A great deal of home owners will experience “negative equity”, if the housing market falls, but it’s unlikely to be fatal if interest rates remain relatively low. However, at the same time, interest rates can control borrowing which has got out of hand. It’s a balancing act.

What we have to remember is that there is a housing shortage. And while many will decide to wait before they purchase, there will still be demand from families – be they wanting to buy or willing to rent (meaning investors will gobble up suitable properties anyway).

Also, house prices may cool and even decline, but they’ll remain the best investment imaginable. You’ll see the market slow and then in a few years, you’ll see a huge correction meaning significant rises again – houses will appreciate by 10% per annum over the next 10-15 yrs. As they always do.

The US recession will not mean a global one – although our Anglo-Saxon economy (and those of NZ and Australia) may see a less damaging one. America’s time as a manufacturing titan is up, what we’re seeing is a market correction on a colossal scale as capital flows into East Asia. America still creates huge wealth in software, business services, and other IP industries. Blue-collar America looks pretty much screwed, though.

Europe is well-placed to become a huge partner for these emerging economies, if we have the sense to embrace it.

Also, the UK government must reduce spending.

Taxes, especially council taxes, have to be reduced to allow families to service their debt. Business taxes must also be simplified and reduced to allow entrepreneurs to create wealth and jobs.

“Also, the UK government must reduce spending.”

If you want 1928, yeah, great… But otherwise, the UK government must not reduce spending – it should either reduce taxes while keeping spending constant, or raise spending while keeping taxation constant. It must continue to put money into the economy to keep up demand and avoid recession.

The current annual government deficit is only around 2.5%, and it’s easy and cheap for governments to borrow at the moment (because they’re among the few groups everyone believes will be able to pay it back), so not doing so would be daft.

Business taxes are already simple and low, so there isn’t much point in simplifying or cutting them. But cutting council tax could be a good idea, as it would stick more money in the pockets of low-to-middle income workers who’re then likely to spend it and/or service their debts (although levels of personal indebtedness relative to spending have been massively overhyped by scaremongering politicians and media…)

John B

There is evidence that public spending circulates money more effectively than in the private sector (where it can be saved or sent abroad either directly or spent on imports), but when you see millions pumped into unreformed public services you have to ask if it’s being wasted?

There is NO economic argument for inefficient spending.

Business taxes are not simple. Trust me. I worked in manufacturing as an accountant for years. The tax code system has been made infinitely more complex since 1997. The tax book has gone from being something that you slipped in your briefcase, to something you need two people to lift!

Business taxes are competitive in certain sectors, but they do not encourage infrastructure investment. Take Brown’s last budget. Yeah, he cut the main corporate tax threshold – a gift to the city – but slashed Capital Expenditure Allowances meaning relief for infrastructure investment was reduced. A kick in the teeth for the country’s manufacturers (who are still the best employers for the working class, not to mention the nation’s trade balance).

(although levels of personal indebtedness relative to spending have been massively overhyped by scaremongering politicians and media…) ~ John B

Err, the numbers don’t support your argument.

Total UK personal debt at the end of February 2008 stood at £1,421bn. The growth rate increased to 8.9% for the previous 12 months which equates to an increase of ~ £111bn.

It has slowed from 10.3% per annum in April ’06, which is heartening. However personal debt only passed the £1,000bn mark in ’05, and it has increased by almost 50% in 3 years, so I don’t see how you can claim it’s media hype.

interesting piece – although I expect that a housing crash would hurt labour whether it was their fault or not. #

But Aaron is spot on that at most, this “correction” is likely only to defer demand for a year or so. Then people want to start buying again and the boom continues amid a lack of housing for private ownership.

It will be interesting to see if this weakens the buy-to-let market much – as that is now a large source of housing that could flood the market and make the “crash” deeper.

That said – Employment figures today are very very strong again – which means that few people are likely to lose their homes due to losing their jobs. That left people in debt thanks to negative equity – wheras this time round they may just stay in their home which could become no less affordable.

The history looks like this:

Interest rates reached 15% *before* ERM membership in Oct 1990, when they were cut to 14% the day we joined.
Initially all looked OK as rates subsequently declined to 10% by Spring 1992.
The election was April 1992.
“Black Wednesday”/”Golden Wednesday” was September 1992.
While Lamont (idiotically) raised rates for a couple of days to 12% to defend membership, the 15% was never implemented and the day he announced it was the day we left.
There was never any “persistence” with 15%, or even with 12% rates.
Once out we could of course control our own destiny, and rates fell rapidly to 7% within weeks and to 5% a year later.
Looking back we can see Black Wed marked the bottom of the cycle, thank goodness, but also showed up the idiocy of ERM membership in the harshest possible light.
Of course, if we had never been in the ERM, rates could have come down much sooner and the housing crash might have been less severe.

The ERM was a disastrous europhile experiment, supported just as much by Labour as anyone else at the time. Sensible (“europhobe”) economists – Patrick Minford, Tim Congdon, Bill Martin and others – pointed out that it could only end in tears.
Needless to say they were ridiculed in the same way as eurosceptics are now.

NB we’re seeing a mini rerun of the ERM disaster now within the eurozone of course as the differing monetary policy requirements of the member countries are becoming clear (Greece has a current account deficit of 12.5% of GDP, Spain a 9.2% deficit, Germany a surplus of 6.2%) and these tensions can only increase.

The housing bubble is in part a global phenomenon, but as the recent IMF study suggested, UK house prices (along with Ireland and Spain) rose much faster (30%) relative to fundamental drivers of prices than did US house prices (10%).

This is in no small part due to Brown’s switching the Bank’s inflation target from RPI to CPI, the latter excluding housing costs. Interest rates have been lower than they should have been.

What is not in question is that, whomever may be responsible for the housing boom/bust, is is *absolutely* Brown’s fault that we face this situation with no fiscal room for stimulus whatsoever.

cjcjc

no fiscal room whatsoever?

I know that sounds very dramatic – but with the IMF predicting growth of over 1.5 percent for this year, and the Treasury (with a more accurate record of 9 out of 10 for predicting the last ten years) suggesting around 2 percent – I have to ask how much fiscal room we need.

I mean I know as economies slow its sensible to use a losening of the purs strings to soften the landing – but even the IMF’s 1.5 percent prediction is a very soft landing. Several western countries have struggled to hit that level in recent better times for the global economy.

m4e – as you well know, the Treasury has a good record on forecasting GDP but a *lousy* record on forecasting the budget deficit…

If it is 1.5% all well and good…if it is *not* then we have the problem of going into a downturn with a maxed out budget deficit.

“Prudence”? Non.

the country’s manufacturers (who are still the best employers for the working class, not to mention the nation’s trade balance).

Only for very subjective values of “best”. The services sector employs far more working class people than industry, and kills/injures fewer of them every year. I suspect wages in industry are now slightly higher than in services, but that reflects the former’s niche status. Meanwhile, we have a negative trade balance on goods and a large positive trade balance on services…

Total UK personal debt at the end of February 2008 stood at £1,421bn.

So under £35k per adult, of which more than 80% is mortgage lending. Or less than £4k per adult on non-mortgage loans, in a country where GDP per adult is closer to £30k. Colour me shocked, amazed, horrified and any other adjectives you fancy… [*]

we face this situation with no fiscal room for stimulus whatsoever.

That’s just barking mad: with the deficit amounting to just 2.5% of GDP, the government has an enormous amount of fiscal room for manoeuvre.

[*] because I’m lazy, and because this is just a blog comment, I’ve assumed 40m economically active adults in the UK for the sums above. But the ratio – ie total unsecured debt is just 13% of one year’s income – holds whatever the actual numbers are.

“If it is 1.5% all well and good…if it is *not* then we have the problem of going into a downturn with a maxed out budget deficit.”

I reckon maxed-out is around 7% (in terms of what can sanely be borrowed, rather than in terms of “rules the Germans made the Italians adopt so they wouldn’t take the piss and screw up the Euro”). If the Treasury has managed to get the deficit forecast wrong by a factor of more than three, I’ll join you in Downing Street baying for heads on pikes.

Oh, Aaron – forgot to mention 1) I agree with your main point about house prices 2) in the context of avoiding short-term demand-side collapse it doesn’t matter whether additional government spending has any productivity at all – Keynes’s point about paying chaps to dig holes and fill them in again still holds. [obviously extra productivity as well as fiscal stimulus is a bonus...]

Oh, semi-relatedly Sky in “not falling” shock

Well – the difference between 2.5% (or even the 3.3% consensus forecast for 2008) and 7% is certainly enormous.

It might be nicer might it not – after all the wonderful sunlit Brown years – to be starting from a surplus (as e.g. Germany, Netherlands, Switzerland, Australia, Canada).

Even the US is forecast to have a lower deficit (2.4%) as is, yes, Italy (2.8%).

PS – I do agree the “sky is falling” stuff is being overdone, which is not to say that house prices will not fall 30%.

Indeed, the only people who should *not* want this to happen are those who are looking to trade down.
Those looking to trade up should always be hoping for lower prices, until the point at which they have bought their largest house.

cjcjc

indeed – although as John said – UK definitions of ‘maxed out’ are wildly different to that of the rest of the developed world. (We have far less public sector debt than most western nations, and exceeding 3% a year is not considered a sin by most).

and against that it is worth noting that the treasury remains a more accurate forcaster of growth than the IMF.

–

Also I’d like to back John’s point about personal debt. The economist did a great bit on that about a year ago, noting that the usa spent used a much larger proportion of personal debt for consumption, while the British spend a much larger proportion on investing in asstes (be that houses or extensions or even an increasing share on education)

Which suggested that the UK consumer was behaving far less recklessly than the headline figure people fret about hinted. (Our net assets are several times our net debt)

John B

I think we agree on most things. But…

Manufacturing is a *far* more valuable contribution to the economy, for the UK’s non-professional workforce, compared to services (bar exportable business services such as pay-roll administration etc). Retail and leisure work circulates existing money (taking out tourism), rather than manufacturing which directly helps UK PLC.

Manufacturing means we can export more and import less.

There is little moral value in stating that services “kills/injures fewer of [workers] every year”, if you’re just going to export manufacturing jobs to other counties where safety controls are less rigourous. I don’t see how a unionised worker in Dagenham is more valuable than a worker in Shanghai.

When calculating debt, it’s easy to aggregate over a population – as if we’re all sharing the burden, when in fact much is loaded on individuals with little hope of servicing it. I wonder what the long-term costs will be as these people struggle to pay off their debt? Depression, confidence, the effect on family life etc…

Finally, I wouldn’t put so much faith in the Keynesian economics, but that’s just my point of view.

Interesting thread.

(ignore, just signing up for emails)

Aaron

You shouldn’t view wealth in such simple terms as to treat it as a finite material sum that we must maximise our share of in the world.

Manufacturing has its place in the UK economy, but it is not the main source of our increased wealth each year. and this is why,,,

1 – The theory of competitive advantage – if nations trade then they increase their combined wealth by specialising in areas of competitive advantage. As such the UK can increase its wealth by specialising in financial services while trading with China that specialises in socks manufacture.

2 – wealth is not entirely material.

To grasp this consider the value of a few square feet of canvass. Then consider the value of the Mona Lisa. Well in the same sense, textile companies in the UK are making a lot of money now despite producing less fabric. That is because high value diesign for short runs of unusual specifications is worth more than lots of repetitive material that we used to churn out but now import from Pakistan.

3 – efficient allocation of wealth.

While shop workers are much maligned, imagine how much wealth would be lost without shopping. Shopping allows people to weigh the value of a shirt (for example) on the basis of their colour preference, whether it fits, how durable it may or may not be, and how expensive it is compared to other shirts. That maximises the total benefit drawn from shirts while demand for durability and low cost results in more efficient and better designed shirt production. And that is an increase in wealth too.

These are fairly limited explanations but they pretty much cover the subject.

—

And as for private debt – I often ask why people imagine debts are going to become unnafordable for millions of people who have afforded them for years already.

I ask because the labour market is very very strong so incomes are not being lost – and because consumer credit is a very competitive market so existing debts don’t suffer repayment hikes – and because the only major debt likely to rise in cost for existing debtors is mortgage debt, which is tied to a major asset and anyway tends to fall in cost during economic hard times.

I know a lady who when her husband passed away last year could no longer afford her bills because of the debts she had on credit cards. But unless we expect lots of people to die in the prime of their life this will remain an unfortunate exception to the norm, which is that people service their debts perfectly well.

M4E,

Oh, my I think I’ve just been taken for a chump.

Thanks for Economics for Numpties 101. Wealth absolutely is finite – as is the economic question. As food and energy continue to rocket in price, we’ll return to more simplistic economic theory, be sure.

Also you do not explain why Gordon Brown slashed CapEx allowances, if we’re to develop these low-volume/high value companies?

And you’ll find that, increasingly, even financial and business services are being outsourced.

As for your debt musings. Does the fact that consumer debt has risen by almost 50% in 3-years, not make your point utterly redundant? They haven’t been servicing this debt for years. It’s new debt based on low interest rates and cheap capital. The treasury is between a rock and hard place, it needs to curb borrowings yet not make repayments impossible.

I don’t think you understand the nature of personal debt. As cheap capital dries up, people will be unable to re-negotiate their borrowings, something they have done regularly, accessing equity in their properties – equity, that’s also disappearing. Borrowing is getting harder and harder.

I’m sorry, but… I sense too much New Labour speak in your comments.

I accept things are being hyped by an economically ignorant media, but things are getting very precarious.

Hopefully I’m not going to achieve the same “treating as numpty” tarring.

Aaron – over the last 12 months, I’ve personally generated well over my salary in services revenues paid by non-UK firms into the UK, only encompassing the work I’ve done for non-UK clients. That money has gone into the UK one way or another and been taxed as corporation tax, dividends and my salary.

Similarly, a lot of people who are working in the UK – far more than those who make things – write software, design things, and generally do “non making shit shit”. At my last employer, we employed people working on data aggregation ["find this, type it in], being paid slightly above minimum wage for slightly above minimum wage work (and plenty of more skilled people on progressively more money, but the starting scale was definitely working clase) for which over 75% of our sales were abroad.

Suggesting that manufacturing = cars and services = cafés for people who make the cars is the complete opposite of how the earning of forex works in this country right now.

Aaron

Sorry – I didn’t mean to take you for a chump – I just wanted to explain why manufacturing is no more important to a nation’s wealth than other sectors.

likewise I didn’t mean to make the theory of comparative advantage sound simplistic – its consequences are of course highly complex and a driving force of all economic activity the world over. Its just that in illustration it ends up being simple because I can’t draw up a model of ten thousand economic activities and 200 hundred countries.

More importantly though, you seem to have mistaken my illustrations as some sort of policy aim or something. They were just illustrations.

so in terms of financial services being outsourced – thats irrelevant. I just used financial services as a classic alternative to manufacturing in an illustration. But to save you further confusion consider it this way. We only have so many workers, and so much land and capital. As such it makes sense to outsource the things we make least money from so as to dedicate our workers, land and capital to things we make most money from. That increases our wealth.

likewise with your CapEx question – this isn’t policy I’m talking, just economics. It has nothing to do with brown or labour or any other politician. Tax changes might change our comparative advantage – but they don’t stop the process of economic shifts towards comparative advantages.

as for the attempt to label my alternative view “new labour” to make yourself feel better. again I’m sorry I made you feel like a chump. I really didn’t mean it and i appreciate that you lashed out as a result of your anger at my doing so.

—

On debt

That consumer debt is largely mortgage debt.

of £1,345billion owed by people in the UK in June 2007 – £1.131billion was mortgage debt – secured against homes – and repayments on those rarely rise in a weak economy, and rarely rise fast at all.

The rest – which the press hopes will be a big problem – is worth just £214billion.

Compare that to net assets (so assets minus debts) of over £6billion in the UK. It is a very small figure we are talking.

Indeed the link below goes to a rather alarmist press release from credit action – yet even with my sceptical view of the “debt = carnage” equation i’m happy to post it as it does include some valuable stats.

note for example, the graph showing that while mortgage lending has risen fast – credit card and other consumer debt barely rose at all between december 2005 and June 2007. Given that brankruptcies fell last year – it would seem that people are indeed servicing their debts, which ammount to less than £9,000 per household.

http://www.creditaction.org.uk/assets/PDF/stats/2007/DebtStatisticsAugust2007.pdf

and of course John has said it a lot better than I can.

“only encompassing the work I’ve done for non-UK clients”

Except for my inability to make any sense. “Only encompassing the work I’ve done for UK clients”, even.

Very interesting discussion as to whether there will or won’t be a housing / consumer crash.

But just to answer the headline “Will the housing crash hurt Gordon?” – the answer is a pretty obvious yes – if there is a crash – it will!