Economics may be bad for your health! - Part 1
Recession! What recession?
So what is this new economic crisis? Are we moving towards the Armageddon of western economics? What does and will recession mean?
Economists define recession as a decline in the production of gross domestic product for six-months based on measures taken in two three month periods.
Neither the USA nor the UK are experiencing what is described as “negative growth” currently, although there is a widely held belief that we may be heading towards recession.
A lot of factors are being cited as the cause of our current economic difficulties, among which are:
1. The crash in the housing market.
The boom in the housing market was an absurd phenomenon.
House prices in the UK were rising at rates of more than six times the rate of inflation in some years.
Suddenly the world was awash with property millionaires. Someone who had bought a London house for £72,000 ($144,000) in 1983 and stayed put, woke up to find their property is worth £1.6 million in 2007! ($3.2 million). A new two bedroom apartment on the outskirts of Oxford, close to a railway line came onto the market last year at around £500,000 ($1 million). Think about it, one million dollars for a small apartment in a small city outside London!
The average age of a first time house buyer is currently somewhere in the mid-thirties age range. So where do the rest live? How do teachers, nurses, doctors, police and essential service staff ever afford these prices? The answer is they don’t.
It had to stop, and stop it did. House prices are going down in the UK. Economic reports from the USA say that house prices there are over-valued by at least 40%, although by UK standards house prices in the USA look dirt-cheap! Prices have fallen by up to 25% in the past year in (some parts of) the USA.
House price equity in an overblown, pumped-up market is fool’s gold. It is wealth created by a market without any corresponding new value. It has provided a mirage of prosperity by fuelling consumer spending and debt.
To put all this in perspective, the average house price in the UK (across all regions) is about £220k ($440k), the average salary is somewhere in the region of £22k - £26k ($44k - $52$k).
So people have taken risks with borrowing, sometimes taking out loans of between 8 and 10 times their annual salaries in order to own a home. It should come as no surprise therefore that the housing market is in deep trouble.
2. So-called high-risk lending, the “sub-prime” market is collapsing. Sub-prime lending involves lending money for greater returns to poorer people who would not otherwise be able to afford conventional home loans. It’s an economic contradiction that sustains poverty. If one is poor access to money comes at a higher price than if one is rich.
Falling house prices in the USA and to some extent, the UK, means a risk of negative home equity at a very high price. Home repossessions are increasing fast. There is an increasing rate of defaults that means that banks lose money and so do the mortgage companies.
3. So we have:
• Shortage of mortgage funding and banks teetering on the edge of solvency
• Decline in market confidence that affects all sectors of the economy
• Property prices that became vastly overvalued
• Increase in supply accompanying falling demand, with housing costs still running at levels in the UK that are inaccessible to average wage earners, young people and essential service providers
4. Next! There’s the ever-increasing oil price pushing up costs. There is the rising cost of food too that is not necessarily all tied to the cost of oil.
5. One more…the booming house price mirage fuelled consumer borrowing. A falling house market and lowered confidence in the rest of the economy means that people are taking on less debt and looking to save. This in turn means lower consumer spending. Lower consumer spending means lower production that increases the chance of a recession. It is interesting to me that that financial prudence, as I might see it, and a move away from consumption for consumption’s sake has an adverse economic consequence. I’ll come back to that in part 2.
Summary
There are a number of factors involved in our current economic difficulties, but the two main issues as I see them are the decline of an over-heated housing market and a decrease in consumer spending.
Part 2 will be about whether economic growth is beneficial to us all. My feelings are that it is not such a good thing after all. We may need to change the way we view our economic lives.
So what is this new economic crisis? Are we moving towards the Armageddon of western economics? What does and will recession mean?
Economists define recession as a decline in the production of gross domestic product for six-months based on measures taken in two three month periods.
Neither the USA nor the UK are experiencing what is described as “negative growth” currently, although there is a widely held belief that we may be heading towards recession.
A lot of factors are being cited as the cause of our current economic difficulties, among which are:
1. The crash in the housing market.
The boom in the housing market was an absurd phenomenon.
House prices in the UK were rising at rates of more than six times the rate of inflation in some years.
Suddenly the world was awash with property millionaires. Someone who had bought a London house for £72,000 ($144,000) in 1983 and stayed put, woke up to find their property is worth £1.6 million in 2007! ($3.2 million). A new two bedroom apartment on the outskirts of Oxford, close to a railway line came onto the market last year at around £500,000 ($1 million). Think about it, one million dollars for a small apartment in a small city outside London!
The average age of a first time house buyer is currently somewhere in the mid-thirties age range. So where do the rest live? How do teachers, nurses, doctors, police and essential service staff ever afford these prices? The answer is they don’t.
It had to stop, and stop it did. House prices are going down in the UK. Economic reports from the USA say that house prices there are over-valued by at least 40%, although by UK standards house prices in the USA look dirt-cheap! Prices have fallen by up to 25% in the past year in (some parts of) the USA.
House price equity in an overblown, pumped-up market is fool’s gold. It is wealth created by a market without any corresponding new value. It has provided a mirage of prosperity by fuelling consumer spending and debt.
To put all this in perspective, the average house price in the UK (across all regions) is about £220k ($440k), the average salary is somewhere in the region of £22k - £26k ($44k - $52$k).
So people have taken risks with borrowing, sometimes taking out loans of between 8 and 10 times their annual salaries in order to own a home. It should come as no surprise therefore that the housing market is in deep trouble.
2. So-called high-risk lending, the “sub-prime” market is collapsing. Sub-prime lending involves lending money for greater returns to poorer people who would not otherwise be able to afford conventional home loans. It’s an economic contradiction that sustains poverty. If one is poor access to money comes at a higher price than if one is rich.
Falling house prices in the USA and to some extent, the UK, means a risk of negative home equity at a very high price. Home repossessions are increasing fast. There is an increasing rate of defaults that means that banks lose money and so do the mortgage companies.
3. So we have:
• Shortage of mortgage funding and banks teetering on the edge of solvency
• Decline in market confidence that affects all sectors of the economy
• Property prices that became vastly overvalued
• Increase in supply accompanying falling demand, with housing costs still running at levels in the UK that are inaccessible to average wage earners, young people and essential service providers
4. Next! There’s the ever-increasing oil price pushing up costs. There is the rising cost of food too that is not necessarily all tied to the cost of oil.
5. One more…the booming house price mirage fuelled consumer borrowing. A falling house market and lowered confidence in the rest of the economy means that people are taking on less debt and looking to save. This in turn means lower consumer spending. Lower consumer spending means lower production that increases the chance of a recession. It is interesting to me that that financial prudence, as I might see it, and a move away from consumption for consumption’s sake has an adverse economic consequence. I’ll come back to that in part 2.
Summary
There are a number of factors involved in our current economic difficulties, but the two main issues as I see them are the decline of an over-heated housing market and a decrease in consumer spending.
Part 2 will be about whether economic growth is beneficial to us all. My feelings are that it is not such a good thing after all. We may need to change the way we view our economic lives.
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