You’ve never had it so good.
That might be a bit of an exaggeration, but as we pointed out a few months ago, it’s fair to say that if you’ve still got a job, and you happen to be the lucky holder of a big mortgage, then there’s every chance that you’re feeling pretty flush right now.
A recent Ernst & Young survey found that the average employed homeowner in Britain actually has around 25% more disposable income than they did a year ago.
But don’t go spending it all at once – there’s a catch…
The problem with increased disposable income
The huge rise in disposable income – Ernst & Young reckons that employed British homeowners have an average of £1,075 a month to spend after fixed costs, compared to £859 a year ago – has been one of the factors helping to alleviate the pain of this recession.
Low interest rates at 0.5% have resulted in a windfall for those with big mortgages. They’ve been shielded from the pain of falling house prices to an extent. And it’s also led to the recent ‘reluctant landlord’ phenomenon – whereby those who want to move home but can’t bear to part with the old one at a “knock-down” price, simply rent out their old property.
Of course, this is only one chunk of the population. Low rates might be good for mortgage slaves, but they’re a nightmare for anyone relying on savings income, such as pensioners.
But mortgagees are hardly in the mood to celebrate either. The trouble is, this is only a temporary reprieve. If the economy genuinely recovers, then inflation will rise and the Bank of England will have to hike rates, driving their bills back up. But if we sink back towards deflation, the ‘real’ cost of their debt will go up anyway. And that’s why, as Ian Campbell points out on Breakingviews.com, the windfall they’re seeing just now is “more likely to be saved than spent”, or used to pay down debt.
What will happen when government debt needs to be paid down?
So all this ‘extra’ money in people’s pockets won’t lead to recovery – it’s just drawing out the pain. But a much larger and more stubborn problem is the scale of the UK’s government debt. The budget deficit is “soaring towards an unsustainable 13% of GDP,” says Campbell.
And this is where the big fault line in the world economy lies today. Even if consumers in the West can start to get their personal finances in order, their countries will still be hobbled by government debt. This has to be paid down at some point (regardless of what Gordon Brown says), and this has to be done by either cutting public spending or raising taxes, or both. For countries growing to rely more and more on ‘big government’ to bail them out, this will come as a shock.
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There are ways to make this process less painful – cutting taxes and regulation can help encourage growth in the private sector to take up the slack as the public sector is trimmed. But that depends very much on the politicians in charge at the time. And the inclination of those in power may be to share the pain instead, and raise taxes on the private sector, thus discouraging growth.
Why investors should be looking east
So any recovery in the West will be sluggish, and potentially very stop-start. But not everyone is in the same trouble as Britain and the US. And that’s why investors should already be looking east for the best opportunities. Christopher Wood at CLSA reckons that “deflation remains the prime threat for the debt-infested West” and that another big correction is quite possible in the coming months, which would probably drag down stock markets across the globe.
However, as central bankers in the West desperately try to avoid deflation by pumping yet more money into the economy, Asia may well be the main beneficiary. Asian countries don’t have the same structural (i.e. long-term) debt problems as the West. And as money “tends to flow to the best investment stories… aggressive monetary easing in the West” is most likely to benefit “Asian and emerging market asset prices, not indebted American and British consumers.”
In fact, says Wood, “there is a real possibility that Asia can enjoy an asset bubble before the Western fiat paper currency system finally implodes.” (For more on Asia in general and investment opportunities in the region, sign up for our free weekly email, MoneyWeek Asia.)
Of course, all that money pumping has a price – and in this case, Wood reckons there’s every chance that in the longer run it will result in “creditors [losing] faith in the Western fiat paper currency system altogether.” What’s the solution for investors? Hold gold, says Wood, to protect against the threat to the wider financial system posed by “the panicky response of Western policy makers to growing deflationary pressures in the West.” He believes that in due course, a paper currency meltdown could see the yellow metal spike to more than $3,000 an ounce. Our regular commodities writer Dominic Frisby will be producing a report on the best ways to get exposure to the gold bull market soon – keep an eye out for it.
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