Friday, July 10, 2009

Three decades of debt

In my most recent post, I proudly declared my zero tolerance for debt. Afterwards I received the following anonymous comment:

"Alice, your sentiment is good and your self-discipline excellent.

However, you still have to find rental payments and you're attempting to store your wealth in the form of paper tickets (pounds) with very questionable long-term value. For somebody like you who is expecting inflation this strategy doesn't make sense."

The first point is easily handled. A mortgage holder rents the money; a renter rents the house. Only a renter can stop renting anytime she wants. If her salary increases, she trades up to a larger house; if her income falls, she downsizes. A mortgage holder is imprisoned in a world of duplicitous estate agents, rapacious banks, sticky contracts and a highly inflexible market.

The second point, however, is more problematic. What should someone do if there is a widespread expectation of future inflation?

To tell the truth, I don't have a good answer to this problem. In broad terms, buying real assets seems to be the solution. However, what assets should I buy, and when? I have a few answers but I don't feel confident about sharing them.

The comment hints at a deeper issue. If the inflation is likely to rise, then there is perverse incentive at work. It makes sense to stock up on debt and allow inflation to erode its real value. In contrast, savers will pay as the purchasing power of their assets are destroyed.

This is, in fact, the crazy world that New Labour and the Bank of England want to create. Quantitative easing, zero interest rates, and double digit deficits are all policies directed at one objective - inflation. There is a debate about whether these policies will work, and I happen to think they will. Nevertheless, there is complete clarity about what Brown, Darling and King want to achieve. On this point at least, we can't accuse them of dishonesty.

Having said that, I don't think the prospect of double digit inflation is enough to convince me to shackle myself down with a debt that will take me at least three decades to pay off.


  1. Inflation doesn't DIRECTLY erode debt.

    Only wage inflation does.

    I can't see any pressure for wage inflation anywhere.

  2. AntiCitizenOne,

    What if the exchange rate collapses against all currencies, creating huge import price inflatoin. The purchasing power of domestic currency falls, but there is no wage inflation.


  3. The odds of the pound falling against all currencies isn't as great as it might first appear. The US is crumbling, and lots of other countries are racing the US and UK for the bottom. All boats sinking together leaves the ratio of currencies relatively untouched, and a ratio is what an exchange rate is.

    And I'm with you, Alice. All cash, no debt, no house until prices fall sufficiently. In fact, we're looking at moving to another town we like and renting there for another six months before we buy just to get to know the area.

  4. And the ultimate form of cash free of government debauchery is gold, and that is the only safe haven at a time like this.
    I do find it astounding how you people who've studied economics at university fail to understand that they teach gold is a relic because that makes it easier for them to rob you.
    Gold is the only protection from inflation and economic collapse. Alan Greenspan has a good article on gold, you can find it on the net. Alternatively look at Iceland, if you had paper money, you lost 90% of your wealth, if you had gold you increased your wealth. Doh, as Homer says.

  5. In the 70's people rushed for rare coins, stamps, antiques etc as hedges against inflation. But in all those markets you're dealing with middlemen who know far more about the market than you do.

    Might be a good strategy if you're old though, as they aren't counted as assets if you need to go into residential care.

    AC One - the buses in South Yorkshire were on strike today as the drivers want a rise from £9 to £10 an hour. Believe me, the minute inflation kicks in we'll see real pressure for wage inflation from the unions.

  6. I've invested my small chunk of money in australian mining and energy stocks in anticipation of inflation (no leverage though).

    The problem is timing. If we have an extended period of deflation first then I will get whacked.

    I've managed to convince myself that if i'm a long term investor the best thing to do is get in and wait. A lot of this stuff is still 60-70% plus down on peak and who knows when the bottom will be.

  7. If things get really bad the government will confiscate your gold. (I hear Brown has a lot of space in his bullion valuts)

    The small investor can't win.

  8. Alice, thank you for being so honest! I haven't got the answer either - but I dont think its houses, which rise with wages and credit (unlikely!)
    Like you, we are mostly in cash, really boring National Savings, some index linked. We do have some gold and silver bullion, but have actually lost money on this. It is VERY volatile, as you know!
    I also bought an ETF in oil avoding leveraged oil ,and managed to get out at a pfofit before the recent crash in oil.
    Im looking for a base in oil, natural gas, and agricultural commodity ETF's at the moment, as well asuranium, but it seems too early in GBP at the moment.
    I am dumfounded that GBP is so high, considering the fundamentals! Im waiting for a crash in GBP, which should really stoke up imported inflation.
    But ive decide to hang onto gold and silver bullion, despite the losses, as an inflation hedge.
    Any comments on my stategy, Alice?
    I'm also looking at shorting stocks, particularly US stocks, when the bear market rally peters out, which could be very soon!
    Best wishes, and thank you for your blog.
    Housing Bear on

  9. to LIAM, you can buy gold and silver bullion stored in a Brinks vault in Zurich, insured by Lloyds of London, though and
    The UK government will find it hard to confiscate that.
    best wishes
    housing bear on

  10. I have to chuckle at Alice's refusal to consider buying real estate. Every single argument she makes (likelihood of inflation, paper currency being debased, existing debt falling in value in real terms) should help her to conclude that taking out debt at very low interest rates and buying real assets is a winning strategy.

    However, her cognitive dissonance kicks in and makes her blind to the obvious fact... hysterical to watch! I am glad people like her fill my apartments and bank accounts each month.

    As for this comment

    "A mortgage holder is imprisoned in a world of duplicitous estate agents, rapacious banks, sticky contracts and a highly inflexible market."

    You could equally well make the point about renters having to use estate agents, terrible landlords, minimum lease terms and inflexible options when it comes to decorating or modifying your home. I am sure most blog readers have had experience of terrible landlords, I know I have.

    One day Alice will wake up and smell the roses - can't wait to see it happen!

  11. I think this is the wisest strategy for anyone in the UK:

    1) Substantial cash savings
    2) No debt
    3) If you have property, have an overseas home for holidays and relaxation
    4) Rent in the UK and stay flexible. Why? Because two factors: UK job market, UK social failure and community volatility. Because of this, you do not want to be trapped in a community and a house. The UK just sucks too much.

  12. The UK: With Extra Faggoty-Goodness!

    Ha, ha, ha, ha, ha...

    Enjoy your failure losers!

  13. The inflation/deflation dichotomy is a false one. There has been and will be import inflation as the UK's foolhardy past reliance on financial services becomes reflected in the exchange rate. However, there has also been and will be massive credit deflation, due to widespread, continuing fear of debt.

    The one form of inflation which would make buying a house a good strategy is wage inflation. This is the only kind of inflation which supports rents and erodes mortgage debt. Even in the boom times the UK only managed wage inflation of 3-4%, and that included city bonuses. The UK economy is not structured to feed new money to household incomes. Therefore house prices and rents will continue to fall, and while cash may lose purchasing power in terms of food, energy etc, it will continue to gain purchasing power in terms of housing.

    frugalista, ghpc

  14. Alice,

    "This is, in fact, the crazy world that New Labour and the Bank of England want to create. Quantitative easing, zero interest rates, and double digit deficits are all policies directed at one objective - inflation. There is a debate about whether these policies will work, and I happen to think they will. Nevertheless, there is complete clarity about what Brown, Darling and King want to achieve. On this point at least, we can't accuse them of dishonesty"

    Of the G7 countries the USA, Canada and Japan all have interest rates lower than the UK's 0.5%. The three eurozone members have an interest marginally higher than our own at 1.0%. Are they all attempting to create inflation? Is this the work of New Labour as well?

    As for quantitative easing, in recent times, it was first tried in Japan in the 1990s, though with little success due to the insufficient sums involved. Today Japan has a more aggressive attitude to QE. In the US, the Federal Reserve is engaging in $1.2 trillion of QE, a figure which on a per capita basis is somewhat larger than our own programme. Did New Labour persuade both the out-going Republican administration and the new Democrat administration to engage in QE even before adopting the policy in Britain?

    As for the deficit, all G7 countries are experiencing increased levels of borrowing as a result of the bank bailouts, increased Government spending and, most importantly, reduced receipts. According to the IMF, Britain's deficit for 2009/10 will be 9.8% of GDP, about the same as Japan's, considerably less than the 13.6% for the US, but rather higher than the European members who are in the 4-6% range. Again, is this all part of some world-wide New Labour conspiracy? If so, it's not a very effective one, as inflation is at record lows in most countries!

    I have a simpler explanation. The authorities round the world are not trying to create inflation, at least not above the 2% target which most monetary authorities operate. Rather they see a greater danger from deflation and recession. They have stated their agenda in plain and simple language. In this, New Labour's policy is little different to that of most other G7 nations.

    If you really believe we're going to have inflation, why not invest in indexed linked savings certificates? You'll get an interest rate based on the RPI, which is currently -1.1%. The good news is that it's tax-free.

    Young Mark

  15. Alice, it was me who left that comment for you, I was just in a hurry and didn't log in.

    I agree with you about housing. I don't think now would be a good time to buy a house.

    Now to the question of protecting your savings against inflation (and possible smash and grab raids by a tax hungry government?).

    I'd avoid pounds sterling. I'd look at government bonds of countries with stable debt positions and commodities. I'm not doing that myself because I already have a mortgage so all I do is pay it down as fast as possible.

  16. I've gone for the simplistic approach. No debt, own home, modest cash savings earning less than the inflation rate now, and much less if (as likely) inflation kicks off.

    So I'm spending. Complete house rewire, new kitchen, just replaced my car, etc. If I wait it will only cost me more and my savings will be worth less. So it strikes me that it makes sense to bring all this kind of expense forwards.

    No idea how best to save ongoing investments though.

  17. I think there will be downward pressure on wages, while upward pressure on energy/utilities/imports. This means less money for housing/rent. Try as they might, the government will not be able to get the housing market merry-go-round going like 2007.

    I don't think hyperinflation will occur because we have had the god of all credit bubble collapses. Any money being pumped into the economy is disappearing down the plug hole of debt and bad investments/hoarding.

  18. Three decades of debt

    Always, now and forever, a stupid idea.

    But a mortgage of 10 years or less with a 50% down payment is not a bad deal unless you overpay for your house.

    The problem of course is that most of the public thought 30-years mortgages were a good deal and demand pushed up prices. 60 years later the public is finally catching on...