Depression? What Depression…

British workers will endure a protracted decline in living standards, according to Bank of England Governor Mervyn King. Not since the run-up to the Depression of the 1930s have employees suffered such a grim prospect. And yet, when I signalled that this would be a depression – in my 2005 book Boom Bust – I was disparaged by economists.

According to the wise-after-the-event experts meeting in Davos this week, the inequality in wealth is the most serious challenge to the world in the years ahead. The gap between rich and poor within the developed and developing countries must be shrunk if the global economy is to enjoy sustained growth.

Statistics show that inequality peaked in 1929 and 2007. In the US, according to people like Min Zhu, a special advisor to the IMF, the top 1% owned 47% of the wealth in 2007 – a rise from 28% in 1968. Our world is divided as never before. Those divisions will provoke the most tragic conflicts in the history of mankind. And yet, the experts still don’t know what to do about it.

An Avoidable Crash
The causes of the 2008 credit crunch have now been investigated by the US government’s commission that was supposed to identify the culprits. According to the official report, the financial melt-down was avoidable. But was it? The conclusions are trite, revealing that the enquiry studiously avoided facing up to the realities.

Regulators are blamed for lacking the political will to hold the banks and their agencies accountable. “The crisis was the result of human action and inaction, not of Mother Nature or computer models gone awry,” declares the report. “The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risk.”

Nowhere in the report is there evidence that the commission had come to grips with the economics of the land market. And yet, it was the extraordinary capital gains from land that enabled banks to drive up credit and delude themselves that property remained the best collateral for their loans.

The Achilles Heel
A similar failure is illustrated by a review of global problems from an historical perspective written by John Plender for the Financial Times (January 27). Although he raises the question of what might be done about the persistence of property as the driver of modern boom/busts, the authorities he consults shift the focus back to reckless bankers. Plender failed to distinguish between land and the bricks and mortar buildings which depreciate in time.

So, blindly, the world is allowed to stumble into the next financial trauma. Over the next two years, hundreds of billions of dollars worth of loans linked to property will have to be renegotiated. The collateral value of those loans has declined markedly, while banks are now shy about re-financing real estate. So expect serious problems in the commercial market that will deepen the crisis in the labour market.

When all the analysts have finished with their hot air diagnoses, we are still left with a void in policy. The only way to forestall the next land-led bubble that will peak in 2026 is to restructure the tax regime. We need to cut taxes on wages (to raise employment) and impose seriously high rental charges on land to maintain the provision of public services. Those rents would reduce the capital gains from land, encouraging banks to direct their credit towards the value-adding sectors. As of today, that’s not going to happen, so batten down the hatches. This depression has only just begun.

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