Paying a mortgage, not rent, is dead money in today’s world

Are you into cameras? Do you marvel at the quality you can get from the most ordinary models these days?
Or what about the extraordinary technology in normal camcorders? Like me, are you amazed at the quality of images from a bog-standard laser printer?

All these are made possible by Canon, the highly innovative Japanese consumer goods company. Canon, like so many other Japanese companies, was in the doldrums ten years ago, but today it is the market leader again. The man behind the resurgent Canon is a quiet, thoughtful septuagenarian called Michiyo Nakamoto.

Nakamoto is no globalisation-obsessed chief executive warning that, unless people work harder for less, jobs will all disappear to China or Mexico, while at the same time, paying himself a fortune.On the contrary, he believes in keeping as many good jobs as possible in expensive Japan.

His entire board is Japanese, despite 87 per cent of Canon’s sales coming from outside Japan. He is shameless when it comes to putting Japanese workers and interests first. According to Nakamoto, if Japan continues to innovate it has little to worry about. Like any good industrialist, he sees the direct link between productivity, the return on equity and wages.

When asked where did Japan go wrong in the 1990s, he spits out the word “land”. You can hear the contempt in his voice when he remembers the land frenzy that almost bankrupted Japan in the late 1980s and early 1990s.The linkbetween land speculation and future debt problems is so well documented that it is amazing we need to re-examine it.

But with our central bank warning this week about house prices, it’s worth examining the land problem in Ireland and how it devalues the currency in our pockets.

Irish banking operates a land standard. The soaring price of land and houses are intricately linked to the profitability of our banking system and as such, both are part of the problem.

Unfortunately, because rising property prices keep the banks looking profitable, the banks have a vested interest in ensuring that the great Irish land rip-off remains in business. The “land standard” is a useful term to explain why credit in Ireland is rising so quickly.The flip side of credit is always debt.

Historically, banks only lent money against gold, otherwise, loosely printed money would soon become worthless. Here in Ireland, land has replaced gold and banks take land or houses as collateral. So, for example, a house worth €300,000 is used as collateral to borrow €270,000 to buy another apartment for investment. The extra €270,000 goes into the system. The golden rule of monetary economics is that the more money in the system, the greater the upward price pressures on all other things.

Thus, the extra cash sloshing around in the system puts upward price pressure on houses because there is too much money chasing too few houses. This makes the original collateral now increase in “value” to €330,000. The bank extends another loan on the same collateral, failing to distinguish the chicken from the egg.

Back in the real world,the only fundamental reason for house prices to rise is if the income from rent is rising. This is not the case in Ireland. Rents have been falling, according to the Central Statistics Office for over 12 months now. If the income from the asset is falling relative to the value of the asset, then we have a problem.

So why does the price not adjust downwards?

Well for a variety of short-term reasons, but mainly because the cheap credit keeps the whole game in business. Yes, there is demand, but this only explains the direction of prices, not the extent of price increases.

History is replete with examples of accommodation shortages. For example, in post-war Germany demand for accommodation was enormous, yet house prices did not increase dramatically because there was no credit.The key in a credit-driven boom is not to be the last buyer.

As long as credit is cheap,the banks will lend. Indeed, the banks are the main reason land prices remain high and the bank’s future is so tied up in land that if they stop lending now prices would fall. Any fall in prices would lead to bad debts, profit warnings, share price collapses and bank takeovers.

No chief executive of an Irish bank would survive such a scenario, so there are good careerist and personal, as well as corporate, reasons for double digit lending to a workforce whose personal income is only rising by 2 or 3 per cent.

Sometimes,we fail to see that banks are simply selling money. Therefore, instead of being the guardians of prudence, the banks can become the agents of profligacy.

And where does all the borrowed money come from? It is not ours in the first place. It comes largely from other people’s hard-earned savings, from the older savings of continental Europe. European Monetary Union means we borrow their savings on the cheap and our banking system trousers the commission.

But forget the land market for a minute and ask what return does the country get from all of our money going into land and houses. Do bricks and mortar generate innovation? No. Once built, do houses generate wages, employment, Vat, income taxes? No. Does investment in bricks and mortar allow Irish productivity and thus wages to rise? No. Does such investment equip us with the skills to compete with Canon? No way, baby!

Ironically, when looked at from the general economic standpoint, money invested in bricks and mortar is actually “dead money” – a term usually reserved by estate agents to describe renting.

If those billions of borrowed euro were diverted into productive rather than unproductive capacity what would happen? First, investment in humans, rather than bricks, would increase our productivity.This raises the return on equity in the country. The greater the return on equity, the more profits and wages that can be paid.

Thus both wages and profits could rise simultaneously.This, surely, is the point of the exercise, is it not? If Irish workers get paid more per hour of work because we are producing more, then we can have more free cash to spend in our free time.

But no, we do precisely the opposite. We invest all we can in land and houses.The opportunity cost of this is lower productivity per worker. This means relatively lower wages than our German neighbours. Lower wages and a much higher proportion of our after-tax take home wage going to rents and mortgages (historically, low interest rates notwithstanding), means less disposable income.

Equally, the huge rise in land prices causes a huge transfer of cash from workers to landlords, for doing nothing and, more egregiously, from the young, who shoulder the debts to the old and middle-aged who own the land. This is not how a modern, sophisticated economy works; it is demographic feudalism.

Mr Nakamoto must be sitting back laughing, because at least he knows there is one country that will never challenge the livelihood of his Japanese workers. “The Irish,” he might say, “we used to worry about them, but they’ve been seduced by the mirage of land, and they will impoverish themselves before they realise that the Emperor is in the raw.”