A Courier article – published here 2 weeks after publication in the paper itself.
I write this on the day that Mr Osborne has raised the rate of VAT to 20%. This is necessary, we are to understand, because without that extra income, the budget will not balance and the country will go bankrupt. Sadly, barring a miracle, I don’t see any way in which some form of bankruptcy can be avoided. Now, before I go further, I should say: this is going to be a very depressing article, so don’t read it until you’re in a robustly positive frame of mind (that, or quite convinced, with me, that the Rector’s reckoning can be wrong).
The future that we face over the next, say, eighteen months to five years, is one of financial depression, specifically deflation. Why do I say this? Well, let us begin by pondering some figures – these are in TRILLIONS of US dollars:
World gross product per year: 55
Total value of global issued currency: 65
Total value of world stock markets: 100
Total value of world real estate: 125
(So far so good, now for the kicker)
Total value of financial derivatives: 1600
Financial derivatives are all those complicated things we’ve heard about on the news over the last few years, like ‘sub-prime mortgages’ and ‘credit default swaps’. The simple conclusion from the above figures is that the financial world has long-since lost touch with the real world of tangible wealth. There simply isn’t enough real wealth corresponding to all the financial obligations that have now been entered into. To put this in simpler, more graphic terms – imagine the amount of wealth in the world as a cake. What the comparatively recent explosion in nominal financial wealth has done is to give a great many different people legal claims to the same bit of cake. On paper, the financial world says that we have a great many cakes – unfortunately there is only the one.
What this means is that the financial system is irretrievably bankrupt. Over the next few years we are going to see something called ‘deleveraging’ – in essence, all the debts are going to be called in. In Warren Buffett’s famous image, ‘we’re going to watch the tide go out and find out who has been swimming without their trunks on’. We are in what I think of as a ‘Wile E Coyote moment’ – remember the great Looney Tunes character, who sprints after the road runner over the edge of the cliff, and manages to keep running on thin air until the moment that he looks down?
Our political leadership has been committed to keeping the show on the road for as long as possible – or at least for long enough to ensure that the movers and shakers are able to get some measure of safety for themselves, eg with the bonuses still being given to Goldman Sachs and other bankers – but they are rapidly running out of options. What we are going to end up living through is a severe contraction of the money supply, what the economists call deflation. Most people are familiar with inflation – the price of everthing goes up – but we’re less familiar with deflation. It sounds at first like a good thing – the price of everything goes down – but the problem is that in a deflation our ability to pay goes down faster. It won’t matter if the average shopping bill comes down to £50 a week rather than £80 if the impact of unemployment and bankruptcies now means that families can only afford to pay £30 rather than £75.
We have been here before – in the 1930s most spectacularly – and the consequences are frightening. One way to get a handle on what it means is to consider real interest rates. If a bank charges a 5% interest rate, and inflation is running at 2%, then the real interest rate is 3% (bank charge minus inflation). However, in a time of deflation, the cost of money could become very high (with consequent damage to the economy) even when the nominal rate of interest is low, or zero (eg bank rate of 1%, deflation of -3% gives a real rate of 4% – the two negatives become a positive). Governments who try to stimulate activity in this context are ‘pushing on a string’, with just as much effect (look at Japan’s recent history). In this context, the very worst place to be is in debt, because the real value of the debt will increase rapidly. That applies especially to mortgages, as the nominal price of housing is likely to plummet leaving a great many people with massive negative equity.
Thomas Hardy once wrote, ‘If a path to the better there be, it begins with a full look at the worst’ (but see here). I’ve only skimmed over the nature of our financial crisis in this article – those who want to explore the background for this post might like to visit a blog site called ‘The Automatic Earth‘ which is where I got the figures from. There is a very great deal that people can do to prepare for these and the other crises that are accumulating around us, linked to the Transition process – but I’ll have to give the positive side in another article.