortgage rates of the UK will rise sharply and the decline in sterling resulting from this event will lead to inflation in costs which would severely diminish the earnings of individuals free to service rent or mortgages

Lets remember that most British property by value is owned by the Boomers – the generation born in the two decades after the war and greatest beneficiary of the housing boom and bubble – over 2,000 of whom now celebrate their 70th birthday everyday in the UK. Their life expectancy is now thankfully high, to well into their eighties, but few have more than modest savings or pension provision (although a lucky fraction have generous defined benefit pensions). In embarking on additional Quantitative Easing (printing money to buy gilts) since Brexit, the Bank of England has crushed long-term gilt rates which has devastated the solvency of defined benefit pensions schemes and the companies that must support the schemes. It also means annuities now pay almost nothing. To support themselves over the remainder of their life it is inevitable that most pensioners will turn sooner or later to the asset all or most of their wealth is tied up in – their house. The store of equity accumulated in British property may well soon be drawn upon on a net basis for the first time. My concern is that whether through interest rate rises in a current account crisis or simply through the need for Britains to draw on their property wealth in retirement, the bubble will burst and a downward spiral in prices will begin. That could then lead to foreign investors selling their British assets to withdraw capital from the economy which would devastate the currency and current account still further. Property is the second layer to the great British Ponzi, it is simply unlikely there will be enough wealth generation elsewhere in private Britain in coming years to avoid it being plundered as an asset class to support life-long living expenses amongst a public whose wages have been dropping or stagnating in real terms for almost a decade

For those who instantly respond that the Bank of England could simply print more money or cut interest rates (negatively if necessary) to support the property market, realise that in a current account crisis they absolutely cannot do so. It would be adding fuel to the fire and in these circumstances they will be doing everything they can to support sterling to keep shop shelves full and petrol stations pumping, not to weaken it. Until then the Bank of England is doing all they can to repress sterling yields and to weaken sterling, for which the Brexit vote provided them with much ammunition, in the hope that a greatly depressed currency will cause an industrial rebalancing before the onset of a current account crisis. For me, it may delay the crisis but the arithmetic is stark and unchanged

The Bank of England need to be very careful, currently Britain is expecting the rest of the world to finance its vast twin deficits, to finance its current account deficit and to finance much of its fiscal deficit at negative real interest rates – with inflation exceeding the return paid – which is equivalent to living on handouts. If we were running a current account surplus as Europe does, we might well be able to embark on a fiscal stimulus adventure, perhaps in infrastructure spending, but for a country that is completely reliant both on low rates and on the rest of the world to tide itself over this would be suicidally reckless.

In the event of a current account crisis the British fiscal deficit and enormous national debt (fortunately fairly long-dated), which would need to be financed and rolled at prevailing interest rates could then become an issue of national solvency if markets concluded a debt spiral was unavoidable. Then we have the risk of a change of government – seemingly very unlikely at present though this could quickly change if the public were suffering in a crisis, had lost much of their home equity and felt they had little to lose. Or even over time if the proportion of homeowners simply continues to plunge. As I write Ladbrokes has Jeremy Corbyn as the favourite individual to succeed Theresa May as next prime minister at 5/1 – if this was to occur market confidence would be devastated

The real question in all this is whether there is a sustainable economic model that the UK can migrate to without a severe and permanent diminution of its people’s living standards – and how it could navigate such a transition without a long and brutal adjustment

Britain has come through darker times before and will come through these, stronger and more balanced than before. But the time for self-delusion over the reality of what Britain faces is over

Full blog :-https://iiblack.wordpress.com/2016/08/16/example-title/

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Nice.

 

I like the bit about boomers generally having no savings or pensions. This is why they are so easily bribed by stupid state pension promises.

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Consistent wth what Danny dorling has said. I believe Michael portillo is pretty much of this opinion too.

 

Steady state finance my bum

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1 minute ago, Maynardgravy said:

...If nothing changes then within ten years the UK will have transferred ownership equivalent to over 50% of its economy to foreigners...

Shambolic.

Perhap It is all part of a cunning plan. Once we reach this stage, anything leaving the country can be taxed at 99 percent. As these people and companies don't have a vote, they cannot change the government through the ballot box

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1 minute ago, One-percent said:

Perhap It is all part of a cunning plan. Once we reach this stage, anything leaving the country can be taxed at 99 percent. As these people and companies don't have a vote, they cannot change the government through the ballot box

They can just put the rent up.

How does it go?................ innit.

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China will implode long before this.Their property bubble is insane.I import from China and have a Chinese lady who handles my business over there who i speak to weekly.27% of new builds remain unsold yet house prices are about 20 times incomes.Most workers are unskilled, and i mean unskilled.They stand on production lines needing constant supervision to do the most simple tasks like putting four bolts in.

Europe is a complete mess.Germany has terrible demographics,worse than Japans before they went into a depression.Importing 1 million welfare claims who will never work wont help that.Southern Europe is gone.Italy is a basket case.

I think everything is going down next year,but i think its all going down together.It might be a case of being nimble and picking up firesale assets before a currency crash.We live in interesting times.

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Excellent article. I have looked at the trade balance chart for nearly a decade and just cant believe £ has not seriously collapsed. But hey you can super-cool a liquid below its freezing point and it will remain a liquid - but only for so long - helps if it is seeded with a very cold particle..

As far as £ fall is concerned - regarding the property market -  it is a" vicious" circle. £ falls inflation up, less affordability to buy and rent. Prices fall. Millions of E Europeans see wages compared to homeland fall, and the pull of returning home for all expats is strong ( I was one) . Demand falls, rents and prices fall. Oh and as they sell their nest egg £, £ fall further thus exacerbating the situation.

Personally I don't see BoE stepping in much and feel when the £ crises comes we are looking at below parity with  Euro - say Euro = £1.20.

For those who think this is crazy have a look at cost of living rent/houses/sports/eating out/films/etc. Forget BigMac index  The UK is a rip-off and £ hugely overvalued

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20 hours ago, iiblack said:

Britain has come through darker times before and will come through these, stronger and more balanced than before. 

When?

After WWII we came out far, far weaker and have remained weaker ever since.

But good post though - should lead to some good discussions.

Edited by Errol

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1 hour ago, Maynardgravy said:

...If nothing changes then within ten years the UK will have transferred ownership equivalent to over 50% of its economy to foreigners...

Shambolic.

Treasonous even.

Excellent first post btw.

Edited by Eddie_George

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Is anyone really surprised? Look at the situation with Hinkley Point, a British nuclear power station that is going to be built by the French and financed by the Chinese. Look at how ARM was basically given away to the Japanese. That is just a microcosm for the overall British economy, and the government seem to think this is fantastic for Britain that we're losing control over investment in key national assets. Can you imagine the Chinese or the French allowing critical infrastructure or assets fall out of domestic ownership like we do?

 

Look at the FTSE ownership levels. 54% of the index is owned by foreigners, and that percentage is rising. It seems instead of investing in productive assets, as a nation we've become property mad. The killing this is that because the obsession with property has become so great, we're now allowing bad money to drive out good money. The illusion of wealth that is generated from buying and selling over-inflated houses to each other is a constant source of leakage (spent on imported BMW's, Gucci handbags, foreign holidays, etc.). In fairness, I do think the powers that be recognise this. What can they do though? When the fate of the nation is decided by those with the most to lose from a property crash, of course they're going to do all they can to stop it. The political will just isn't there to call a halt to it all.

 

So what happens from here? Well, I think the implementation of Brexit really is key. If we go down the route of a hard Brexit where immigration is restricted and we lose common market access, then I fear for the country. An exodus of immigrants is will be a deflationary event for the UK and if we spook exporters enough, then we're undoubtedly going to see jobs go abroad.

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1 hour ago, Errol said:

When?

After WWII we came out far, far weaker and have remained weaker ever since.

But good post though - should lead to some good discussions.

Living standards were low, health service and education expectations very low and demographics excellent in that the retired just died at 70. So, however, high the debt to GDP ratios appeared and indeed house prices to incomes (an eye watering nine times in 1949) then we always had the growth card and the fact we hadn't actually promised ourselves the moon and back in retirement. Now we are saddled with impossible health and welfare promises and we just don't have the growth to meet them.

 

The worst of it is we are trying to buy ourselves time, epsecially with regard to the retirement Ponzi, by importing people; who eventually will want repaying several times their worth in retirement and health benefits,

Edited by crashmonitor

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Interesting article. But I am often left wondering at a much lower level that if we all agree a hurricane is coming - then where should we be standing to keep safe? 

Assuming you have something to lose then where is the best position to take? Cash, equities, gold, property. How does an individual best mitigate their own position?

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Been stocking up on certain items that are extremely volatile in price while the going is good, car tyres are a good example, if you are putting off buying some to squeeze a few more miles out then don't bother, get them now as they will cost you much more in the next few months.

With no return on your money you will need to make it go further by predicting what things will cost in the future as exchange rates are hammered.

Can't wait to see what happens to the price of German cars, I expect to see their dealerships closing and Suzuki ones on the up as people switch to more sensibly priced but still reasonably well made alternatives.

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Good point about German cars , will be nice to have fewer audi merc and bmws up your ar3e. Itll be like the 70s again when foreign cars and holidays were very rare.

 

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1 hour ago, ChewingGrass said:

Been stocking up on certain items that are extremely volatile in price while the going is good, car tyres are a good example, if you are putting off buying some to squeeze a few more miles out then don't bother, get them now as they will cost you much more in the next few months.

With no return on your money you will need to make it go further by predicting what things will cost in the future as exchange rates are hammered.

Can't wait to see what happens to the price of German cars, I expect to see their dealerships closing and Suzuki ones on the up as people switch to more sensibly priced but still reasonably well made alternatives.

If the EU try to hammer us over trade deals, then I suspect the various Asian car building nations will be keen to replace our German car imports with Asian equivalents. Not sure what France think punishing us will achieve.

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6 minutes ago, Si1 said:

If the EU try to hammer us over trade deals, then I suspect the various Asian car building nations will be keen to replace our German car imports with Asian equivalents. Not sure what France think punishing us will achieve.

We (the UK)  don't have a monopoly on stupid & self serving politicians who fail to consider the potential consequences of their actions.......

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That is a great first post @iiblack.

There is one thing you appear to have overlooked though.

A sudden and quite massive weakening of the currency gives foreign buyers of UK assets a massive shot in the arm. We have already seen this with US and other foreign funds snapping up "bargains" on the FTSE 100.

A weaker pound should eventually lead to renewed growth of manufacturing in the UK, but this will take time (I'm thinking 5-10 years, not 6 months). In the UK it will actually take longer than most comparable countries because successive governments of both colours have been positioning the UK as a "knowledge economy". This is detrimental to manufacturing on multiple levels, but three critical aspects are;

mindset - at every level of government there is no clear policy or process for encouraging new industrial growth. e.g. Planning permission is hard to come by, land is expensive and often owned by others.

workforce - the UK has managed to maintain the adversarial us vs them mindset both from potential staff and employers. It also has a particular problem with a large number of "overqualified" young people and a high number of people of all ages with "zero skills" - the ideal for manufacturing is somewhere in the middle. The cost of living is high in the UK for these semi-skilled staff, meaning they will require higher wages than someone in say Poland or Romania.

infrastructure - the road and rail network are suffering from years of underinvestment (and in the case of rail - mismanagement), the power network is creaking at the seams and we are about ten years late building new nuclear power stations.

Toss in huge uncertainty about tariffs, quotas and access to nearby markets into the mix and you have a poisonous blend that would put off all but the most determined investor. 

In summary - you can negotiate the purchase of a British power station or a tranche of land in prime London from China much quicker than you can plan, finance, build, staff and tool a factory if you are in the UK.

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15 hours ago, Phil321 said:

Assuming you have something to lose then where is the best position to take? Cash, equities, gold, property. How does an individual best mitigate their own position?

My previous actions were :

1. Buy property from desperate seller in the 2010 dip with large garden for outbuildings and growing food 
2. Equities in the 2016 dips. Mostly those with non-£ earnings in boring markets.
3. Maximise use of low-charge SIPP to defer taxes, reducing my marginal rate from 65%+ to 15%

Next actions are:

1. Decline pay rises and make use of EMI option schemes to reduce marginal rates income from 65+% to ~5%.
2. Keep some cash in SIPP for occasional opportunities, e.g. P2P lending when the platform supports it
3. Some platinum when it gets cheap enough. I generally hate non-yielding investments but at least it's nice and shiny.
4. Develop outbuilding(s) for kids or tax-free rental income
 

and generally spend as little as possible on consumption....

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37 minutes ago, VeryMeanReversion said:

Next actions are:

1. Decline pay rises and make use of EMI option schemes to reduce marginal rates income from 65+% to ~5%.
2. Keep some cash in SIPP for occasional opportunities, e.g. P2P lending when the platform supports it
3. Some platinum when it gets cheap enough. I generally hate non-yielding investments but at least it's nice and shiny.
 

Hey VMR - I'm doing pretty much everything you wrote *except* declining pay rises. Would you mind going into why you would do that?

I already work part time, but I'm trying to up my paye income at the moment by moving jobs. Almost everything above the Personal allowance is obvs going in the SIPP either way so at the moment, my effective tax rate (pre vat, c tax etc) is 3% (for anyone shocked reading this,  we've gone into the reasons ad nauseum on the 'not supporting the rotten system' thread), but in the case where someone offered me more money where my options for sheltering it in the SIPP expire, I'm unlikely to refuse it even if it does mean my marginal rate increases and I end up paying a little more tax.

Intrigued to know if there's something I'm missing?

 

Edit - PS platinum is already cheap enough imho - $300 less per ounce than gold. The annoyance is paying VAT, but if I'm picking between a gold kruggerand and an plat maple, it's the maple all the way at the mo.

Edited by Frugal Git

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33 minutes ago, Grumpysod said:

There has been a number of threads on HPC about prices of everything going up soon, with the exception of houses hopefully. I seriously think I must be one of the only people that welcomes this. I am old enough to remember what it was like to brew your own 10 gallons of ale with your mates and on the magic day when it was finally ready necking it in the garage with your buddies, male bonding at it's best.

We have lost that feeling of appreciating so many things, I earn good money these days, but I still look up at the heavens when I come out of Lidl with loads healthy shopping and a good malt whiskey for less than £60, cannot say many other do the same. We have unemployed people in this day and age getting obese, how is that even possible, you have un employed people(the idle ones I might add) who think it is a god given right to have things  I  still see as luxuries, people carriers even in some cases.

 

People complain about food inflation, and maybe they have a point with some red meats. But it was not that long ago in our history that it was struggle just to work hard enough in a day to put a meal on the table, I could feed myself well for a week on one hours work now. We could be well reaching a point now where the priorities change rapidly and people realise they will not get sick or die if they do not pay the rent of large mortgage, but they will if the do not eat, and they might soon be forced to make that choice.

It still cracks me up when self righteous people put a little food in food charity banks these days, when the real wage guzzler was shelter and housing, if these people offered highly affordable digs for the young maybe, then I would be impressed, then they would have no problem supporting themselves and paying there way.

I'm with you on all of this. The squeeze on incomes because of the inflation in essentials will be a reality check and when people (glacially slowly) realise how they've been duped into pledging it all on the bricks round them, it'll be a good thing.

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43 minutes ago, Grumpysod said:

There has been a number of threads on HPC about prices of everything going up soon, with the exception of houses hopefully. I seriously think I must be one of the only people that welcomes this. I am old enough to remember what it was like to brew your own 10 gallons of ale with your mates and on the magic day when it was finally ready necking it in the garage with your buddies, male bonding at it's best.

There is nothing like huddling around the Gaz stove with your 3 month old child for family bonding. Or so my parents tell me.

Not being able to get expensive cancer treatments on the NHS will probably suck a bit though. If you have cancer.

You are right about food prices. Food in the UK is extremely cheap by almost any standards. As the prices rise hopefully this improve the health of the nation.

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14 hours ago, ChewingGrass said:

Been stocking up on certain items that are extremely volatile in price while the going is good, car tyres are a good example, if you are putting off buying some to squeeze a few more miles out then don't bother, get them now as they will cost you much more in the next few months.

With no return on your money you will need to make it go further by predicting what things will cost in the future as exchange rates are hammered.

Can't wait to see what happens to the price of German cars, I expect to see their dealerships closing and Suzuki ones on the up as people switch to more sensibly priced but still reasonably well made alternatives.

My family is battening down the hatches for the coming storm. 

Good point re. the German cars and for that reason I have brought forward my purchase of a cheap run around by a year. Currently drive a BMW 120D sport on a two year lease (and before that a Mercedes C250CDi AMG Sport Estate), the change is this one will be a PCP on a Skoda Citigo Colour edition that I've manage to get with a whopping discount and on 0% so my monthly instalment has halved again (merc £350, Beamer £250) to £118. This could be my 10 year car. I don't expect prices to be as competive in the next quarter or any other quarter after that. 

I'm impressing no one, least of all my self driving around in posh cars. 

#proudtobeanillionaire

Edited by longtomsilver

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