This is Money Blog

Retire at 70? No chance. Our unfixable demographic problem

This demograhic problem is really coming home to roost.

It's a pet subject of mine...

- Demographic investments - I'm loving the returns (Apr 2009)
- How baby boomers will extend the financial crisis (Jan 2009)
- Demographics make emerging markets a screaming buy (Jan 2009)
- Demographics to spark a shares slump next year (Dec 2007)
- Demographics will spark a 15-yr slump, starting with falling London house prices in 2008 (Mar 2002)

...so I thoroughly enjoy these spells when the issue of population surges up the news agenda, given it is possibly the biggest and most immediate challenge facing the developed world...

- FSA boss says work until you're 70 (Daily Mail)
- Special report on ageing populations (The Economist - front page)

The problem in a nutshell

The post-war baby booms in Western economies (1945 to 1965) mean that a huge bulge in the population is transfering from contributing to the economy to taking from the economy because they are:
- Less likely to pay tax
- Less likely to spend
- More likely to use costly public services
- Certain to draw a state pension increasing pressure on public finances
- Likely to draw on stretched company pension schemes, increasing pressure on company finances

All these factors are then amplified by increasing longevity - life expectancy when the full state pension was introduced in the 1940s was around the same as pensionable age. Now it's 77 for men, and increasing by two years every decade.

The crest of this population bulge hits retirement age next year (or four years ago for women).

Before I trigger the hate mail/comments, I entirely accept that this hard-working generation deserves a well-earned retirement. I'm simply laying out the harsh reality of the economic impact.

And the solutions?

- Dramatically increase the pensionable age
- Dramatically increase immigration (a younger population helps pay for the old)

The first option is now impossible. The older population bulge also have the most votes - so no government would dare force them to work signifcantly longer. The opportunity has been lost. So open the floodgates to immigration? Again, political suicide.

So that's it. Just grin and bear it. The Japanese, who hit their own demographic wall 20 years before us in 1989, seem to have come to terms with the fact they're not constantly getting richer. Now we need to make the same adjustment.

- Andrew Oxlade, Editor, This is Money

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We have the rail system that we deserve

As a nation of whingeing motorists the British public has no right to lament the latest twist in the debacle that is the UK rail system.

For decades the great British motorist has made it perfectly clear where his priorities lie: with driving his own little car – usually on his own and not so little – exactly wherever and whenever he likes. He wants more roads and cheaper petrol and lower road tax.

Each hint that the motorist should pay more and the selfishness turns to anger – either at the pumps or at new road tax measures or at traffic wardens or at speeding cameras.

'I wouldn’t mind,' the put-upon sigh goes up, 'if the revenues went towards better roads.'

Motorists pay a fraction of the real social and economic cost of driving. No other private pursuit is subsidised in quite the same way; no other luxury has come to be treated as a necessity with such a disastrous outcome for the standard of living in this country.

'But it IS a necessity for most of us,' the angry cry goes up. 'Public transport doesn't exist where I live. It's so bad and expensive it forces us into cars.'

Well that might well be the case on a day-to-day basis - but it is not a carte blanche out of individual responsibility.

Where was your anger over rail privatisation? Where was your anger over successive train fare increases? Where was your anger over station closures and poor service and management bonuses and rail disasters that cost dozens of lives?

Compared to the regular uproar over the poor old driver being hit in the pocket again, I seem to remember an overwhelming indifference. If you’ve ever complained about rising road tax or petrol tax or parking fines or speeding fines – then you are part of the collective attitude that has ushered transport in this country into the dark ages.

Public transport is in the state it’s in because as a nation obsessed with the motor car, we have gladly allowed it to become so. 

Those staring forward bright-eyed from motoring’s golden age of the 1950s and 1960s might not have been able to foresee the dysfunctional and I would argue dystopian outcome that the switch from train and bus to car would bring about.

But it's been the elephant in the room since the mid-1980s and we have stood around doing precisely nothing about it. And we haven’t even started paying for it.

- Adrian Lowery, Assistant editor, This is Money

Deflationwatch part III: what is getting cheaper?

Prices are falling right? After all May's figures showed the third successive month of RPI deflation, but for some reason everything still seems to be managing to get more expensive.

So here is Deflationwatch part III: an ongoing look at the figures that reveal what exactly is getting cheaper (Hint, not a lot).

First the inflation report in a nutshell:

Inflation figures for May showed the third successive month of Retail Prices Index deflation, at -1.1%, this was a smaller 12-month price fall than the 1.2% seen in April.

Yet again Consumer Prices Inflation remained above the 2% target at 2.2%, but eased back a little from the 2.3% seen in April.

Again the ONS report reveals how the report is being skewed by an exceptional cut in interest rates and last year's petrol price spike.

It said the main deflationary forces were mortgage costs and motoring expenditure. Clothes, shoes and leisure goods also pulled down RPI, but all the stuff many need on a daily basis, such as food, electricity and gas and fares and other costs rose.

Here's the RPI figures:

Here's the CPI figures:

- Deflationwatch part I - What exactly is falling in price?

- Deflationwatch part II - We could do with some real falling prices

- Simon Lambert, assistant editor, This is Money

I'd like low house prices and higher interest rates

If it came to the crunch which one would you choose: higher interest rates and lower house prices, or vice versa?

I know which way I’d cast my vote: I’ll take lower and more stable house prices with a higher cost of borrowing, please Bob.

Unfortunately, the portents don’t look good for this. Property optimists are getting excited as monthly reports show property price rises, the Royal Institution of Chartered Surveyors reveals high levels of interest, and the economy shows slight signs of perking up.

The pessimists are frantically running around tearing the green shoots up, but there is an undeniable bit of some spring in the property market’s step. Of course, this should not add up to recovery: unemployment is rising, the economy is fragile, lending is still tight, redundancy is a dinner party topic, etc.

Common sense says ‘no to house price rises’. But then common sense has had a terrible run when it comes to the property market.

On top of this, despite the current economic mess, we are failing to reassess our attitude to how the whole property prices game works. The seeds of another boom are being sown now, in the middle of the bust.

Currently there are a lot of people looking at properties 20% cheaper than late 2007, combined with interest rates below 4%, and thinking ‘bargain’.

Except, of course, even at this substantial discount on the peak, most properties are not a bargain. They might look cheap, but that’s because we've become desensitized to ludicrous property prices - and it is low interest rates that have done this.

It is only because the base rate has been at 6% for the past decade, and typically a fair bit below this, that house price inflation spiralled, yet bizarrely there was little attempt to tackle this inflation in a nation of homeowners.

The average house price managed to rise 263%, from £75,751 in June 1999, to peak at £199,612 in August 2007 (Halifax). It has since fallen back by 21% to £158,565, but this remains six times the average wage.

So have there been any beneficiaries of that astronomical rise in house prices? Well some families feel richer because they have a home that’s worth lots, but that’s an illusion.

If you’re mortgaged then high house prices simply mean more debt not more wealth. If you own outright you can only release that gain by selling up and either buying a smaller and inferior house, or leaving your home area, otherwise your rent or any other property you buy will negate your profit.

High house prices deliver a mirage of wealth, make it expensive to move, leave families hugely in debt, mean children can’t buy without parents’ help, and the inevitable popping of a property bubble has catastrophic economic effects.

With a charge sheet like that you wonder why anyone wants high house prices. And then you remember who the winners are: the banks.

If the average home costs £75,000 and you raise a 25% deposit, you have to borrow £56,250 over 25 years; if it costs £200,000 you have to borrow £150,000 (and in the boom years you don't do that you borrow £180,000-plus.) The benefit to the bank from high house prices, in the interest you pay it and the total charge over the 25 years, is substantial.

So while rates had to be slashed to deal with the very real prospect of economic collapse, the cuts have saved many from repossession and I would wish negative equity on no-one, I hope that when house price inflation rears its ugly head again the powers that be tackle it properly through interest rates.

If we are nearing the bottom of the property market, it would be nice if we used this as an opportunity to start again and try to control house prices, because frankly we've given the banks more than enough cash recently.

- Simon Lambert, assistant editor, This is Money

- Interest rates: What next - news and analysis

- Property prices: What next - news and analysis

 

Robert Shiller: 'House prices to fall further'

Robert Shiller (pictured) is a renowned US economist. 

Not only is he professor of economics and finance at Yale, he has also written respected books on economics and investor psychology - and his repeat-sales home price indices, developed originally with Karl E. Case, are now published as the Standard & Poor’s/Case Shiller Home Price Indices - a standard measure of the market in America (it suggest prices are down 33% so far). 

As you can imagine, his views carry weight. So it's worth pointing out an article he wrote at the weekend for the New York Times.

In it, he predicts that despite three years of falling house prices he expects more of the same. The health of the US property market is a linchpin for the global economy - further falls mean bigger losses - the extent is unknown - for financial institutions around the world.

He also cites reasons why property declines are so protracted...

• >> Sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers think that home prices are in decline, most have no reason to hurry because they are not really leaving the market.
• >> Few homeowners consider exiting the housing market for purely speculative reasons. Owners don’t like shifting from being owners to renters. It also takes agreement from both halves of a couple - and there are children with school places, and friends, to think about. 'Most decisions to exit the market in favour of renting... are due to economic necessity.'
• >> Young couples, seeing rising unemployment and property turmoil, remain renters. They may not revisit that house-buying decision for some years.
• >> At the other end, elderly couples who during the boom were holding out against selling their home and moving to a continuing-care retirement community have decided that it’s finally the time to do so. It may take them a year or two to sort through a lifetime of belongings and prepare for the move, but they may never revisit their decision again.

And the conclusion:

'As a result, we will have a seller and no buyer, and there will be that much less demand relative to supply — and one more reason that prices may continue to fall, or stagnate, in 2010 or 2011.'

Although he admits these people 'could be made to change their plans if a sharp improvement in the economy got their attention', which might provide an 'upward kick to the market price'. He adds: 'That's why not all economists agree that home price declines are really predictable'.

And the UK impact?

Shiller didn't go into that - so I will. As previously observed on this blog, UK house prices still look wildly overvalued on fundamental measures, such as average wages vs property. However, I also suggested that we may get short-term bounces on the long road down. The Bank of England is dumping billions of pounds of printed money into the economy - that has helped improved confidence and helped make mortgage borrowing cheaper. I would imagine the Government and the BoE must be desperate to stabilise the housing market, knowing that further declines will inflict further bad debts on UK banks. They would surely do anything to protect the recent nascent recovery in banking confidence.

Meanwhile, there are legions of would-be buyers waiting on the sidelines ready to pounce on any sign that the bottom has been reached. A short period of sustained rises could, in theory, be followed by a longer period of sustained rises.

I talked to an estate agent in my area today - the Surrey/London borders - and he said sales dramatically picked up in March, although prices are still not rising. He even has one seller who wants to raise the price of his property.

Prices may rise short-term, but long-term I think Shiller is bang on the money. He points out that after the recession of 1991, US house prices didn't start rising until 1997. In the UK, it was small rises with 1995 with a substantial pick-up in 1997. This recession is far, far deeper than the last and the recovery faces additional headwinds.

- Andrew Oxlade, Editor, This is Money

For a full round-up of the factors, don't miss: What next for property prices?

Archive posts
- Shrewd buy-to-let seller buys again
- My buy-to-let barometer: confidence rises
- Are these towns property-crash proof?
- A Place in the Sun: 'Cape Verde prices will rise 75%'

Deflation: we could do with some real falling prices

The latest inflation figures have prompted yet more warnings of deflation from economists.

The Retail Prices Index' fall to -1.2% has delivered inevitable deflation headlines. Except of course, this isn't strictly deflation.

Deflation would be if the official measure of inflation the consumer prices index (CPI) went negative and that is still above the 2% target, at 2.3%.

But would a good bout of deflation really be that bad?

The criticisms are that it increases borrowing in real terms, leads to wage freezes and slows the economy. But, on the flip side, it's lower mortgage borrowing costs driving deflation, while people's wages are already being frozen, the Government has promised a pensions rise, and aren't lower prices generally used to attract customers?

A look at the inflation data shows why deflation would help the man in the street, despite the economic arguments otherwise.

What is driving RPI deflation is falling housing costs - but this is down to the base rate being slashed to 0.5%, compared to 5% a year ago. Further major factors are cheaper clothing and footwear, as stores desperately discount to sell off goods, and lower motoring costs, but that is compared to exceptionally high petrol costs a year ago.

The vast majority of things are still getting more expensive and that is from a point last year when they were already rising in price.

RPI deflation is being skewed by mortgages and petrol at the moment: and these will drop away within a year, leaving the figures looking very different.

Arguably we could do with the items on the right of the graphs below heading left. Who doesn't want cheaper food, fuel and light (energy bills), household goods, fares and other travel costs? At least it would make up for the pay freezes, inevitable tax rises, and rising unemployment we're already dealing with.

And you never know, we might actually spend more if people stopped ripping us off.

- Simon Lambert, assistant editor, This is Money

Here's the RPI figures:

And here's the CPI figures, the official measure of inflation which is still above the 2% target:

 

- Interest rates: What next - news and analysis

- Property prices: What next - news and analysis

 

The profit-mirage behind bank bonuses

Today the Treasury Select Committee warns that the bank bonus culture is still 'flourishing'. The industry could argue that the bankers who have skillfully protected their banks from the need for direct taxpayer bailouts should be richly rewarded.

I don't agree. I agree with the Nobel Award-winning economist Paul Krugman (right). His column in the New York Times last month reflected a growing irritation that I felt...

'You might argue that we have a free-market economy, and it’s up to the private sector to decide how much its employees are worth. But... Wall Street is no longer, in any real sense, part of the private sector. It’s a ward of the state, every bit as dependent on government aid as recipients of Temporary Assistance for Needy Families, a k a “welfare.”

'I’m not just talking about the $600bn or so already committed under the TARP. There are also the huge credit lines extended by the Federal Reserve; large-scale lending by Federal Home Loan Banks; the taxpayer-financed payoffs of A.I.G. contracts; the vast expansion of F.D.I.C. guarantees; and, more broadly, the implicit backing provided to every financial firm considered too big, or too strategic, to fail.'

His point is that all parts of the banking industry have benefited from taxpayer assistance of one sort or another. And it's similar for other countries. In the UK, for instance, we have the Special Liquidity Scheme, a line of heavily subsidised credit that has been accessed by 32 banks and building societies, according to the Bank of England. It's just one of a handful of schemes launched by the BoE [more explained here].

Yes, I understand that improving credit was necessary. But when banks borrow cheap public money and make bumper profits - taxpayer-subsidised profits - is it right to use those profits to justify bonuses?

This profit-mirage also delays the inevitable restructuring and reordering of the banks. Most people who live within commuting distance of the City will have noticed, on a personal level, the vast pay disparity between bank workers and those in the comparable jobs of other industries.  As Krugman says: 'From the 1930s until around 1980 banking was a staid, rather boring business that paid no better, on average, than other industries, yet kept the economy’s wheels turning.'

This normality will return. Some bankers recognise it, but there's still a chance to churn more bumper 'profits' and bonuses in the meantime.

- Andrew Oxlade, Editor, This is Money 

>> Poll: Should bank bonuses be banned?

Student loan interest rate decision is a disgrace

The Government's decision not to pay interest on student loans is disgraceful. Albeit, in the long line of current scandals it's not a massive one, but this is far more invidious than claiming you forgot you paid off the mortgage for expenses purposes.

We have always been told that the current student loan system is designed so that loans do not grow or shrink in real terms and that is why the interest rate is set at inflation.

The thing is though, what students don’t have properly explained to them before they are coerced into taking on £10,000-plus of debt is that the UK runs a bizarre inflation system.

This has official inflation regarded as the Consumer Prices Index measure but uses the old measure of the Retail Prices Index to set various things, including the student loan interest rate.

So the first problem with student loans is that Government is pushing students towards university and then encouraging them to start their adult financial life with £10,000-plus worth of borrowing that they don’t understand.

Quite why the student loan interest rate is based on the broadest inflation measure, which includes mortgages and housing costs and was therefore jettisoned as the official inflation figure, has never been properly explained.

Except of course, that this has worked in the Government’s favour for years, as RPI has been consistently higher than CPI.
 
Therefore the student loan interest rate, set at the March RPI figure and imposed for a year from September, has always cheated those students who foolishly believed a loan that tracked inflation would actually be set by the Government’s official inflation figure.

This problem came to a head in 2007, when March’s RPI figure spiked to 4.8% and the student loan interest rate was set at that level for an entire year.

This doubled the previous year’s rate and to give a personal example, I was now paying an interest rate just 0.19% below my fixed mortgage rate, on a supposedly low cost loan.

Protests followed this rate hike but the Government stood firm and confirmed student loan rates would always be based on the March RPI figure. That was of course, until suddenly RPI no longer worked in its favour.

The need to slash interest rates down to 0.5% to combat a deep recession has now pulled RPI down so dramatically that RPI for March 2009 was -0.4%. Deflation had arrived and so under the principal of keeping student loans stable in real terms and always using the March RPI figure, they should have started paying interest of 0.4% from September.

But, of course, they won’t. The Government it seems can’t and won't change the rules when students are being hammered with an almost 5% rate caused by inflation, but it certainly can when it comes to paying interest and ensuring the loan doesn’t increase in real terms due to deflation.

Oh, and just to make it a little bit more galling, that will be the Government full of MPs that had free university education and student grants.

Sure, it’s not a lot of money. At -0.4% deflation on a £10,000 loan, it’s only £40 a year, although the Budget has predicted -3% RPI by September and that would be £300 a year. But it’s the principle of the matter. If you make a rule that you refuse to bend on, then you should stick by that: and not just when it works in your favour.

And in a nation afflicted by its debt and driven deep into recession by it, you do not make daft statements justifying your decisions by saying the interest rate doesn’t affect monthly payments, implying that means it doesn’t really matter.

Such as this by the Student Loans Company: ‘The rate of interest makes no difference to borrowers’ monthly repayments. Borrowers repay 9% of their earnings over the income threshold of £15,000.  Whatever the rate of interest is, that monthly repayment will not change.

‘The repayment threshold will also remain at £15,000 for the next 12 months. Had the Government used a negative RPI rate to calculate this, the threshold would have reduced and borrowers would have started repaying earlier and ended up paying more. Setting interest at 0% has prevented this from happening.’

That mirrors a similar statement made by then minister for education and skills Bill Rammell, when the loan rate doubled to 4.8%: ‘It is crucial to note that, for the vast majority of borrowers with income-contingent loans, there will be no difference at all in their monthly repayments, which will continue to be deducted from their salaries at the rate of 9% of any income over £15,000 per annum. The interest rate affects only their outstanding loan balances.’

That is like saying that it doesn’t matter if your credit card company hikes the rate on a long-outstanding balance, because your minimum monthly payments won’t change, or it cuts your minimum payment. Of course it does, the size of your debt will increase and that’s the most important thing.

But then why would we need all the students that we are supposedly training to become the leaders of the future to understand how a £10,000 debt that they start financial life with works?

If we are going to encourage people into university on the premise that they will earn more than others rather than as a social good, as we currently do, then perhaps I agree they should pay: although I’m not sure on this.

What I definitely don’t agree with though is getting people into years of debt under a badly explained Government–sponsored system that changes the rules to suit itself.

- Simon Lambert, assistant editor, This is Money

- Interest rates: What next - news and analysis

- Property prices: What next - news and analysis

 

Will the recession be W-shaped?

Welcome to the W-shaped recession. After some hefty debate last year over whether the recession would be U, V, or even L-shaped, a new contender is ready to gain more attention.

The beauty of it is that it currently manages to match both the optimists' green shoots and the pessimists' gloomy warnings.
 
Before the banking crisis, economists were debating a number of scenarios:

The V-shaped recession: short and shallow - a swift plunge followed by a bounce back

A U-shaped recession: longer a deeper - a dive down to the doldrums and then recovery

An L-Shaped recession: Not good (note the lack of a recovery) - a plunge then a long period of stagnation

Each of these letters still has their backers, with some switching between letters and others hedging their bets.

The W shaped recession has been lurking around the edges for a while, but was thrown into the mix again by George Buckley, chief UK economist at Deutsche Bank, who suggested the economy may grow again by June.

He warned though: 'The big risk is you could see a W-shaped recession. We could see policymakers taking back some of the easing too quickly.'

The W shape would essentially mean that green shoots being spotted are just that, but these would then be wiped out (perhaps by a late frost) and growth will fall again before recovering.

And if you think about it, the W has its merits. The juddering halt the global economy was brought to came courtesy of the exceptional event that was the banking crisis. Meanwhile, the internet age has enabled companies around the world to hit the big red button to startling effect, bringing a rapid decline in output and big job losses.

The kitchen sink approach to easing the banking crisis has seen a huge amount of money thrown at the money markets around the world, which is filtering through to the economy, and output is increasing again to meet demand after destocking and a collapse in industrial production.

Added into the mix is that those who have kept their jobs have not seen much economic pain and having done a few months of saving, they are now going out and spending again, albeit cautiously, and possibly even thinking about buying a house at 20% off two years ago.

All of this is giving momentum to a blip that will provide the little peak in the middle of the W, before things take a turn for the worst again, as unemployment, pay freezes and banks feeling the pain of bad mortgage and commercial loans kicks in.

It makes sense, so are people convinced? Well the W is still very much a small time contender, with bulls pushing for a V, the more cautious a U and the doommongers a very long L.

Oh and just to make things slightly more complicated, here's another thrown into the mix courtesy of Merrill Lynch: the slightly tilted square root recession.

In a European investment research note, Holger Schmieding, head of developed Europe economics, says: 'The 'square root' scenario is becoming quite popular, with a sharp initial recovery followed by a levelling off halfway down the road.'

So that's a v with a long tail, showing dive in GDP, recovery and then semi-stagnation, or a modest loss of momentum as Merrill Lynch prefers.

There you go, letter based recessions. Hours of fun (for some), but you can bet the overall picture is bound to be an O, with boom and bust rolling around in a vicious circle.

- Simon Lambert, assistant editor, This is Money

- Interest rates: What next - news and analysis

- Property prices: What next - news and analysis

 

When will interest rates rise again? Ask a child

It’s a fairly safe bet that interest rates will be kept on hold at 0.5% by the Bank of England tomorrow – but when will the base rate rise again?

This is the million dollar question for those trying to make the most of their savings, or decide on a fixed or tracker rate mortgage.

The problem with forecasting what will happen is that no-one really has the faintest idea. Sure, there are plenty of economic forecasts out there, but commentators can’t even reach a consensus on whether deflation or inflation is the real risk.

The world’s governments have thrown so much money and effort at the problem, in a scattergun fashion, and its difficult to know whether it’s actually working or whether we’re about to end straight back in the hole we are trying to dig our way out of.

So what should you do? Voraciously read economic research, work out your own cunning interest rate predictor, flip a coin?

My suggestion would be ask a child. Try and explain the current situation to them simply and carefully and see what they say. You won’t get an answer. They’ll point out the whole situation is bonkers and eventually get bored. (If they don’t they will probably grow up to be an economist, so I’d be wary of any answers).

That solution will then remind you that in the current economic madness you might as well just make a choice and stick by it and not berate yourself when you get it wrong.

Alternatively, you could look at what a whole bunch of people who don’t really know what is going to happen are staking their cash on.

Spread betting firm Spreadex says its punters think we could be looking at very low rates until at least December 2010. It allows investors to bet on future Libor quotes and there is so little movement in future prices that some are heading as far as the end of next year for their bets – and still only predicting between 2.7% and 2.8%, compared to 1.4% now.

Libor measures the rates at which banks lend to each other, and while it doesn’t necessarily move in line with the base rate this indicates betting types in the City, don’t reckon rates are rising by much anytime soon.

Personally, I reckon we might start to see rises from the current 0.5% base rate at the end of the year and be back up to 2% to 3% by the end of next year, which if Libor returns to its normal relationship with the base rate means Spreadex’s punters almost agree with me.

But then I’m neither an economist or a child, so I wouldn’t recommend listening to me either.

- Simon Lambert, assistant editor, This is Money

- Interest rates: What next - news and analysis

- Property prices: What next - news and analysis