British financial pundits are suddenly feeling the gravitational pull of the Great European (aka Global) Black Hole of Debt.
Jeremy Warner in the Telegraph today feels the need to make brave and reassuring noises about the UK’s financial stability.
“With household debt at an eye-popping 160pc of disposable income, surely the real adjustment hasn’t even begun? If the nation really does start doing as David Cameron suggests, and paying off credit cards, then isn’t the main part of the damage to demand yet to come?
“Not necessarily. Household debt in the UK is undoubtedly high, but not as high as some. Ireland we all know about, but in economically-stable Holland and Denmark it is also much higher. In all these countries, the growth in household debt relative to income has been caused almost entirely by house prices.”
Oh, so that’s all right then. Blowing up a massive house price bubble doesn’t matter as long as your neighbours blew up even bigger ones.
“Those coming into the housing market have had to borrow a lot more to buy their homes than previous generations. Over the past 10 to 15 years, there has been a massive redistribution of wealth through the housing market from the younger to the older generation. You might call it a scandal, but you tend not to if you are living in a £1m house you paid just £100,000 for 25 years ago.”
Did you notice where Jeremy slipped-on his beer goggles there? Technically, a mind-boggling expansion of credit is not the same as a massive redistribution of wealth. House prices went up because the UK, the US, Ireland, China and a lot of countries went on the greatest borrowing binge in history.
The younger generation didn’t suddenly decide that £100,000 houses ought to be worth £1 million in real wealth. If they had, they’d have had to gather together every last piece of string, lump of sealing wax, wrinkly conker, chipped Dinky toy, PS2 game, etc. that they could lay their hands on and pawn it to raise the missing £900,000.
Do you think they actually had that much wealth? No. But Jeremy does.
“…although debt at 160pc of income looks high, it’s dwarfed by counterbalancing levels of household assets. Savings in financial assets alone are worth 450pc of income on average. Housing equity is worth more than 400pc. Net worth per household therefore comes in at more than 700pc of income. Despite its debt, Britain is still, by any standards, an extraordinarily wealthy country.”
It’s not wealth, Jeremy, it’s debt. House prices are only where they are because the banks loaned them all the way up there. They can only stay there if people keep borrowing more and more – which as yesterday’s post pointed out, people can no longer afford to do.
Round here in Cotswoldshire we’re starting to hear stories of “£750,000” houses quietly changing hands at £500,000, as we did a couple of years ago.
Pouf! A quarter of a million pounds of Mr Warner’s “wealth” instantly vanishes into thin air. If that goes on for a while, you end up finding you were just as well off with just the conkers, stale jelly babies and pocket fluff you started out with.
And that’s why the financiers and politicos and media moguls fear deflation like nothing else. It’s why they increasingly look towards Greece and Italy with the same horrid, paralysed fascination as a rabbit looking at a stoat.
Unless someone invents a perpetual motion machine, we will be able to say with certainty that financial bubbles will always collapse. And the bigger the bubble, the louder the pop. Right now, the euro area bubble is being kept inflated by sheer willpower and breathtaking sleight of hand: it’s a marvel to behold the weekly roller coaster of despair followed by false hope followed by deeper despair.
It can go on for much longer than you’d think but it can’t go on for ever. Debt collapses unless it is fed with more borrowing. But borrowing can only be supported in the long run by work. And in our high energy intensity industrial civilisation, that work is done by fossil fuels.
For most of the last century, fossil fuels were as good as free. For every unit of fossil energy needed to find, extract, process and deliver oil or coal or gas, you got 50 or 100 units of energy to play with. Civilisation could, and did, grow like topsy despite its own massive carelessness, wastefulness and frequent destructiveness.
We’re no smarter than the ancient Greeks but we’ve got easyJet and iPhones and family holidays in Orlando and Mauritius. Why? Because every citizen in Europe and America has several hundred ‘energy slaves’ working away for virtually nothing.
Or at least, they used to. Now the cheap oil is already gone, along with most of the best quality coal. More and more, we’re having to put our energy slaves to work just getting more energy. Net energy – what’s available to civilisation – is declining even though the gross amount of fossil fuel extracted is still marginally expanding. Forget about nuclear and renewables: they will help but they only pack a fraction of the firepower of fossil fuels.
We’re moving into an era where, whatever we do, less work will be done. The chart below is from an article by George Mobus on the Question Everything blog. I really recommend that you read it. It explains precisely why declining energy will have a profound effect on the debt-based economics that grew today’s civilisation (and which, on steroids, blew the massive bubble that’s collapsing around us).
Graph: Assets are produced as a function of net energy according to the equation above. This graph is for the aggregate of all asset types as described above. Assets decay or are consumed at a rate less than production as long as net energy is in its pre-peak phase. Assets continue to accumulate and the peak of asset accumulation comes after net and gross have both peaked. http://questioneverything.typepad.com.
It’s not a pretty prospect and it’s a very good reason for Governments to stop throwing more debt down the rat hole in the futile hope that they can somehow re-start the system they got used to over the last 100 years despite the absence of the necessary fuels.
Back at the Telegraph, Mr Warner chooses to look no further than his beer goggles will allow. “The problem,” as he sees it:
“…occurs because those with the assets tend not to be the same as those with the debt. As a rule of thumb, it’s the young who have the debt, and the old who have the assets. Even so, in aggregate, the debt doesn’t matter, and will only begin to decline in a meaningful way once there is a significant fall in house prices.” (My emphasis)
There you go. A couple of paragraphs earlier in his piece the debt did matter enough to have to be explained away by totting up Britain’s supposedly massive and real housing “wealth.” Now, suddenly, debt doesn’t matter – and neither, remarkably enough, does the value of houses, which Mr Warner happily expects to fall in order to evaporate the wealth-that-is-only-really-debt.
The big shock will come (to many of Mr Warner’s readers although I expect not to Mr Warner) when the value of houses and all other assets carries on falling without any offsetting increase in economic activity because there’s too little surplus energy in the system to support growth.
At worst, it could be like the Great Depression without the promise of a golden age of oil-fuelled expansion at the end of it. At best, humans should be smart enough to muddle through to a post-fossil-fuel, post-debt-based-growth form of capitalism with a degree of comfort and dignity.
But that will require the establishment to abandon their pet brand of faith-based economics and reality-distorting goggles, and we’re still a long way from that point.