Thursday, 12 March 2009

An idea from Bexhill-on-Sea

An interesting contribution in the Letters columns of The Times today came from someone in Bexhill-on-Sea. She suggested that, instead of the government pouring money into banks, it should pay-off personal indebtedness so that the economy could be revived by the little people spending again. She wrote: "This would make it possible for people to spend money again on large items, such as cars and furniture; it would kickstart the housing market ..." At this point I felt an icy shiver down the spine, but there was worse to come. "Rather than heap blame on those in debt, let us instead remember that if it were not for people's willingness to go into debt we would never have had a boom in the first place." Her proposal is to wipe-off all personal debt (although not made clear in the letter, it seems home-purchase loans would not be included).

There is a certain illusory logic to her argument because a lot more jobs are directly dependent on the continuing flow of little individual transactions through the tills of small businesses than on the result of individual corporate mega-deals or huge lumps of inter-bank lending. Eradicating current personal indebtedness would give people more spending power, but not, I think, in the way she suggested.

You see, there are two very different aspects to the effect of credit on consumer spending and they work against each other. On the one hand, expanding credit gives people more money to spend today. On the other hand, once they have taken out credit they have less money to spend tomorrow. The reason they have less money to spend tomorrow is because tomorrow they have to pay interest on the money they spent today and they have to repay the capital debt. If you wipe-off a debt of £5,000 today the only additional money made available for the happy beneficiary to spend tomorrow is the money they would otherwise use servicing that debt.

A quick bit of research suggests to me that average credit card interest rates are currently somewhere north of 20%pa. Call it 24% and, to keep it all nice and simple, let's call that 2% a month. If you owe £5,000 and have to pay 2% a month, you are forking out £100 each month. No doubt additional spending power of £100 a month for all those currently owing £5,000 or more on credit cards could make a significant difference to the small shopkeepers of the country. Ah, but maybe not as much as we might hope. Those who actually owe £10,000 and have seen their monthly repayments rise from £75 to £200 might think better of spending their additional £100 a month booty, and use it instead to make additional repayments against the other £5,000 they owe, after all they have to pay very hefty interest on it. Nonetheless, wiping-off a certain level of consumer indebtedness would free-up some extra spending money and this could save jobs.

The other way businesses could be saved is by those who have had a certain amount of debt paid for them borrowing the same amount again. In the example I have given, you find the government paying-off £5,000 so you rack-up another £5,000 on your piece of plastic by feeding your addiction to unnecessary fripperies. That throws money into the tills of the shops selling fridges with two doors, suitcases with wheels and little wooden racks full of decorative thimbles. But once it's spent, it's spent. Then you are in the position you were before the government gave you another £5,000, namely you are stuck with a £10,000 debt.

Credit does not provide limitless opportunities for ever-expanding consumer spending because the day must always come when the cost of repaying what you have already borrowed becomes so high that you cannot afford to borrow any more. In other words, the limit to consumer credit lies not in the amount of credit offered but in the amount of money available to repay the borrowing.

For months I have been bleating like a deranged goat about the problem of unsustainable credit. That is not to say that all credit is unsustainable. Credit is a facility to allow us to pay over time for something we wish to possess today. Large purchases, such as houses and cars, are not readily affordable for most people without credit. Every prospective purchaser has to balance how much he can afford to repay out of his monthly income against the desirability of having the thing now rather than saving up and having it later. Some conclude that they cannot afford a car at all, others buy one for £3,000 over five years, others buy one for £40,000 over three years; what can be afforded is a matter for individual budgets. The one inescapable fact is that you can only repay what you can afford to repay. When it comes to smaller things costing just a few hundred pounds - beds, televisions, chairs, dishwashers and the like - credit allows people to buy them a little bit earlier than if they had saved but overall it just makes them much more expensive than they would otherwise be.

The essential difference between sustainable and unsustainable credit is that sustainable credit is based on fact and unsustainable credit is based on unrealistic hope. Sustainable credit is paid for now from money you have and in the future from money you reasonably expect to have. Unsustainable credit is paid for now from money you either have or borrow, and in the future from money you can only hope to receive.

The correspondent's proposal is for all personal debt (excluding home-purchase loans) to be wiped-off, not just part. It seems to carry with it the necessity not to allow such indebtedness to arise again. I will leave to one side the obvious moral argument that it is obscene to allow the spendthrift to wallow in thousands of pounds worth of fancy home cinema arrangements and other electronic wizardry they acquired on the never-never while the prudent make do with a small fat telly, a single-doored fridge and the abject poverty of no bidet. I will also leave aside the obvious fact that everyone will have to pay the cost of the write-off because it won't just happen by magic. How, as she suggests, will the big purchases be made? Cars will be just as unaffordable without credit as they have been for years. Her other example was furniture, much of that could be saved for over a relatively short period without undue difficulty, but while it is being saved for other purchases will be forgone. And how will it kick-start the housing market? (Not that I am suggesting for one second that the housing market should do anything other than fall by another 20% or so to reach a genuinely affordable level.)

The answer, of course, is that the big purchases will still need credit and restricting credit for small purchases cannot affect the housing market directly. The only likely consequence of wiping-off existing credit card and personal loan debt is that cash spending in shops will increase. I certainly don't have a problem with the concept that that would save many small businesses, both shops and those who supply them. It will transfer some spending from finance companies to florists and from banks to bakeries. But it won't do anything for big purchases.

Therein lies both the strength and the weakness of her suggestion. Insofar as she wants to eradicate some of the means by which people have borrowed beyond their capacity to repay, I am with her all the way. I would happily see credit cards abolished tomorrow without shedding even one thousandth of a tear. They cause far more trouble than they are worth. Yet the fact remains that many businesses became dependent on the short-term additional sales they made to people using expensive forms of personal credit. Those businesses are first in the firing line if consumer credit is restricted heavily. The reason they are in jeopardy is that they were built on a foundation of pretend money. Remove the pretend money and you have a necessarily more stable economy, albeit one with a smaller overall turnover than before.

That is what poor Gordon's boom of doom was based on - an awful lot of people borrowing more than they could afford to repay. The correspondent from Bexhill wrote "... if it were not for people's willingness to go into debt we would never have had a boom in the first place", as though the boom were a good thing and something we should seek to replicate and continue to the end of time. The boom was never anything more than a bust waiting to happen because the time had to come when the unaffordability of a massive chunk of consumer credit could no longer be hidden inside yet further personal borrowing. Payback day had to arrive.

The problems arising when payback day arrives depend on many factors. As things have turned out its arrival coincided with, and perhaps was brought forward by, the pickle banks got themselves into. Yet even without current banking problems there was a structural difficulty caused by overspending. As people spend more over a lengthy period businesses react to increased receipts by expanding to meet perceived future demand. Shops hire more staff because they are busier, they open more branches because they expect to be busier still; their new staff earn money which they spend in other shops who also expand, and so the whole merry-go-round turns.

It all seems so wonderful until you realise that a proportion of the money being spent must dry up when the credit card is full. It would be a different day for different people, but eventually it would have to happen to so many people that overall spending on the optional extras of life would slow down. And where does that leave the shops? There's less in the till yet fixed costs remain the same, and there's the new branch they have just opened and which isn't yet covering the rent. Something has to give. What gives first is the most flexible of all costs, wages, and that means jobs. And lost jobs means lost income for the unlucky few. And lost income for them means less spending by them. And less spending by them means more lost jobs elsewhere. Of course it's not just shops but they are a good illustration of the problem.

We can "boom" our way out of recession, as called for by the letter I am discussing, but we can only do so for a short time. The same structural problem of unsustainable credit that we are now witnessing will happen again and again because there really is no such thing as a free lunch. Make Mr Visa pay for lunch today and it might seem free, but you will have to pay the price eventually and you'll pay him 2% a month in the meantime. No one should look on poor Gordon's boom of doom as anything but a disaster. It might have seemed great for those who found jobs and enjoyed a decent income for a few years, but too many of them are now in more pain than if they had never had the job in the first place. And, sadly, there are many more who will find themselves in that position in the months ahead.

1 comment:

Mark Wadsworth said...

Yes, we have a stupid debt/credit bubble.

The good old fashioned liberal approach is that either debts are paid off, or borrowers declare themselves bankrupt, whoever it was made the loan takes the loss on the chin*, good bank/bad bank split etc.

The political-corporatist approach is to reduce real debts by having massive inflation, printing money.

The pie-in-the-sky is a one off debt forgiveness, which is great for the reckless borrower but a bit of a slap in the face for people with cash in the bank.

You pays your money and you takes your choice.

* As to quite who owns those loans and whether they are secured or not ..?