"This was a bust without a boom"

The words of Mervyn King again  speaking in the Today programme lecture last night. on the financial crisis. History provides evidence that this statement is a physical impossibility and the same will be confirmed eventually with the current depression. His comment illustrates how he completely misses the underlying causes. Relying on inflation measures missed the enormous expansion in mortgage lending by the private banks which fuelled a tripling of house prices in 12 years. Astonishingly, when questioned on this, King claimed that this house price increase was sustainable by the low interest rates and the borrowing of first time buyers (95% mortgages and 7 time earnings sustainable!)

In a credit based economy it is the natural tendency for asset prices to outstrip the productive side and this is the foundation of the boom-bust cycle. This will be shown to be the case in the UK again; the fragility of our economy, too reliant on the expansion of debt cannot support land prices that remain inflated. Until policy makers understand this, the boom-bust process will continue to fuel inequality, unemployment and misery.

Yorkie, officially for girls

Towards the end of last year I noticed that picking out my customary Yorkie bar from the vending machine was easier than normal and its consumption was far less satisfying. I also spotted that they were no longer using the catch phrase "Its not for girls". More recently I was pleased to pick up some 'old stock' Yorkies approaching their use-by-date from my local Coop and I was able to do a direct comparison.

So Nestle have decreased the mass of the Yorkie bar by a staggering 15% and are selling it at the same price. I can only conclude that the new Yorkie "is for girls", perhaps those that are on a diet for the new year. Sadly I expect this change to be permanent and I will have to look elsewhere for a chunky chocolate fix.

This did get me thinking about the nature of 'inflation'. The price of the product has not changed, however the price/g of the chocolate has gone up. For the chocolate consumer this represents an increase in the cost of living but I don't believe this will be recognised via the 'basket of goods' by which 'inflation' is measured. However there is a fundamental difference between a price increase caused by, say, a poor cocoa harvest reducing supply to the market and a price increase brought about by a devaluation in the currency caused by an increased supply of money. Which is true 'inflation'?

On another thing I am more certain, an increase in base money from the Bank of England is not directly inflationary. Since it tends to sit in commercial bank reserve accounts and does not flow outwards into the wider economy. The amount of money in active circulation is increased by commercial banks creating new loans. This is something that they are not currently doing much of, since the pool of credit worthy borrowers is shrinking (as unemployment increases and businesses contract) and their security of choice, real-estate, is falling in value.

Bank of England, there is hope?

I was rather critical of Mervyn King and the BoE's inability to spot the enormous credit bubble developing in the run up to the current financial crisis. However, I have just been directed to this publication from last year that appears to make a less orthodox economic assessment of the run-up to the crisis "the Great Moderation".  Although, yes the horse had long since bolted. I have only just started digesting this but on the face of it, it is very interesting to see Hymen Minsky cited describing the inherent instabilities of the finance sector. In a nutshell the paper concludes that although established macroeconomic indicators (inflation and unemployment) were stable, credit, balance sheets and asset prices were certainly not, so in the future we should probably keep an eye on these. Halleluja!

One interesting figure that I can pull out straight away is this plot confirming the much debated transfer of  "wealth" from young to old over the past 15 years:

Housing wealth gains are clearly concentrated amongst baby boomers (50-65yrs). Net financial wealth (less pension assets) actually reduces across most age groups but is clearly skewed towards the youngest since they have been taking on proportionately more debt (larger mortgages) and so their liabilities have increased substantially. Only the oldest have seen a net actual increase in financial wealth (less pensions) since this cohort have typically paid off mortgages and come from a more debt averse generation. Across the population the net financial wealth asset (area above line) is clearly smaller than the net financial liabilities (area below line), I deduce that the missing bit must be with the banks!

I do wonder why the more insightful work of the BoE such as this is buried but frankly deluded statements such as "Mortgage debt cut by £8.6bn but Bank of England sees little sign of rush by households to reduce debts" are publicised.