Credit Crunch on the Horizon Again
Clouds are gathering. There is open talk of another credit crunch. Too many banks are either exposed to shakey European sovereign debt, or need to start repaying soon loans given to bail them out or both. Some banks may be at risk. This makes all of them nervous. They stop lending to each other. We know the pattern now.
The problem for this country is twofold. First we have the problem of how to get out of the recession. We are still in it. Forget about double dips. it is still here. The illusion that we had emerged came from, yes, borrowed money. In real terms there is a long way to go. This is because the old economic model we used could not any longer fly and only now are we starting to reconstruct one which can and will. This will be a painful process from which there is no escape. Numbers are beginning to appear. 600,000 public sector jobs(at least) to go. A 25% cut in departmental budgets, i.e state sponsored economic activity. Across Europe big trouble is brewing. Deficits have to be cut. Merkel is in political difficulty.
In the new economies of Asia and South America there is real growth and expansion and to some extent, but more fragile, in the US. Here lies our route to recovery. This is where manufacturing and business must turn to build new markets where people are ready to buy as well as at home where we must buy home produced. This needs financing. To come up with the cash banks will have go back to their day job of being bankers and financiers of economic growth and not traders financing their own growth.
At the core of the economic re-structure is the issue of the cost of housing. We have catastrophically created an illusion of wealth (which in a crunch disappears overnight) by building an economy stoked by increasing house prices against which people borrow ever greater sums to finance everything they do. Incomes are used almost exclusively to service debt and debt is the pool from which bills are paid. This sucks money out of the economy into the banks which then use it to pump up asset prices and spawn more debt, all enhancing their profits to enable ever bigger trades for their own benefit. Money is recycled again and again, yet little, if any, new wealth is actually being created.
It fact wealth is being diminished, because the huge cost of housing forces people to demand higher pay to get a roof over their heads which in turn forces up costs to the point where GB ltd. ceases to be a competitive manufacturer. The wealth creating base shrinks. This has to be corrected. It looks as if house prices are starting to fall again which helps the overall project, but not the over borrowed owners.
It is imperative nevertheless and no matter how painful, that we get to a point where the average house costs no more than three times (at most 3.5times) the average wage. If this stands at the moment at £25000 pa you are looking at an ideal house price average of £75000 and a maximum of £87500. For a family home with two incomes combined to £50000, this rises to £150000 or a maximum of £175000 for a family house with four bedrooms.
Until we get to these ratios (they should be a focus of the Financial Policy Committee) we will not achieve a sustainable recovery. We will simply go on living in cloud cuckoo land, bouncing from one credit crunch to the next, sinking ever lower in the league of world economies. To get there will require a combination of letting house prices fall and then not allowing them to rise above the rate of inflation and making sure that inflation is kept within target. That means raising interest rates quite soon. That would hurt business. The case for two rates, Bank Rate and Mortgage Rate, already there in practice in many ways, is getting stronger by the day.