The new normal
The year is 2030. Self driving cars are delivering fast food right to people’s front doors. China surpasses the U.S. as the world’s largest economy. Everyone uses mobile wallets instead of credit cards. Increasing wealth inequality has created constant social unrest. But one thing hasn’t changed. Interest rates continue to remain at rock bottom. You can still get a mortgage for less than 2.5%. 🙂
The economy has fallen into a deep pit of debt – so deep you can find Adele rolling in it. Policy makers around the world manufactured liquidity and bailed out corporations. Everyone has become accustomed to cheap money. If interest rates were to climb by just 1% then a third of mortgages will become delinquent.
Inflating money with impunity
Today in 2020 the United States government is already technically insolvent. But it can continue to make its debt payments because…
- It has the ability to borrow money from a line of credit with no credit limit. And..
- It can choose the interest rate at which it borrows thanks to the Federal Reserve.
From the total revenue collected by the U.S. federal government, 17% of it is used to pay interest on the debt it owes. If interest rates were to rise by just 1% then nearly a quarter of the federal revenue will have to go towards interest costs. That would be insane. Doing so would be the equivalent of someone with a $50,000 salary taking on a $500,000 mortgage at 2.5% interest rate. Nobody can qualify for a mortgage 10x their annual income. Even if the borrower thinks he can afford it, good luck finding a lender audacious enough to approve his loan application. Most mortgages are only 3 to 5 times one’s income.
Typically if a debtor starts to borrow more than he can adequately service – market forces will begin to push back. Lenders will either reject any new credit increase requests, or they will raise the interest rate to compensate for the debtor becoming a higher risk. But this doesn’t happen for governments with their own printing presses. The result: massive asset price inflation.
The lost decade
From 2010 to 2020 policies makers did try to normalize interest rates. But it was a catastrophe. As soon as rates went up they tumbled back down again.
- European rates were raised by 0.50% in 2011 before being dropped by 1.50% to zero.
- Canada had better luck increasing the benchmark rate by 1.25%. But then had to cut it by 1.50%.
- The U.S. was the most hawkish and managed to raise rates by 2.5% – before dropping them by 2.5%.
So after 12 years of “recovery” since the 2008 financial meltdown the world is back to square one today. Any extended period of higher interest rates just couldn’t be sustained.
The next 10 years
Some may blame today’s low interest rates on a disease that’s been going around. But the virus was only the pin that pricked the precarious bubble we were already in. If it wasn’t a pandemic it would have been something else. It wasn’t hard to predict this recession. The signs were already there 2 years ago.
The longer interest rates remain low the more 💲 people will borrow. That’s exactly what we’re seeing in the real estate market. Mortgage debt growth has exploded and helped fuel higher housing prices. Canadians owe literally twice as much mortgage debt today as compared to 2008. In other words, it took all of Canada’s 100+ years of history up to 2008 to accumulate $800 billion of mortgage debt. Then it took just 12 more years to build up another $800 billion. Oh man. That is a scary reality. 😮
This can only mean one thing. Low interest rates are here to stay for at least 10 more years. Prepare for low mortgage rates and low bond yields all the way to the 2030 Olympics. This is the new normal. It’s great news if you’re a borrower. Bad news if you’re a saver.
Policy makers tried to normalize rates before and evidently failed. Is there any reason to believe they will succeed on their next attempt when the economy will be even more entrenched in debt? Nope. Both governments and consumers have become too reliant on cheap money. Any attempt to raise rates in the short and medium term will surely backfire.
Politicians take care of the economy like grandparents take care of small children for the weekend. They just want to be liked and revered in the present. That’s why they do what’s expedient instead of what’s responsible. But a lack of discipline will eventually lead to disaster. But that’s fine. They won’t be responsible anymore when the consequences come due.
The only way out of this perennial cheap credit cycle is a major shock to the underlying economic system itself. This could mean a restructuring of government debt, an accelerated increase in the cost of living, or a new world reserve currency.
In any case, I plan to continue buying hard assets and infrastructure companies. All this is just conjecture. But if rates really do stay low for the next 10 years then I want to be prepared. 🙂 That’s why I’m looking to purchase another real estate property before the end of this year. 🏠
What are you doing with your money these days?
Random Useless Fact:
Internet companies make money by selling your information to advertisers.