How do consumers manage their debts going forward? This is a very tricky balancing act to get right. The reason it is tricky is because we face very complex cross currents.
The cross currents are to do with prices inflation and money supply.
As the credit destruction continues unabated, the value of debts in real terms is beginning to rise. This is because prices are falling and as unemployment continues to rise, wages are beginning to fall as well.
The Wild West days of the London financial markets are behind us and will not return for a very long time. In addition, one of the key drivers of UK growth has gone into terminal decline. The one-time gift of North Sea oil is quickly running dry and coupled with the financial markets, two of the biggest contributors to UK GDP have gone in to long-term reverse.
This is having an impact on unemployment which, coupled with the credit destruction is forcing the price of UK produced goods and wages down for the first time in a couple of decades.
The effect of deflation on wages and debt means that in real terms the levels of debt are rising. This is because it takes a proportionately larger amount of disposable income to service the debt. However, rest bite is on the horizon in a couple of years.
The printing presses have been turned on in Theadneedle Street and inflation is on the way. There are two ways to play this change from deflation to probably quite large inflation. Today, if you have debts and savings or spare income, you would be well advised to get rid of the debts. It will cost an ever increasing amount of your income to cover these debts so it is best to retire them as quickly as possible.
Once the inflation starts to come in earnest, I will be getting into as much debt as I possibly can to buy inflation protected investments. This is because the inflation will erode the real value of the debt as wages must rise to compensate for the increasing cost of living.
However, wages are only able to rise insofar as we have goods to sell to the rest of the world which are demanded. Since our oil industry, financial services industry and manufacturing base has been crippled by recent events, it is definitely not a certainty that we will be able to manufacture our way out of this crisis.
Should you see an upturn in manufacturing and an upturn in money printing coupled with a decrease in unemployment, it is a strong set of signals that you should begin to take on debt again.
If you do, you can buy real assets that produce inflation proofed income like farmland and, to a certain extent property. You could see the income from those assets continue to rise while a proportion of your expenditure required to service those assets continue to fall due to inflation. This is a smart way to play what could be about to unfold.
