As we watch interest rates continue to spike across Europe today I am actually encouraged. The truth about debt levels and systemic risk are finally seeping out into the light of day. Yes higher rates mean higher carrying costs and higher default rates. But higher rates are also a good and natural precursor to a healthy economy and the efficient allocation of capital.
Having lived through some of the most historically reckless fiscal, monetary and regulatory policy over the past 15 years, thinking people should look forward to a return to sanity–to yield curves, math and rules that make sense once more. Far from a curse, higher rates will fix much of the dysfunction and imbalance that has become our global economy. In a normal, healthy world, rates will return to at least historic ranges: North American government bonds about 6%, first mortgage rates about 8%, cars and revolving lines of credit about 12%. Higher, more normalized rates will help the world heal: savers will once again be rewarded, borrowers will be forced into discipline and care with their credit use and spending habits, investors with cash will be back in the driver’s seat able to make calculated assessments for attractive reward on reasonable risk once more.
While the Boomer generation was in charge of the rules, governments, companies and finance sector over the past 20 years, they proved to be weak, undisciplined and selfish leaders. They have continually opted for the easy way out: lower interest rates, lower taxes, lower regulation, lower investment in infrastructure–all so that they could indulge more in the creature comforts of homes, recreation and consumer goods. Short-term thinking has been the death of us. Time to admit–like it or not, there is no free lunch.
The world is now polarized into a tiny minority that have net assets and a huge majority that have less than nothing–debt. The trouble is that the minority with the assets are getting old and are now being penalized by the very low rate environment they created. Low rates and low yields are hurting their retirement income and pensions just when they are coming to need them. Boomers need the younger generation behind to supply them with liquidity- to buy Boomer homes, businesses and financial assets.
Elders are supposed to be wise leaders who look out for the weak and young, not sacrifice them for their own gain. Karma sucks: the young people today are now broke–1 in 4 is unemployed and wobbling under loans and credit they should never have been advanced.
Real estate prices will continue to fall until average households can reasonably afford them. Just as China and Germany are learning today, if you advance too much credit to keep your customers buying it will eventually lead you full circle to a bunch of bad debts and crippled customers.
This Reuters article on new plans in the UK to keep the credit bubble alive so that sellers can find buyers is excellent:
“To be sure, first-time buyers purchasing new houses helps to create jobs but this is a stimulative policy that depends on putting people in harm’s way for a supposedly greater good. Some borrowers will naively assume that it must be safe to borrow so disproportionately to their means simply because it is being done as part of a government program. They, however, are not the prime beneficiaries here. Instead, it is the building industry, and to a certain extent existing home owners and the banks which hold their mortgages…
Ultimately this phenomenon calls into question the solvency of borrowers, be they individuals owning housing, banks owning mortgages or governments backstopping banks. It is tempting then to support the asset prices by adding a bit more leverage.
What’s really needed is either a sustained bout of salutary inflation — a polite default on the debt — or some kind of organized jubilee to rebase both asset prices and the debt which supports them.
While the Bank of England is mulling yet another round of quantitative easing, the current high rate of UK inflation should fall rapidly, and shows little sign of spreading to housing.
Britain, and especially its young nurses and police, would do well to keep their heads down, save their pennies and wait for housing to fall another 20 percent in real terms, as ultimately it must.” See: Britian eats (leverages) its young
Canada too by the way: see Canadian housing frothier than US at peak