Posts Tagged ‘debt’

DCF 1.0

Fear. In different times greed is just as important. But right now, and across most of Europe, fear is the key driver. Money sloshes around, and all that those who control it want to do is limit the downsize. They are trying to mitigate against fear. And so afraid are they, that at times they have put money in assets that give negative interest rates, just to feel safe. This has been rather good news for Germany, because while fear has driven money away from Greece and Spain and co, making the government cost of repaying debt in these countries seem prohibitive, in Germany it has been quite different. Fear has boosted Germany coffers. And a new report tells us that the boost has been dramatic. This is why.

The euro crisis just won’t go away. In Germany they are sick of it too, and with good reason. Germany has done nothing wrong. Its work force has worked hard, saved for retirement, and what is wrong with that? Yet they are being punished; they are told that to atone for their sins of working hard and saving for the future, they must pick up the tab for indebted Europe. Yet, there is another way of looking at this, according to data produced by Germany’s own finance ministry, because the country has made a tidy profit from the euro crisis.

It all boils down the fact that money has to go somewhere. Corporates are saving. Across much of Europe, households are saving. Where does the money go? One thing is for sure, putting it in Greek bonds is risky. Spanish, Italian and Portuguese bonds don’t seem much safer either. But German bonds, in contrast, feel as safe as a safe house in a land with no crime. In fact so safe are German government bonds or bunds, perceived to be, that there have been times when the yields on some of them have been negative. So actually, Germany has done rather well out of fear created by the euro crisis – or should that be the other way around – a euro crisis created by fear? But can we put a number on how well?

German Social Democrat Joachim Poss wanted to know how much, and, as a man in power, he got an answer. The Germany finance ministry responded to Poss’s question by getting the abacus out and making some calculations. The ministry took its estimate for interest payments on its debt, and subtracted from that the actual interest. From its calculations it drew the conclusion that between 2010 and 2014, it will save 40.9 billion euros thanks to interest rates being lower than expected, which is thanks to money flooding into German bunds for the sake of safety.

This is a rather important point. Right now, Italy is posting a primary budget surplus, meaning its government is spending less than it receives before deducting interest on debt. If it was paying the kind of interest on debt that the German government pays, Italy would be close to being in surplus. And that in a nut shell is the case for euro bonds; that is to say for all countries in the euro area to raise money by using the same bonds, backed by each and every government. You can see why Germany does not like that idea, but then again, a monetary union with one central bank controlling monetary policy, cannot really work unless governments pay the same interest on their debts.

But the data relating to German savings on its debt does not tell the full story. The fact is that German exporters, the drivers of its economy, have done well out of the euro for another reason. If Germany still had the Deutsche mark, the currency would surely have risen sharply in recent years. By sharing a currency with the likes of Greece, Germany has enjoyed a massive terms of trade benefit.

So actually, for Germany there have been plenty of upsides to being in the euro, which is why it is right that it pays for the downsides too.

© Investment & Business News 2013


The threat posed by debt just won’t die down. Last week we reported that the Bank of England’s figures suggest that the UK cannot afford much higher interest rates. New figures from the Resolution Foundation suggest that the situation is even worse than the Bank of England suggested.

“If interest rates rise 1 per cent,” said the Bank of England in its latest Financial Stability Report, “households accounting for 9 per cent of mortgage debt would need to take some kind of action — such as cut essential spending, earn more income (for example, by working longer hours), or change mortgage — in order to afford their debt payments if interest rates rise…If interest rates rise by 2 per cent,” continued the Bank, “ditto, except that that it will be households accounting for 20 per cent of mortgage debt who will be so cursed.”

The Resolution Foundation has also taken a look at the story of the UK’s household debt, and its conclusions are even more disturbing.

Before the crisis of 2008 household debt across much of the developed world was worryingly high. Some countries, such as Denmark, Ireland, the Netherlands and Norway had it worse. Nonetheless with a ratio of household debt to gross house disposable income of 174, it was worryingly high in the UK. The good news is that it has since fallen, and the ratio at the end of 2012 was 146.

Alas, according to estimates from the Office of Budget Responsibility (OBR) it is set to rise again – not by much, for sure, but any rise is worrying. The OBR does in fact project that there will be a household debt to disposable income ratio of 151 by 2017 . To put that in context the ratio was just 112 in the year 2000. In the US, at the end of 2012 the ratio was 106.

According to the Resolution Foundation, at the end of 2012 no less than 3.6 million households were spending more than a quarter of their disposable income on debt repayments. Debt levels, however, are expected to rise as the government attempts to kick life into the UK housing market by encouraging greater mortgage lending.

But in its most recent report the Resolution Foundation looked at households whose debt repayments make up more than half of disposable income, or those in so-called debt peril. Right now, around 2 per cent of all households are in this position. If things carry on the way they are supposed to, and rates rise in line with Bank of England projections and real wages increase in line with projections for GDP, the Resolution Foundation estimates that the percentage number of households in debt peril will rise to just under 3 per cent by 2017. This is similar to the level seen in 2007, in fact.

If rates rise by 2 percentage points more than expected, the foundation estimates that the percentage number of households in debt peril will rise to 4 per cent. If, in addition to this, wages fail to rise with GDP, but rather – as has been the case in recent years – increases in wages continue to be outstripped by inflation the Foundation estimates that the number of households in debt peril will rise to 5 per cent.

Okay, you might say, but if this is the case then the Bank of England may not let interest rates rise. Unfortunately, central banks may have less say over the matter than is generally thought. See: The Great Reset 
There are all sorts of combinations and permutations.

But the points to remember are these: as rates rise in the US, the Bank of England may be forced to either up rates, or let the pound fall. If rates rise, debt levels in the UK will increase. If the pound falls, inflation will pick up, real wages may fall, and once again debt to income may fall.

In short, we may be in big trouble whatever happens.

But just bear this in mind. Debt does not matter if the percentage interest on debt is less than the percentage increase in income. What the UK really needs is for incomes to rise, and for this to happen it needs improving productivity, which comes from more investment.

© Investment & Business News 2013


We asked is the debt on your home ‘a heavy burden’, ‘somewhat of a burden’ or ‘no problem at all’. The survey said: UH UHHHHH.

Actually, it was a bit more positive than that. The ONS has been looking at what it calls the burden of property debt in the UK, and compared the years 2006-08 with 2008-10. When the survey asked the key questions, the response elicited more of a ringing sound. In 2006-08 15.2 per cent of households opted for ‘heavy burden’. By 2008-10 the number had fallen to 13.6 per cent.

The percentage number who said ‘somewhat of a burden’ also decreased, from 38.0 to 37.0 per cent.

Surveys are great if your idea of fun is hearing buzzers. But what about some cold hard data?

It turns out that in 2008-10, 37.3 per cent of households said they had property debt. That was 0.9 percentage points down on the previous period.

The combined value of this property debt rose, however, from £822.2 billion to £847.9 billion.

© Investment & Business News 2013

What is better: boom and bust or gradual?

In the US it was boom time in the noughties. Real house prices soared some 40 per cent between 2000 and 2006. Household debt leapt from around 90 per cent of income in 2000 to around 130 per cent in 2006.

In Europe, things were more gradual. Real house prices peaked in 2007 when they were around 30 per cent up on the 2000 level. Household debt to income rose from about 80 per cent of income in 2000 to around 108 per cent by 2012.

It is just that in the US, real house prices crashed, falling back to their 2000 level by around 2012, and have been slowly recovering since then. Household debt to income dropped from 130 or so per cent to around 106 today.

In the euro area, house prices have now fallen back, but are still some 18 per cent over peak.

In other words, US household debt to income is now lower than in Europe, and house prices appear to be on the road to a slow recovery.

In Europe house prices probably have further to fall and debt to income is looking worrisome. The US had a very nasty recession circa 2008, but is now recovering. The euro area seems stuck in depression.

© Investment & Business News 2013

“You don’t get it.” “You are trying to apply Western ideas to China, and it doesn’t work.” That is what supporters of all things Chinese say when western economists talk about a bubble in the making in any one area of China.

That may be right, but does that observation not smack you as being a touch racist. Don’t you think that people are much the same everywhere?

Now a Chinese economist (note that Chinese economist) has warned that local government debt across China is “out of control.” Zhang Ke vice-chairman of China’s accounting association, was quoted in the ‘FT’ as saying: “We audited some local government bond issues and found them very dangerous, so we pulled out…A crisis is possible. But since the debt is being rolled over and is long-term, the timing of its explosion is uncertain.”

The ‘FT’ paraphrased Mr Ke as saying the potential crisis in the making could be as serious as US subprime.

In the West we tend to assume central government in China is all powerful; that what it says goes. In fact, it finds it very hard to exert much control at all over the regions. As the ‘FT’ piece pointed out, there are 2,800 counties in China.

It is not hard to envisage a debt crisis in the making; indeed Fitch may have anticipated this when it downgraded Chinese debt recently. It is very hard indeed for an economy to grow at the kind of rates seen in China over the last two decades without bubbles growing. Its government may be very clever, but it is not omnipotent, and its ability to stop a bubble is limited.

One more point on the question of Chinese cultural attitudes being different. If anything, China may be more susceptible to the groupthink and group compliance which may lie behind bubbles. Back in the 1950s, psychologist Solomon Ashe showed how it is human nature to comply with the group, even if that means saying something that is obviously not true. Psychologists have re-run the tests worldwide, and have found that the tendency to comply with the group, even when the group is clearly wrong, is even stronger in countries known for their cooperative culture, such as China.

It would be a mistake to over-egg this because the differences shown by the psychological tests were not great. But to say that western-style bubbles are not likely in China is manifestly untrue.

©2013 Investment and Business News.

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You don’t need to look far. The Internet is full of stories proclaiming doom. The US, they say, is on a one way street to financial ruin. Well it appears they are wrong. And if even if you could say that at a pinch there is a kind of one way street to debt hell, the street is very, very long, and it would not be hard to construct a diversion, and furthermore, we have plenty of time to do it.

Oh woe is us! Or is that woe is the US? And since the US will remain the most important advanced economy as far into the future as we can possibly predict, maybe the US and us is kind of the same thing.

At the end of 2011 US total liabilities were worth 741 per cent of GDP. Foreign holdings of US debt are currently worth around 60 per cent of US GDP – a big chunk of that is owned by China. The level is rising too. And then there is the so called elephant in the room – healthcare costs.

Estimates suggested that the net present value of unfunded US liability for US healthcare is $42.8 trillion, and $20.5 trillion for social security. Last November the ‘Wall Street Journal’ ran an article by Chris Cox and Bill Archer arguing that the true liabilities of the US government are nearer 500 per cent of GDP.

These are scary numbers. It is just that they are seriously misleading.

Take a look at any plan. It could be a business plan, a plan for funding retirement, a plan for a holiday or buying a house, or one for emigrating. And then ignore all the good news, all the promise. Quelle surprise the plan that is left does not look very attractive. Those who say the US is bust are applying similar logic.

According to Capital Economics, if you take into account the assets owned by the US, including equities, property, assets abroad, and indeed US infrastructure owned by the US government you are not left with net debt at all. In fact, the US has a net worth of around 550 per cent of GDP. Capital Economics calculates that the net worth of US households is 408 per cent of GDP, for non-financial businesses it is 118 per cent of GDP, for the financial sector it is 36 per cent of GDP, and minus 13 per cent of the US Government.

Bear in mind that this balance sheet applies at a moment that has succeeded a crash in US house prices. By historical standards US house prices look cheap.

Sure, the US has owns money abroad. But then again, the US also owns foreign assets. You can’t count US debt, but ignore money owed to the US. Take the full story into account, and net US foreign debt is about 30 per cent of GDP, less than a quarter of Greece’s external liabilities.

Besides, the US tends to enjoy much higher returns from the money owing to it, than it pays out on money owing abroad. This is largely because much of US debt held by foreigner is in the form of very low risk, low yielding government bonds.

Then there are heathcare and social security costs. In calculating the net current value of these costs, the doomsayers have looked at 75 year actuarial projections. As Capital Economics said, “Why stop at 75-year projections? Why not keep going for 100 years so the debt runs into the hundreds of trillions?”

In calculating the net current value of healthcare costs, the doomsayers have assumed costs will continue to grow at a much faster rate than GDP, and have built in assumptions about what the US economy will look like between 2040 and 2090.

Even if their assumptions are right – and it will be one very lucky guess if they are – the US has plenty of time to implement measures to address this, such as raising the retirement age, or upping taxes.

So here is the real shock. If the US carries on the way its critics predict, maybe at some point in the next 30 years it will have to see a rise in the retirement age and some kind of VAT.

Of course, there is something missing from all these guesses. Forget about the lone elephant in the room; there is a herd of mammoths, and it is technology. How anyone can start making sensible guesses as to what the US will look like in 60 years’ time, without taking into account the possible changes technology may bring is something of a puzzle.

©2013 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here

Look, you have to be patient. It takes time to repay debt, but once it is repaid, well…yippee. That is one argument.

Others go further, and say things such as: “If it isn’t hurting, it isn’t working.”

Those who support austerity don’t deny it will be painful – except that is for a few nutters in the US Tea Party that seem to think there is an automatic and immediate positive relationship between austerity and growth.  No, the sane austerians are simply saying that it is worth it in the long run: pain today, wealth tomorrow.

And, of course, for most individuals such an attitude is right. Some businesses may argue that the way to deal with debt is to expand, but on the whole, most agree that times of peril mean cuts.

The snag is that when we are talking about the whole economy, things can get very nasty if we all start behaving in the same way. If all those with debts make cutbacks, and as a result there is less demand, and those with savings see the fall in demand, so start saving even more, then the economy will start contracting faster. And supposing that as a result of these cuts, demand shrinks, our income falls, and as a result our debts actually increase. In such circumstances, the more we cut back, the worse our debts.

The National Institute of Economic and Social Research (NIESR) reckons this is precisely what’s happening.

In a report published this morning it said: “As a result of the fiscal consolidation plans currently in train, debt ratios will be higher in 2013 in the EU as a whole rather than lower.”

Its argument continued: “under normal circumstances a tightening in fiscal policy would also lead to a relaxation in monetary policy. However, with interest rates already at exceptionally low levels, this is unlikely or unfeasible.” To put it another way, when interest rates are near zero, the argument that you need to make cuts so that the central bank can then make interest rate cuts doesn’t hold up. Right now, we are in what’s called a liquidity trap. Rates can’t fall much further, but when the economy is struggling like it is, the normal solution is to cut interest rates. Quantitative easing is not proving very effective because people don’t want to borrow more. The Bank of England hopes, by the way, that QE will push up the price of government bonds, meaning other assets will look cheap in comparison and push their prices up, which will make us feel richer, so that we will spend more.

Returning to the NIESR report it stated: “During a downturn, when unemployment is high and job security low, a greater percentage of households and firms are likely to find themselves liquidity constrained.”

NIESR added – and this is the key bit – “With all countries consolidating simultaneously, output in each country is reduced not just by fiscal consolidation domestically, but by that in other countries, because of trade. In the EU, such spill-over effects are likely to be large.”

Now it is only right to point out at this stage that the NIESR director, Jonathon Portes, is very much a supporter of the idea of stimulus. He bats for the same side as Paul Krugman – an out an out supporter of Keynesianism. So given this, perhaps the conclusions of the NIESR report are not surprising.

But then again  austerity can work when applied by individual countries which can simultaneously grow via exports. But when austerity becomes a global thing, it becomes very dangerous.

On the other hand…

The big snag with fiscal stimulus is that sometimes economies need to adjust. There is a danger that a fiscal stimulus can take away the need for change.

Take Japan, as an example. In Japan failure is not popular. In fact, it is seen as something that needs to be avoided at all costs. But as a result, maybe Japan is too slow to change. This morning both Sharp and Panasonic warned of heavy losses in their current financial year.  Truth is, Japanese electronics companies are getting a drubbing.  Being thrashed by Apple, and Samsung and Google and Amazon is bad enough, but now even Microsoft with its Surface tablet is making the once seemingly invincible Japanese giants look like dinosaurs.

Maybe Keynesian is partly to blame. There’s not enough creative destruction in Japan.

So returning to the NIESR, it is right. Austerity is causing damage, and may even be making debt worse, but that does not mean we don’t need creative destruction.

The debate has become polarised. Either you are an Austerian or a Keynesian. Why can’t you be both?

Anyway to finish on a more cheerful note, here is piece by yours truly on some promising news out of China today.

©2012 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here