You might think house prices are not that important, but the reality is, credit cycles caused by the purchase of land are the primary economic driver in the modern debt based economy (USA, UK, Australia, New Zealand).
The UK is in the middle of a ‘housing crisis’. What this ‘crisis’ constitutes is debatable. Is it a crisis of failing to put roofs over heads i.e. a problem of overcrowded, decrepit properties, and homelessness caused my material lack of habitable space? Or is it simply a crisis of affordability? Most likely it is a combination of the two.
The UK economy, whether by design or by chance has become something of a one trick pony, almost totally reliant on investment in the property market. Residential and commercial, domestic and foreign; the property market has widespread appeal, and for good reason; British law and property rights are well regarded throughout the world, and this combined with over forty years of falling interest rates have resulted in property being seen as the safe haven for personal wealth in a world awash with funny money.
Since credit has existed, the majority has gone into the purchase of land and property, inflating its price. The property market is like any other market; the more money flows into it, the higher the price goes. Cycles of expanding and contracting credit are what drives economies, but also lead to economically damaging booms and busts; the credit expands until it becomes unserviceable, at which point it shrinks. As credit makes up the majority of the money supply in a economy, when the credit shrinks the money supply does too. It leads to an interesting paradox; while excessive debt is very damaging to economic activity, in the absence of any other means of providing liquidity (cash), the only proposed solution is to encourage more indebtedness. Just as ‘hair of the dog’ does not cure a hangover, more debt just prolongs the malaise until a future, more painful day of fiscal sobriety.
Mortgage credit affordability is not tethered to incomes, but to interest rates
While rent is paid for out of household income, which means that rental prices are tethered to the reality of household salaries (no one would ever consider taking out a mortgage to pay the rent), mortgages are not.
Money creation into the property market need bear no relevance to reality as long as it is deemed to be ‘affordable’ in terms of monthly payments. As interest rates have fallen, so greater and greater loans have become ‘affordable’ when stretched over 30, 35 and even 40 years.
This would be fine if the interest rate was fixed for the duration of the loan term, but it isn’t. It is fixed for a maximum of 5 years, after which the debt is refinanced according to the latest interest rates. This basically means that you have to buy your house every five years, at whatever the current cost of money happens to be. This leaves households at the mercy of central banks’ interest rate setting, and the retail banking sector spread between base rates and what they choose to charge.
The inflation caused by credit creation has made the stock of UK houses more expensive to buy. They are largely the same houses, just much more expensive than they were. Why can’t we have cheaper houses? One supposes that we could, if a will existed at governmental and central bank level to provide them. Mark Carney may resemble a cross between George Clooney and the Milk Tray man, but any ex JP Morgan man knows their financial onions, and Carney understands what he’s doing.
He knows that the largest portion of money in the UK economy is credit, and he understands credit cycles, and will not do anything to fracture a fragile banking sector before it has recapitalised itself and is ready to start making loans again, thereby increasing the money supply. So interest rates languish until he gets the green light from his mates at Barclays, HSBC, JP Morgan etc. This is the situation in which we find ourselves today.
Buying a house as an inflationary hedge
When most of the money in an economy is created as credit and flows into a specific asset class, buying into that asset class is the only way to hedge against inflation of the money supply. If you own a house, some of the extra cash created will eventually come to you, when you sell. If you don’t own a house, you’re left behind by inflation, and your chances of owning a house grow slimmer by the day.
Once upon a time a sole parent working in a normal job could afford to support the family, including paying for the roof over their heads. Nowadays it is much more likely to be both parents working full time. Granted, some of these individuals actually want to work, but there are plenty who would rather stay at home and raise their own children. So why the shift to two earners? Because when credit is only limited by individuals’ ability to pay it back, you can always send another person out to work.
The amount of credit that banks can create is practically unlimited, and has a virtually zero cost of production. Wouldn’t you like to sit back and make millions on the back of compound interest on a ‘product’ (credit) that costs virtually nothing to bring into existence, that didn’t exist beforehand, that was the equivalent of real money, and had the full backing of the government if anything went wrong? It certainly beats working for a living.
It’s not as though banks even have the overhead cost of printing and distributing bank notes or coins, they just type some numbers into a computer database. The royal mint, which banks contribute nothing towards the cost of, pays for the paper cash that bank credit is very often converted into.
Let me be clear. I’m not bashing banks. I just think they have an overly privileged existence, with zero risk and their hands on the money printing machine. Many of my friends work in the city, and they are very intelligent people, but I don’t wonder whether their intelligence might be better spent in other pursuits. I don’t begrudge them their success or their multimillion pound houses, but as an engineer looking in, I cannot accept that the current monetary status quo is helping to take the UK forward in any progressive way. I want to see cost of living fall, I want to see happier people, I want to see people fairly rewarded for the value that they contribute to society, I want to see technological progress and investment in the areas in life which will improve standards for all.
In the current economic and monetary setup then, the UK’s money supply is not created by the Bank of England, rather it is loaned into existence by retail banks when they ‘make loans’ (make being the operative word).
Homes for British families or diversified investment portfolios?
The government, by failing to place adequate importance on British families’ most basic requirement of shelter, has (through its constant interference in the property market) encouraged the circumstances which have raised the cost of living for the majority, scuppered the value of pensions (which has driven even more money into the property market), prioritised rent seeking activities over productive ones (everyone it seems is a buy to let landlord) and sidelined family creation and home ownership, forcing many young families to rent or decades of debt servitude.
Houses cost a fortune because interest rates are low. Falling rates means the market can continue to grow as households can afford to borrow more. The reason rates are at an all time low is because raising them will not just bust the banking sector, but put an inordinate strain on governments finances.
The government seems to think that a material lack of houses is the primary reason for rising prices; that it is simple supply and demand of houses at work, but the real cause of expensive housing is one of unlimited supply of credit, not housing. In Australia, housing is not constrained and yet prices there are skyrocketing for precisely the same reason.
The lack of supply of decent houses does push up prices somewhat, but without practically unlimited credit creation by banks, house prices would have gone nowhere since the 1980s.
This money expansion has largely benefitted financial services, to the detriment of everyone else. When I tell people that banks create money at will, out of nothing, they often don’t believe me. I ask them where they think all of the billions of pounds of value of the property market come from. Savings? Investments? Chinese mom and pop investors?
It’s simply money created by banks when they ‘lend’. We should stop using the word ‘lend’, as it is a false description of the situation. It should be called ‘Money Creation’. Money Creation is creating money that didn’t exist before, but unlike a banknote which has a marginal cost of production but thereafter can merrily sit there without having to justify its existence, credit comes at a huge financial and social cost to an economy.
The interest due on over £1trillion of household debt is not inconsiderable. Where do you think such a large amount of money can be found to meet these repayments, when nearly all of the money in the economy is created as credit? Some of it turns over from GDP activity, but the rest is made up by more credit. It’s easy to see the underlying boom-bust cycles of economies which rely on credit creation for adequate liquidity.
I should say at this stage that the property Ponzi scheme which was fuelled by David Cameron’s government did save the UK economy’s bacon post 2009. UK economy needs money to function, and the biggest contribution of money to an economy is housing purchases. So while it seemed perverse, the only way to save an illiquid economy was to get more money flowing round; this was done by means of QE, and encouraging people to borrow more, to pump up the Property Ponzi Scheme, as well as encouraging foreigners with cash to burn to buy London property, which they did with enthusiasm.
While it is cooling off, the London property bull run may not yet have run its course. According to Steve Keen, the UK property market has some headroom to expand, with Private debt to GDP having fallen somewhat since 2009. Professor Keen uses credit to GDP ratios (particularly the rate of change of these) as a means to determine when contraction of excessive amounts of credit negatively impact economies.
Australia is at the top of a housing bubble with private debt at 1.2 times GDP, and prices due to fall simply because of a lack of affordability to borrow any more money – and pay it back. In the UK private mortgage debt has actually fallen over the last few years, to around 80% of GDP, so there is some headroom for this to expand, and prices could continue to rise.
Banking: A tax on economic activity
As 97% of money is created as private bank credit, banks effectively apply a universal tax on economic activity, purely through having the power to create the money supply. Wouldn’t it be interesting if this fee went to the government, instead of to banks? I wonder how much government could reduce taxes?
When the credit in an economy gets too large for the economy on which it feeds, the parasite ends up killing the host. In the case of the U.K. economy, with a disproportionately large financial services sector, perhaps the City of London should be excluded from GDP figures, or at least the benefit from its activities cancelled out as zero sum.
Cheap money is lazy money
When interest rates are at an all-time low, not just in the short-term, but over a period of a decade, investors are encouraged to seek riskier forms of return; when it appears that everybody is leaving their dull-but-stable jobs to become day traders, this is a sign that government policy needs a re-think. The lower interest rates, the more worthless the money, and the less work that money has to do to justify its existence.
Why create anything new when you can ‘create’ a hundred million at 0.25%, buy a company, strip out the value, and flog it to someone else in a few years time at a profit. How about using newly created money to speculate on the future price of something via derivatives contracts. It’s certainly less risky than investing in something altogether new, something which has the potential to move society forwards, but entails greater risk.
Low interest rates lead to casino style banking. Occasionally in this climate, risk takers and entrepreneurs still emerge, and when they make even a little effort they are richly rewarded; see Elon Musk and Tesla. Let’s not forget Musk has seed capital from PayPal, so he started out in the financial services world too.
The cheaper the money, the more likely it is to be used for speculative purposes, and for activities which are morally questionable; asset stripping I’ve already mentioned, but debt funded share buy-backs are popular, as are Mergers and Acquisitions which provide little value to society, but give senior management teams, lawyers and brokers a way to justify their existence and bolster their performance based remuneration packages. Rather than a choice of 100 agile businesses, the public gets a ‘choice’ of five bureaucratic mega-corporations. In a decentralising world, business seems to wants to cartelise, to emulate the ‘bigger is better’ banks.
More (credit) money in an economy means more money to banks
Increasing credit means more personal indebtedness, and more homeowner household income flowing to the banks, making bankers richer and leaving less money for other elements of society, less technological progress, less opportunity to live well, and a requirement to chase money to pay back the banks, working two jobs or foregoing other life experiences (travel, hobbies, private education, a larger family) because of the excessive cost of putting a roof over your head.
When banks overstretched themselves in the late 2000’s and were bailed out, they spent the next 5 years sorting out their balance sheets before once more feeling comfortable about creating more money and putting it into the property market. The injection of new money makes for a good economy, but none more so than for the banks. As I always say of pensions. The only person making any money out of pensions are the pension fund managers. A 1% fee may not look like much, but when you multiply it by a big number (and a lot of the pension funds are huge) you get a very big number indeed. Here’s an example. Legal and General UK Equity Fund has a fund value of 2.5bn, and a fee of 0.98%. That’s an annual fee of £24.5m for managing the fund. Nice work if you can get it.
Equally, the only people making any money out of excessive credit and inflation of the money supply are the banks. Based on October 2016 trends, the interest payment on outstanding household debt over the last 12 months was 50.8 billion pounds, that’s an average of £139 million pounds per day. Do you ever wonder why bankers live in nice houses?
I am not normally an advocate of telling other people what to do, but institutions which are systemically important, like banks, become effective arms of the government, they cannot be allowed to fail and therefore enjoy a privilege that no other capitalist business enjoys; that of zero risk. Just as a government cannot go bust, neither can their banks. When (not if) banks’ excessive credit creation and clever financial instruments blow up in their faces, they must be protected by the government to avoid a global societal meltdown.
This safety net, combined with the government and society’s desire for money (and in the absence of any other kind of money, this means credit), does not encourage responsible, sensible behaviour by banks. Banks should either accept responsibility for their own actions – and be allowed to fail, and the government form contingency plans for this eventuality – or banks should consider themselves owned by the people, an effective arm of government, and their seigniorage fees passed to government in lieu of significant chunks of income tax. As effective public sector bodies, banks should accept more regulation. They cannot and should not have it both ways. Martin Wolf explains:
Money lubricates the economic wheels
Money is like the lubricating oil in an economic engine, required for the machine to function properly. Just as a larger engine requires more oil to lubricate its greater moving parts, a larger economy requires more money to provide increased liquidity for the greater economic exchange taking place. When an engine has too little oil, it will seize up, but too much oil can be just as damaging, and frothing of oil occurs which causes havoc with the internal workings. An economy, like a well functioning engine must have the right amount of lubricant. There is currently no mechanism to achieve this right balance.
Many commentators such as positive money advocate returning to a full reserve banking system, but I find this too rigid. There is nothing inherently wrong with paper money. It can work perfectly well, as long as it is allowed to stand among other currencies and stores of value.
Positive money is correct that the problem in the UK economy is that of monopoly of the money supply, but it is not banks that are the problem, it is the government which backs those banks. As Hayek proposed in his Hobart paper of 1977 – The Denationalisation of Money, benefit will only come when the monopoly on the creation of money is taken away from government, and its agents, the banks. Only when all forms are allowed as legal tender, from gold to Bitcoin to US Dollars, will the free market find those which are the best managed, and punish those which are subject to distortion and inflation.
Under such a system, you could choose which currency you wanted to be paid in, and also which you wanted to purchase your goods in. This would force issuers of money to do so responsibly as excessive inflation would drive customers towards better stores of value. The decision to perform Quantitative Easing would be taken with great care, and moderately. We may well see this scenario playing out in the next few years as the QE experiment and the inflation it has caused gradually unravels.
Interest rates as a means to control inflation
UK average house price inflation over the last year has been 7.4% while interest rates are languishing at close to zero. The statistical means used to determine inflation, CPI, excludes house prices. The argument being that houses are an investment and therefore shouldn’t be included. Instead an equivalent rental cost is provided. I appreciate the logic here, but I thought the whole point of adjusting interest rates was to keep the inflation of the money supply in check. Considering we know that the majority of newly created money goes into property (just look at house price inflation) then surely omitting house price inflation from inflation statistics is pure folly. Investment or not, paying off a mortgage is the largest chunk of monthly outgoings of any newly formed household, and so it must be included in inflation figures.
It has been sold to the world that rising property value is a good thing. But in reality the reverse is true. High house prices come at a huge cost to society because they indicate huge debt, and huge debt has huge interest payments.
A lot of this property hypnotism is put out by the people who benefit from a pumped up housing market; estate agents, property TV shows, the newspapers (who sell papers and advertising), property investment funds, mortgage lenders, they all want to talk up property. As for the rest of us? What do we get from an overblown property market?
- We pay a higher cost of living
- We pay more of our money to those with a licence to print our money supply
- We have to spend more of our lives working when we could be doing something more interesting like spending time with our children
- We live in smaller, more cramped dwellings (the UK has the most cramped dwellings in Europe)
- There is less land available for building, as a rising cost of land encourages sitting on land banks until the price is right
- Old houses are too costly to demolish, so many poor quality, inefficient houses prevail costing more to buy, and more to run.
Negative equity as a good thing?
While nobody likes the idea of negative equity, one suspects that for the majority of households on the property ladder, negative equity would be a better scenario than the ever spiralling prices currently observed; the majority of households want to increase the size of their property, and so falling prices gives them an easier reach to the higher rungs of the property ladder, while rising prices principally benefit the salesmen (who get paid a percentage commission), and money creators such as banks and building societies. As negative equity took hold, households would need to borrow less in the future, the interest rates would likely be higher, meaning less debt, a shorter payback period and less cash taken by the bank. This benefits the economy as a whole.
First time buyers, very often with a helping hand from the bank of mum and dad or the government, come in at the bottom of the Property Ponzi scheme and keep the whole charade going for a bit longer. But at what cost to society? At what cost to the family which will grow up in the tiny home which requires both adults working full time to make ends meet? Is the future of the families in Britain worth so little that it should be trampled under foot by Chinese portfolio investors? Perhaps having a prime minister whose father was a stockbroker wasn’t such a good idea after all.
I don’t blame governments for their weak-mindedness, after all (as we observe with President Trump) the government of the day reflects the general mood of the people. That we can find no discernible difference between the so-called Labour and Conservative parties suggests that the majority of the population sits comfortably in the centre ground, the middle class. We have skyrocketing house prices not because of government but because the majority of the population, either because they have been brainwashed into believing it, or because they are all complicit in the rent-seeking, wants house prices to be high. As long as we want high house prices, we shall continue to have government policy which encourages this situation, and very little will change.
A large part of the growing malaise of the population, as evidenced by both the Brexit vote and President elect Trump, is a desire for a fairer society.
There is not just a feeling, but clear evidence that the government and its banking arm are taking too much. As I have explained, the solution lies in reform of the monetary system. We are paying too high a price for our money supply, and our perception of money as a physical, tangible entity needs reconsideration.
You can talk about global warming until the cows come home, but you’ll never make any headway into changing the planets temperature. But monetary reform? Now that would change the lives of billions. It is the single change which would make money something which works for the people, rather than against them. This is the main reason I think Bitcoin’s time will come sooner rather than later.
What worked for your parents, doesn’t work for you
Were you told that if you worked hard, went to college, studied a good subject like medicine, accountancy, law or engineering that you would do well and live a good life, find wealth, health and happiness? Are you wondering why you are buying your first home at 40, and starting a family just as late, while school drop outs are multimillionaires before they hit 30? Are you starting to think that they were telling you things that would benefit them, rather than you?
Do you ever wonder why is so much power and money is concentrated into banking and finance? Do you ever question why does the government always seems to act in the interest of big business while the middle classes pay all the tax. Have you wondered why large companies pay hardly any taxes, while small ones must always pay their fair share? Never mind the university graduates, how does Mr Jones benefit from the current economic setup? These questions and many more explain why Donald Trump is the president of America and why David Cameron and George Osborne fell from grace so rapidly after asking the question; “Do you like things just the way they are?”
Why, in the 21st century, are we still working 40-60 hour weeks, when we have such clever advances in technology? Why isn’t this new technology benefitting us? Why can’t we have more time to enjoy our lives? The most sympathetic to these sentiments are those recently retired who leave the working world with a retrospective sense of bemusement “What the hell was that all about? I spent the best years of my life working on something I didn’t enjoy, just so I could ‘retire’. And for what? What a crock!”. If you take the time to understand credit money, you will be able to answer all these questions and more.
The following paragraphs will come as a huge surprise to young people who have been working in the City for the last 7-8 years, since the global financial crisis.
Markets exist in order to discover the price of something. It is not known, it is not set by a central authority. It is discovered by the market, based upon supply and demand of goods and the individuals and the money available to purchase them. Price Discovery is why markets exist, and why they function as effectively as they do. If prices are too high, they adjust until an acceptable price is agreed upon.
We have known no genuine market behaviour since at least 2009, but more likely since the late 1970’s. Governments and their central banks have been distorting markets with monopoly money printing activities, bank bailouts and the austerity which was used to pay for them. The suppression of interest rates and the distortion of the price of money has been hugely damaging to the real economy and its participants. Debt is the problem, and cheaper money is not the fix. Market making has become price fixing, and governments’ meddling in the housing market has been an unbridled disaster, the most idiotic and ill informed policy decision ever made.
There is no reason that first time buyers cannot be provided for by the housing market. If they cannot afford to buy the very cheapest houses which are on sale, then the prices of those houses should fall until they can afford them. This is market price discovery. Unfortunately, the government doesn’t believe in markets, it believes in the power of the Great British Property Ponzi (GBPP)
Rather than letting the market fall to affordable levels which suits the participants, the government wades in and promises to subsidise first time buyers, to help them to ‘get a foot on the property ladder’. In so doing it keeps the Ponzi scheme alive, and frees up the rest of the participants to continue to buy overpriced property on the rungs above.
The government seems to think that subsidies for first time buyers’ “starter homes” sold at a 20% discount are a good idea. Does anyone remember George W. Bush’s speech about Home Ownership, the American Dream, about Fanny Mae and Freddie Mac, or am I the only person having a sub-prime deja-vu? Nobody in the mainstream media seems to be that interested in calling out the government for its extremely dubious housing initiatives.
Governments will not allow property prices to fall (not if they want to be re-elected). So we get government subsidies aplenty to keep the Ponzi scheme going; Right to Buy, Help to Buy, Affordable Housing and now Starter Homes.
It’s high time we asked ourselves whether we want to have a higher cost of living. Because that’s what higher house prices means for all of us. It would be like saying that we would rather be paying year on year 8% more for our food bill. It’s the same food, it just costs more that it did last year. Just as it’s the same house, it just costs more to buy every year. So £100 a week food bill in 2010 would become £108 in 2011, £116.64 in 2012, £125.97 in 2013, £136.04 in 2014, £146.93 in 2015, and £158.69 in 2016. Your annual food bill would have risen from £5,200 a year to £8,251.88.
“But a house is an investment” you all cry “so when you sell it you will get the money”. Well yes, in a sense that is true, but the effect of the money which has poured into the housing market affects the whole market, not just your house. The inflation is widespread. So unless you buy in an area which draws in more of the credit money (like London with its foreign buyers) inflating it more than other parts of the UK which you later decide to move to, you’ve not gained one jot. Yes, you could sell your 1 bed flat in Chelsea and buy a 16 bed castle in Dumfries & Galloway, but otherwise, you are still going to have to put a roof over your head, so the next house will also be expensive, and you haven’t benefitted as much as not been disadvantaged by not buying a house. Buying your house has simply been a hedge against inflation of the money supply. You’re pretty much Even-Stevens like everyone else with a house; paying more than you need for that disintegrating roof over your head.
I fully believe that when people want affordable housing, housing will become affordable. Until then we will continue to have a housing crisis, bankers will make and take all the money, and your cost of living will be higher than it ought to be.
Believe the property hype at your peril. The cost of credit money means much more than just expensive houses, it means less money for the NHS, less R&D and innovation on things which might actually improve our lives. It means families living in the smallest houses in Europe, with two parents working full time. It means a poorer standard of education, it means disintegrating roads and poorer social care for the elderly. It means many consigned to living out their days in a caravan parks.
If you believe this is a cost worth paying, then let’s carry on with things the way they are. But if you think there are better ways to structure a modern forward looking economy, it’s time we reconsidered the true cost of our debt based money supply, and called for reform to monetary policy for the good of the people, not the banks.
Also published on Medium.