Sunday, August 10, 2003

Kate Burgess opines in Monday's Financial Times that the specter of deflation is causing folks to abandon the whole idea of saving in favor of spending.
Kate Barker, a member of the Bank of England's monetary policy committee, has pointed out the risk that individuals think "it is not worth saving today" because low nominal interest rates and investment returns on almost any savings products from annuities and pensions to with-profit bonds seem so unattractive.

Meanwhile, consumer debt has risen to some �860bn - four-fifths of it secured on houses - from around �398bn a decade ago. The Bank of England calculates that debt has risen from around 90 per cent of household disposable income in 1989 to more than 120 per cent.

Instinctively, investors believe that the time to borrow is when the interest rates quoted on the high street are low. Few of us are bothered how much we owe, with unemployment and interest rates at record lows and house prices still rising.

But this is money illusion and it is distorting rational economic behaviour say the economists, who worry that consumers will find it increasingly difficult to pay off their steep debts.
A good point well made. In a low-growth low-inflation environment, huge debt loads are a flailing albatross around the necks of millions of UK and US consumers. This is especially clear when compared to the 1950s and 1960s -- the so-called "Golden Era" of capitalism.
Moreover, money illusion disguises the real cost of debt. Strip out inflation and the "real cost of borrowing is not particularly low," says Kalyan.

Since 2000, the real cost of mortgage debt, stripping out inflation, has averaged around 3.6 per cent. Real mortgage rates rarely reached more than that until 1980.

Take the loss of mortgage interest tax relief (abolished in 1999) into account as well as inflation and "the real cost of borrowing is higher now than in the 1950s, 1960s and 1970s, and is only marginally lower than in the 1980s and 1990s," says Capital Economics.
When Brits and Yanks refuse to save, they depend heavily on all those diligent hard-working Asians to ship their savings to the Anglo world. In the US particularly, with a current account deficit now over 5% of GDP and likely to go far higher, that deal will look less and less appealing. And then the profligacy of the baby boomers will truly be meted out to the third and to the fourth generations.

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