Thursday, August 11, 2011

King: Savers MUST pay – ‘losses caused by vast debts to be “shared between creditors and debtors’

UK growth is now in China's hands

There should be no doubt in anyones mind about what Mervyn King is going to do '...only one way for the world to go, said the Bank's Governor Sir Mervyn King: for the pent-up losses caused by the vast debts amassed in the boom to be "shared between creditors and debtors". This, he said, meant "in the world economy between creditors in the East and debtors in the West, and within the euro-area between creditors in the North and debtors in the South". '

Posted by hpwatcher @ 08:14 AM (2360 views)
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27 thoughts on “King: Savers MUST pay – ‘losses caused by vast debts to be “shared between creditors and debtors’

  • When debt becomes too big and concentrated, creditors have no choice other than to write off or modify a portion of the debt. That is what is happening now and that is what has happened for thousands of years.

    We are now at the negotiation stage where the various parties beat their chests to maximise or minimize the write offs/modifications. King is just doing his bit in the chest beating process

    The process began quietly two years go and it will go on for another year or so. Once it completes, the whole cycle will start again. Breathe in, breathe out

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  • interesting phrasing Flash…. i wonder if anyone at your place looks at cycle analysis and where we are in them? [for whatever we look at] I must admit t a fascination of these. From the very short term – through to some might call seasonals to the longer term K waves. I have been looking a lot at Hurst lately, familiar? thoughts?

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  • Hi techie. The only way I would look at it would be to calculate how much of the debt remains to be modified/forgiven. To that end, I would estimate that the peak debts needed to be reduced/modified by circa 20% and that we are about one third of the way through that process.

    Kondratiev waves and the like work because they fundamentally recognise the inevitability of cycles. This fundamentally sound basis makes it hard for them not to work, to some extent. A mathematical approach has a degree of subjectivity to it, in the inputs, so it is no better or worse than any wave or cycle type approach. The breathe in, breathe out phrasing has been used for decades (and probably longer), so I cannot take credit for that

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  • techie: Just out of curiosity, I looked up ‘breathe in, breathe out’ to see if I could find some clever geezer who first used it in this context. I found lots of references to it but while I was looking, I found the following quote “Cycles are not economic theory, they are economic law”

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  • Hey Flash… Some time back more or less when i first came onto this site – there was some guy called Greenbay who was a BTLr and have given some regulars here a pretty bad time of it. He had obviously built his “empire” on the back of the great credit expansion, which to be fair had gone on for a lot longer than i and most others had expected. I pointed out to him however that there were very obvious signs (i.e. the tipping point in my opinion being Northern Rock) that credit conditions were reversing and that a tightening was on the way.

    I then said he should consider getting out then – while prices were still good – and perhaps buy back later. [much like you with your pl;ot of land]. i.e. to play the cycle. He said “there is no cycle in the property market” and “what did i know anyway? “. Obviously i wasnt going to rub his nose in it by mentioning the odd bar or two, but thought it was amusing for someone who had looked into and obviously done his homework at the micro level but not at the macro level. It reminds me of the stock pickers who value a stock based on what the company says it will do without analysing the market risk. Lambs to the slaughter really….

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  • Creditors will only ever make a concession if it is made abundantly clear that any other course of action will leave them worse off.

    – Do not expect charity from those you owe.

    The detail that jumps off the page when you look at the debts of the developed nations, is the assumption that inflation will stay low, not just now, but for the next half century. Considerable quantities of sovereign debt have long or very long maturation dates, with attendant low coupons.

    This presents those nations with the option of deliberately inflating those debts away, as a means of reducing their sovereign debt liabilities.

    If the US inflates the greenback down, China has the choice of either allowing its currency peg stay in place, and see its currency devalue in tandem, or allowing it to appreciate in order to maintain parity with a broader basket of currencies.

    My guess is they would grudgingly do the latter..

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  • “If the US inflates the greenback down” – UT your following alternatives make that sound like a forgone conclusion. They may try to do that but are you certain they will be able to?

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  • mark wadsworth says:

    Yes, in practice the creditors have to take some of the losses, call it what you will, debt-for-equity swap, bankruptcy, restructuring, rescheduling, inflation, negative interest rates etc, that’s all absolutely fine.

    But what King really means is that he will use inflation as a stealth tax on savers and creditors in order to prop up house prices and possibly share prices. Again, if we allow over-mortgaged people to escape (say) a quarter of their mortgage debts to get them back on track financially, that in itself is not objectionable PROVIDED THAT house prices are allowed to slide by (say) a quarter as well, or else the savers are just being shafted for no benefit and the Home-Owner-Ists incl. bankers are doing their usual trick of privatising the gains and socialising the losses.

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  • techie: For some reason most humans are wired to delude themselves. Greenbay probably had done his homework but his study was most likely constrained and guided by what he wanted to believe. Every boom in history has been accompanied by excited ‘new paradigm’ claims.

    I can’t take credit for playing any cycles with those plots. I really enjoy the process of building a house every few years, so when I saw some cheap plots, I bought them. Over the years I’ve attended a ton of night courses and much to the amusement of my mates, I’m a part qualified electrician, plumber and bricklayer. Grafting away in a sea of mud is a serious antidote to desk jockey work. Anyway, the local planners made such a nuisance of themselves that they took all the fun out of it, so sold I them again. No analysis or timing went into it

    The interesting thing about investing personal money in something tangible like housebuilding is that you can’t really lose (it’s a new paradigm!!). If you don’t borrow anything, it doesn’t really matter if house prices and land plummet (during the course of the project) because the eventual price of the product is still worth as much as it ever was, in terms of purchasing power for equivalent items. The same thing applies to rising prices because you still don’t end up with any more purchasing power, in real terms. Of course if you borrow money for the project then plummeting prices are a disaster and rising prices are a boon

    uncle tom: “Creditors will only ever make a concession if it is made abundantly clear that any other course of action will leave them worse off”

    It usually becomes abundantly clear in the end, so they do. They are bound to beat their chests in the run up because its annoying when people don’t cough up in full. It also usually becomes clear in the end, that the creditors share some responsibility for the imbalance

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  • techieman (Thursday, August 11, 2011 09:57AM) – I can remember many a late night debating alongside yourself with greenbay which was all good fun really, but one thing stands out from all of the comments he put forward and that is the lengths to which the Government/BOE would stretch to support the residential property market. I was briefly reading yesterday that some lenders are again offering golden goodbye’s to borrowers which rather illustrates the point he made some 3-4 years ago.

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  • Of course, the debt is likely to keep on growing too….

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  • Wadders: just a quick philosophical LVT question. How would you regard a situation vis-a-vis LVT, where an occupier/self builder of a house has caused his previously unusable land to rise in value, at great financial risk to himself and of course by way of hard work? I’m specifically thinking about earned/unearned increases in value

    I’ll flesh out a scenario:

    -3 meters of soil has to be removed from a nasty strip of blighted land, at great expense
    -A very expensive planning war is fought
    -Intellectual design and hard physical graft go into the build
    -His neighbours property goes up in value as a result of his improvement of an adjacent blighted strip of land (so they’ve got unearned income but he’s got earned income)

    My specific question is this: Can LVT theory distinguish between his hard earned increase in value and the unearned increases enjoyed by his neighbours? Would you advocate a different tax band in this scenario or can there be no exceptions?

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  • mark wadsworth says:

    Flash 12, sure, stripping out the contaminated land costs a lot of money, but wouldn’t a sensible purchaser knock that off the purchase price?

    If the government passed a law saying “Contaminated unused land has to be de-contaminated by the original owner or future purchaser” that might depress the selling price to a negative value. So if naughty Waddy Industries owns a site which would be worth £100,000 in uncontaminated state, but where it will cost me £150,000 to de-contaminate it, I’m happy to give your homebuilder the land for free with a £50,000 contribution on top. He then spends £150,000, uses up the £50,000 contribution from me and £100,000 of his own money and ends up with a site worth £100,000 at a cost of £100,000.

    The expensive planning war will also depress the purchase price, so if Waddy Industries and homebuilder know that he’ll have to spend another £30,000 on legal battles before the site becomes worth £100,000, my contribution to him to take the site off my hands is £80,000.

    For sure, the neighbours have unearned capital gain, but if the site is small, it is only a small gain to a few people and so what, frankly? maybe our homebuilder can pop round to all the neighbours and say “I will go ahead with the decontamination if you all chip in £5,000”?

    If the site is huge and benefits hundreds or neighbours significantly, then that would be sufficient to bump up values and hence the local LVT rate at the next revaltuation, so it all cancels out.

    The hard graft going in to the build is irrelevant*, that doesn’t affect the future LVT bill, the LVT bill is a sunk cost, it’s payable whatever you do whether you build a small house, a big house, a beautiful one or a monstrosity, whether it lasts a thousand years or collapses at the next downpour), you can just ignore it completely (again, if the LVT rate for that site is perceived to be “too high” it will depress the purchase price for the site).

    * Look on the bright side, under current rules, construction companies have huge tax bills as they go along, i.e. income tax and NIC for all the people working there, under full-on LVT there’s no income tax or NIC, so construction companies would usually end up paying less tax during construction phase.

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  • yep Jack on that he was right. I think they knew, had some contingency plans and were looking for an orderly correction rather than a panic. to that end “safari sogoody”

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  • China has kept its currency undervalued. This has been a core element to their growth strategy, with the downside risk being elevated levels of inflation. The downside risk it seems is now beginning to dominate (inflation hit 6.5% recently) despite efforts to tighten. The Chinese will tighten more which will eventually mean breaking the peg with the dollar.

    This will serve as the end to the great moderation. Initially western bond yields at the long end will spiral (to avoid the inflation that China will be exporting by tightening), this will result in a flight from Risk assets and especially a flight from equities and commodities. The March lows of 2009 will be broken, and eventually this will lead to a the end of the current secular bear market, with the FT 100 at about 2000 and the S and P at about 400.

    Time frame 2 – 4 years.

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  • Wadders: Thanks for the comprehensive answer. I’d better come clean and tell you that my story about a mate/hypothetical situation is actually closer to home. In a perfect world, land costs would take possible contamination into account and all the neighbours would chip in because its’ for their benefit etc. Unfortunately it hardly ever/never works like that.

    In my case I had the opportunity to purchase some land but I could only get ahead of the buying queue by acting very quickly and by offering cash. Most of the sellers of this type of land (too big for a self builder but too small for a national builder) will not deal with private punters and they think surveys and mortgages are for wimps. Building plots are so scarce in this neck of the woods that you sometimes have to be bold and a little reckless. If I had asked for a clause that gave me money back, in whatever eventuality, I would have been placed at the back of a very large queue. The seller of the land wanted what he called ‘adult’ buyers only and it was never offered through an estate agent. There is no chance that he would have permitted me to do a contamination test before signing. The attitude in this type of situation is that ‘adult’ buyers are expected to take the occasional fiasco on the chin. I made myself the preferred purchaser by presenting myself as a cavalier nerve-free buyer. That’s just the way it is, unfortunately and it’s why self-builders find it so hard to buy a decent plot. These days they advertise some plots as ‘for self-builders only”. What that means is that they are hideously overpriced and only saleable because someone’s’ wife wants to waste money on a Grand Designs style project. It all worked out well in the end but only because of risk acceptance and hard work. I suppose that all taxes systems will leave someone feeling justifiably hard done-by but that’s just the way of.

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  • mark wadsworth says:

    F, sure, but nobody is forced to go into this property developing malarkey (let alone self-build tomfoolery), that’s a risk of doing business, an ‘adult’ purchaser makes his own guess about whether site is contaminated, and if you guess wrong you lose money and if you guess right you make money. Some of these self builders do a fantastic job, build something lovely for cheap, others don;t have a clue and get totally ripped off and end up divorced and bankrupt a few years later. I take your point that neighbours wouldn’t chip in, so what, that’s life.

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  • bellwether: That’s one distinctly possible scenario but only one of many. The type of scenario you are describing is usually self-limiting. When a set of conditions become so overbearing that they can only cause the sort of end result you describe, then the conditions will often kill or moderate the root cause. A simple example is oil prices. When they start inexorably rising, the talk turns to entrenched inflation because oil is in such ‘permanently’ high demand etc. Then against most expectation, the oil price implodes and the inflation problem moderates

    In your scenario, the increasing Western bond yields (they couldn’t be contained by western boundaries) and the increasing Chinese interest rates would probably moderate Chinas inflation long before it got to the stage where money completely and utterly evacuated from commodities and equities. There will also come a time where Chinas domestic demand and appreciating currency (even when pegged, its been appreciating) nullifies some of exported inflation you mention.

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  • wadders:

    “F, sure, but nobody is forced to go into this property developing malarkey”

    In a way we are all forced to go into something because we can’t all be astronauts and porn stars. House building is really no more tomfoolery than something as prima facie sensible as being an actuary. The actuarial job may seem like less tomfoolery but there is always the hidden risk of being sacked or harassed. We are all at risk, working fools, one way or another and society needs someone to do every job

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  • mark wadsworth says:

    F, ignoring the land speculation aspect, I’ve a lot of respect of construction companies, house builders and so on, it is a high risk business but somehow it seems to work. I don’t begrudge them a 25% profit margin on a job because there’s always the risk that something will go against you – interest rates, a late planning appeal, discovering Roman relics, subsidence, whatever and they lose money on a lot of jobs.

    A lot of my clients are in that line of work, and most of them agree with the rule of thumb that you should sell the site as soon as you get planning – you can bank the relatively risk free windfall gain and leave the tricky bit to somebody else. Which is the bit that irks me – the biggest and easiest gain is made by the owner of the site who gets planning, and this is the gain which LVT would wipe out, thus leaving the actual wealth creator, risk takers – the construction company, the building site workers etc with a larger slice of the pie.

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  • Flash I think it times well with the notion that stocks are not cheap, on a CAPE basis, and never even got especially cheap even in early 2009. If we assume we are at anytime in either a secular bear or bull market, and this is a bear phase since say 2000, then we might expect it to end with stocks dirt cheap and no-one wanting to buy.

    A shift of the sort described in my last post would tend to bring the current system to an end (developing producing developed consuming), and post dislocation with the developed and developing markets working better together the basis for a new bull will emerge. Such a change will not happen without upheaval and at the time upheaval tends to be bad for risk assets.

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  • wadders: You wont get any argument from me there. The seller usually makes his dough by doing nothing and the builder takes all the risk, while employing local people, buying local materials and creating something tangible and worthwhile. Farmers are the worst. They sell off tiny parcels of crap land at the margins of their farms and make enough to retire on, each time. Most of them will run out of small parcels to sell in about 200 generations time.

    You have one preferred solution to this jointly acknowledged problem and I have another (more liberal planning laws and compulsory land purchases for the building of a million or so council houses)

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  • bellwether: I hear what you are saying but I don’t believe that we are being inevitably and irrevocably pulled towards a black hole moment of upheaval and subsequent rebirth. I am firmly of the opinion that the world operates in a system of kinetic chaos (with an incalculable number of variables). In such a system, anything is possible and any one specific scenario is unlikely

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  • mark wadsworth says:

    Flash, in economic terms, LVT and council housing is the same thing*, it’s just that LVT is cooler and better.

    * Thought experiment – the Liberal government of 1909 had simply not bothered trying to introduce LVT against stiff resistance from the House of Landowners and had just built social housing for the 90% of people who were private tenants, and every government since had done the same. There’d be no credit crisis, no house price bubbles as nothing to buy or sell, no nequity and barely any taxation as the UK government could get all its income from rents.

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  • Flash, generally speaking I tend to agree with you, although I’m a bit of a sucker for patterns and cycles, and I’m rather attached to the notion of secular bull and bear markets. History seems to suggest some kind of cycle, although even if that’s the case, obviously it doesn’t mean it will happen this time, or even again.

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  • Wadders: Well, we both agree on the benefits of building council houses, so perhaps you will indulge me in my mass building fantasy:

    The one million or so council houses should be built to a size and specification that matches the stock of other first world countries (i.e. much bigger and posher). Compulsory purchases of land would make these larger homes possible.

    These larger, posher homes would increase the living standards of the inhabitants which is always desirable

    Millions of local people would be employed building and manufacturing/selling materials (a far more effective stimulus than lowering interest rates)

    The greatly increased stock of council houses would lower the living costs of our population (social and private), which in turn would make Britain more competitive

    The larger size of the new council houses would drastically reduce the price and desirability of much smaller private dwellings. Ultimately these small private dwellings would end up providing economical housing to pensioners, divorcees and first time buyers

    The increased volume of housing stock would reduce house prices, across the board

    For reasons that you already understand and I can’t be bothered to explain, this mass building project would ultimately cost the country nothing. As you would say, what not to like?

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  • mark wadsworth says:

    Flash, from where I’m sitting, that looks like a splendid plan.

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