torsdag 27 mars 2008

The sinking pound

I have drawn attention several times to the falling value of the Pound against the Euro, which was worth about €1.50 when the Euro was instituted in 2002, €1.40 last summer and has now slid to €1.27, a drop of over15% in less than a year.

At last the issue is being noticed. There was talk on the radio this morning of allowing it to fall to 1 pound to the Euro, a devaluation of one third since 2002. In any case it should not be forgotten that the Euro has been subject to inflation of around 15% over the same period. This recent fall in the value of the £ against the € will quickly show up in higher prices in the shops, though it is good news for British producers and manufacturers, and exporters in particular.

Personally, I suspect that the Euro will itself drop before long, which will lead to a flight of investors into gold and commodities. It is a pity that Gordon Brown sold half the UK's gold reserves when the metal was at its rock bottom price, as they could have been sold now to support the currency.

Part of the present problem is that the € has gone up as people have shifted their US$ balances and has nothing to do with anything in particular that has happened here. However, some of the fall is due to the UK balance of payments deficit which has resulted in large sterling balances being held abroad. How has this happened? There has been a consumer spending spree. And some of it has been funded out of the property (land price) boom as people have borrowed to release equity from their homes.

Amongst the things that I was taught when I learned economics were that (1) Land is not wealth and (2) Not to borrow except to pay for something that would increase one's ability to produce ie actual physical capital.

If this were widely and properly understood, banks would not be lending money on the security of land as collateral and people would not be borrowing money to pay for holidays or to buy cars other than those used for business. So this latest problem would not have arisen and we would not be about to see substantial inflation.

The reason why people believe land is wealth is because it can be traded, often at a profit. But what is actually being traded is the capitalisation of the real or imputed income stream, known as rent, from the land, which is a different matter. It is the same thing as buying an annuity. The only way, ultimately, to prevent this nonsense is for governments to collect the rental income from land and use it as its principal source of revenue, instead of troublesome and destructive taxes such as Income Tax and VAT. Then the whole stupid practice of over-lending and over-borrowing would have to stop, bringing with it an end to these disruptive land-fuelled boom-slump cycles which appear to recur at intervals of around 18 years.

How would banks function in such a fiscal environment? Perfectly well, is the answer. When making loans they would need only to make an assessment of the likelihood of getting their money back and make a charge according to the risk. There would be no need even to charge interest as they could simply have a fee scale based on the cost of administration plus risk cover. They would no longer make spectacular profits and losses but would instead operate in relatively stable conditions earning a steady return for the work they did.

Interestingly, such a system would be in accordance of the ordinances of the major religions which have always condemned the practice of lending money for interest. Given the misery that is about to be inflicted on nearly everyone, it seems as if they were on to something.

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