When you are punished for paying back all your loans
The other day I was talking to a mechanic friend of mine who has a garage down the country in a smallish town. He told me an extraordinary story about a friend of his who came into the garage a few weeks back to get his car touched up before he flogged it online. The story explains why an economy needs demand as well as supply to boost the recovery. In the past week since the Budget, there has been lots of talk about job creation through boosting supply. This little tale explains why boosting supply is not enough.
A few weeks later, the same bloke was back to the same mechanic. He hadn't sold it and so he was looking for the mechanic to get the car up to speed in order to pass the NCT.
He was doing the NCT on the old car because he couldn't get finance to buy the new car. He wanted to flog his old one to save on tax, fuel and upkeep. He was going to put that cash towards getting a new car. He hasn't changed his car in years. He aimed to use the cash, top it up with his savings and borrow the rest. He calculated that he'd actually save cash on tax and fuel each month.
The bank wouldn't finance him after it discovered he had a mortgage. Before he told them he had a mortgage, the finance was going to be released. Once he said he had a mortgage, which he has been paying for the past eight years, the bank declined the car loan.
He went to four other financial institutions and they all refused him because he had a mortgage. The banks explained (unofficially) that they didn't want to give car loans to people with mortgages because when it came down to deciding which to pay, people always choose the mortgage.
The bank had used the fact that he had paid the mortgage each month as "evidence" to substantiate its view that he would always opt for paying the mortgage over the car loan if he got into difficulty. This is a guy with a decent job, who has been working throughout the recession.
This is a bizarre example of the virtuous borrower being penalised because he is actually paying back his loans.
This is what the credit crunch does to an economy. It squeezes everyone and depresses demand. Even the people trying to do the right thing are penalised because banks put across-the-board credit limits on everyone.
This vicious cycle affects demand enormously because each individual decision has a massive aggregate impact on the overall economy.
When each car doesn't sell, a little bit more liquidity dries up and, over time, little by little, case by case, the car market seizes up.
We can see this in the latest evidence on the second-hand car market.
Cartell.ie reports that owners of pre-2009 vehicles are finding it increasingly difficult to offload their vehicle and re-enter the market for a newer car.
The company found that 34pc of all 2008 vehicles are still on their first owner. This is higher than the comparable figure for 2009 vehicles, which stands at 31pc.
Thus there is no problem with supply. There are loads of cars out there, loads of dealers trying to sell them. The price of second-hand cars has fallen dramatically and it is not as if dealers in this hyper-competitive market are taking big cuts of each deal. The problem is there aren't enough buyers.
In the language of economics, there's plenty of supply and not enough demand. But there should be demand because Irish people love their cars and for many there is no alternative to owning a car.
The reality in Ireland is that Irish people depend on their cars more than most other Europeans. According to the NTA's annual household travel survey, 85pc of all long journeys were taken by car. Seven out of 10 citizens said the car was their most used form of transport.
In addition, when consumer credit dries up it is not just the car market that is affected.
Consider that many of the people who can't get the loans to trade up are having to pay large amounts of tax, upkeep and fuel consumption on their old cars. NCT failure rates are increasing, meaning much more money for the NCT testers.
For the man in the opening example, he was going to save on fuel, tax and upkeep while also saving a small amount every month. Without the loan, he has to pay a large sum so his car will pass the NCT and meanwhile save as much as he can afford in an attempt to buy some sort of car to keep him going. This means he can't save for a rainy day nor can he spend today and then pay it back little by little over the course of the loan.
This is how demand in the economy is punctured and if credit isn't being extended by the banks, there is no way to kick-start demand.
Consumer credit and money supply have been falling constantly since 2007/08. This means the amount of money in the economy is contracting.
There is no demand in the economy and without demand there can be no recovery.
The Government continues to talk about supply in the economy as if making supply more plentiful, demand will come and people will miraculously be inclined to employ more people. The small example from the second- hand car market shows you why this is unfortunately wishful thinking.
What is happening in the car market is happening all over the economy and why stories of an incipient recovery are isolated incidents, specific to certain sectors – like the south Dublin housing market – but have little meaningful general relevance.