Ireland and the U.K. and Debt

So Britain has gone to the aid of a friend in need. Meanwhile the friend’s troubles grow. The government totters. The bail-out is to the tune of 127 billion euros. Even that may not be enough. Worries surface about whether a small economy can ever hope to repay such staggering sums. We should worry too. Our debts are much bigger, but, at the moment anyway, our credit rating is top notch.

It is a moment to reinforce a point of arithmetic principle, even if to do so, is to sound like a shrill, admonishing, maiden aunt. The principle is this. Money is a measurement. It is not an entity on its own. It cannot, literally, be made. When people talk about making money they are using a figure of speech, like the sky falling in. It is not a statement of fact.

We have learned that quantitative easing is when a Central Bank  creates electronic money to buy real assets, usually government bonds. This generates money balances which flow into the financial system, which simply did not exist the day before. This process is used with caution as, because it does not represent a real increase in wealth, it debases the currency and if overdone will cause the currency to collapse.

Unfortunately in the modern world it is possible for everyone, not just governments, to do this by artificially inflating assets such as property and then borrowing real money from abroad against them.  Thus a house is bought for £100,000. A little later the same house is said to be worth £400,000. The excited owners, feeling themselves wealthy, borrow against the inflated value of their asset, under a process misleadingly described as equity release. Let us say they spend this on goods and equipment made in China, which also supplied the cash for the loan. The money from the goods immediately flows back to China, as do all the repayments on the loan.

Here is the nub. That money for those repayments has to be earned, because in the beginning the property owners did not have it. So now they have not only to earn enough to repay what they did not have, but also the charges, called interest, added on. The value in their lovely new goods and stuff has already gone to China in the purchase price. The property owners have neither the money, nor the value. This is why they have to set about earning real money to pay.

Of course they think they have the asset. But the true value of the house remains £100, 000. If they chose to sell now, they may get the £400,000 of its inflated value, but they may not if others need to sell at the same time. If  lots of others need to sell the value of the house will fall back to its true value, which is about 3 times the income of the person  for whom such a property was originally built. This is what has happened in Ireland where property has dropped by 50% and is falling still.

In the U.K. we need to think about the fact that the total indebtedness of our island state and its population is approaching £10 trillion. Most of this is secured against property. The true value of that property is about one third of what we think. About £3 trillion. The other £7 trillion we have, over the coming years, to repay out of real earnings. In other words we have the earn real money to fill the whole left by the evaporation of the money we thought our inflated assets represented, but which, actually never existed.

This is why the Sun and others are unwise to crow about how Ireland is in a mess because it is in the Euro. The Euro is merely the measure. The reality is the total debt, whatever the currency applied. The double reality is the inflation of property assets creating phantom wealth. We are in that position too. Only bigger.