Outstanding debt on other forms of consumer credit is ten times that. The main risks are with the finance companies offering these contracts – typically arms of car manufacturers. Unlike credit cards or personal loans, the lenders here are predominantly the finance arms of car companies. Their losses – however painful to them – pale in significance for the wider economy next to situations in which it’s the banking system making the losses. Nevertheless, the banks that are involved, as well as the shareholders of car companies, will want to think very carefully about the risks. While the borrower knows the monthly payments they are committing to, the lender does not know with any certainty whether they will make money on the deal. The initial deposit and the monthly payments are set to cover the expected depreciation in the value of the car, plus a margin. The final balloon payment is therefore less than the expected value of the car at the end of the contract. But if used car prices were to fall, the PCP purchaser has every incentive to give the car back after making the monthly payments, skipping the final balloon payment and instead buying the same car from a used car dealer for a lower price. The finance company is left with a car that has depreciated by more than they’ve been paid. Unlike a credit card or a personal loan, the borrower does not need to miss payments for the lender to lose money.
Various adjustments to this set-up might reduce some partial imbalances, but if the cause of the problem is not tackled head on, the effects of such adjustments will be short-lived and it will only be a matter of time before the whole system comes crashing down. Now let’s move forward in time some 20 years, to the split of the Czechoslovak currency following the dissolution of Czechoslovakia in 1993. For many years, fiscal transfers had masked the significantly inferior performance of Slovak economy relative to its Czech neighbour to the west. This performance gap was further widened by the closing-off of the Slovak armament industry from the federal centre at the beginning of the 1990s. After the country split in two, the stated goal of keeping a common currency came under market pressures as Czech and Slovak entities transferred their deposits to Czech banks and capital flowed out of both countries. As a result, this goal was abandoned in less than two months and an independent Czech crown – or koruna – was introduced. I should add that the CNB had its plan B and had been running preparations for the currency split since the second half of 1992. Consequently, after it had decided to act, it was able to act fast. So, what lessons can we learn from this event? The lack of political will to preserve the federal Czechoslovak state had quickly recognisable consequences for the common currency.