DOUBLING HOME LOAN INTEREST RATES IN 6 MONTHS: A BAD IDEA!
Make 2022 The Year You Start Your Journey As A First Home Buyer
Mortgage rates have almost doubled over the course of 2022 and I feel like the unease about interest rates has kind of dissipated the last couple of months as everyone is used to the news.
This is probably a dangerous spot to be in as history tells us that quite often the real pain is noticed 6 to 9 months after the increases in rates start.
Today I’m going to go into why raising interest rates so fast is actually a bad idea… and not just for the obvious reasons.
How our money system works
First, it is beneficial for you to understand why interest rates are going up so fast.
Let me put this into context for you by explaining in about a minute how the money system works.
So, have you ever seen a graph of the stock market or the property market over the past 50 or a hundred years?
The reason it goes up all the time is because our system constantly creates more money, the system works well when our governments can spend in case of emergencies.
It’s actually one of the reasons why we changed the money that we use from gold to paper, and now we even have digital money. We need to keep on creating money because that’s the way the system works.
The Central Bank’s job, apart from being the lender of last resort to the normal banks when they aren’t going so well, is to ensure the economy is kept stable. In their eyes, stable is inflation at 2% to 3%.
So generally what happens is whenever you go for a home loan, the vast majority of that money is actually created money, and the Central Bank’s job is to regulate along with the government, how quickly money is created in the economy, and that’s going to control the inflation.
I’m just going to simplify this and say that our economy and our governments should be printing 2% to 3% more money supply per year to make sure that the economy runs and is in its maximum efficiency. That’s all you need to know.
Fast forward to the pandemic – every Western country’s response was to print 20% to 30% of the money supply.
In my opinion, when you print 20% to 30% more for your money supply, it solves a lot of immediate short-term problems, and that’s fine. You can actually argue whether they printed too much or they should’ve printed less. This has resulted in many arguments over the last two or three years, but it did help us financially with the pandemic in the short term. But it isn’t over yet.
Think about this – if to print 2% to 3% more money every year is our sweet zone or what we should be doing to keep the economy stable and then most Western countries print 20% to 30% of their money supply, then that is 10 times above the sweet zone.
So, there’s definitely going to be ramifications for that.
All the money is now flowing through the economy and when there’s more money, the prices of goods go up, especially if they’re scarce. Property is a great example of that.
That’s the issue; the problems that money creation solve are just short-term problems.
Why is inflation bad?
Now, there’s high inflation. So, why is inflation bad?
Three’s a lot of panic created but at the same time a lot of people don’t actually know what it means and why it’s bad.
The point I want to make is not all things inflate equally.
I’ll use Property as an example. Property’s been inflating like crazy in Australia for a long time.
Wages right now in the pandemic are actually not even increasing as much as the inflation, so what’s happening is we’re actually losing our purchasing power. You can see in this article that wage growth is 2.6% and a quick google search shows current inflation at 6.1%.
Basically, we’re making less as other things go up. Let’s tease this out.
Assume you earn $100,000 per year. You buy $100,000 worth of stuff.
Next year with wage growth at 2.6% that means you now earn $102,600. Excellent your income’s gone up.
Not so fast. That $100,000 worth of stuff you could buy is now going to cost you $106,100.
That’s why inflation’s bad.
And generally what happens is the wealthy can deal with inflation because they’re wealthy, but the poor can’t and it puts them into hardship.
Sadly, quite often those people that are put into hardship get turned into generational hardships. Their kids are poor and then their kids’ kids are poor. We don’t want that do we?
So, one question here is about the printing off all of this money, since no one’s income is going up, who’s getting all the money? Obviously, it makes sense that wealthy people have the cash.
So there, you can see that inflation is a real problem.
What central banks do to fight it?
The way I see it, it’s such a problem because central banks thought this was just transitionary inflation – meaning, experts expected that it won’t last. They believe it was just caused by the war in Ukraine or the people coming out from lockdowns.
Actually, I agreed with them and I kind of still agree with that notion that a lot of this is transitionary, but I think it can go over a long period of time, and obviously they weren’t thinking with the same time frames.
Now, earlier I’ve said that inflation hurts the “poorest” of our economy. Unfortunately that means the majority of us because there’s only a few wealthy or rich, and most of us are actually poor.
So the government or the central bank says, “okay, we have a problem… now we’re going to fight it.” What that actually means is they’re going to increase interest rates.
Why rising interest rates so fast is bad?
Now, the idea of increasing interest rates will mean the cost of debt increases. Your home loan, repayments, credit cards, all of that sort of stuff actually goes up, and basically means we’ve got less money to spend.
More of our daily or weekly budget will go towards debt repayments. That means less money can be spent on goods and services, which therefore puts a deflationary effect on things to fight the inflation.
So, I really think that the central bank doesn’t actually know when they’ve gone too far in terms of interest rate hikes and this goes the same with the whole money printing thing, which I always complain about.
From my viewpoint, I think they’re trying to hit a bullseye with a blindfold on, and what will happen here is they may push interest rates too high.
That will definitely put people into more hardship. But also, if they do nothing, they’re going to have the inflation, which pushes people into hardship as well. The is the difficult position the Reserve Bank are in.
Businesses will not be able to borrow as much because if interest rates continue to go up, it reduces their borrowing power. In return, they have to raise the cost of their goods and services.
We’re seeing that now. I paid $25 for a burger and chips at lunch the other day, and it’s crazy. It wasn’t even a proper restaurant.
It means that if things go up in value, people will eventually stop buying a $25-burger-and-chips, which means businesses will then make less money, which also means they’ll have to lay off staff.
This starts spreading around the economy, and once people start getting on the same page, people actually start holding their money because they don’t know how bad things are going to get. People will save as much as they possibly can because they’ve got to think of what they need to pay for the coming months like the electricity, food, petrol, etc.
So this is the crux of things – how high does the Reserve Bank go before it’s worse than doing nothing?
What I think is they’re going to try and take the lesser of two evils, which is just increasing rates and let the economy crash rather than having to deal with runaway inflation.
We’ve also got the other side and that is when they realize that it isn’t working. Interest rates will have to be eased and The Reserve Bank will continue to print money more than 2% to 3%, which actually has been happening for quite a long time now.
I’m actually a believer of cycles as I’ve observed that over the years is the economy gets too hot. We get inflation. The central bank raises interest rates. It crushes the economy. You get a recession. Then the governments can come in and print more money to rescue everyone from the recession.
The problem here is the speed at which governments are tinkering with these things and it makes things more volatile.
The issue is the wealthier you are, the easier you can weather this. But the poorer you are, the harder it is to deal with the volatility of the economy.
So, generational poverty is a real risk, but that is the downside of the government mismanaging the economy.
The take-away
Bad outcomes can happen anytime.
There are just too many things that are out of our control so the take-away here is just be more responsible with your finances.
We’ve grown up through a Goldilocks period and that’s cushioned us from some of the harsh realities of the world, and the fact is that there are winners and losers.
I believe that the volatile times that we are going through means a lot of people who thought they are winning are going to realize that they’re actually losing… just don’t become one of them!
If you love this video or if there’s something that really rubbed you up the wrong way, please like and subscribe anyway, and leave a comment below so we can have a healthy discussion.
Till next time!
Will Bell
Will Bell has 15 years’ experience in the finance industry, the last 11 years he has owned and operated Will Bell Mortgage Broker. He specializes in residential home loans and over the years has carved out a trusted brand. This is proven by the reviews his customers have made regarding the service and the experience he has provided.
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