B Invested

LOW INTEREST RATES WILL MAKE DEBT IRRELEVANT AND SAVERS THE LOSERS

 

Do you feel poorer than you used to? Does your weekly household spend cost more than it did five years ago even though you are buying the same products?

 

The answer lies in inflation. As time ticks on, things get more expensive, which means money is losing its buying power.

 

This is not a naturally occurring phenomenon!  Inflation is inevitable in any fiat currency and it is something that the RBA aims to keep “low and steady.”

 

Usually, if inflation rises at a higher than optimal rate, policy makers will consider raising interest rates. If inflation is lower than optimal, rates may be cut.

 

THE TWO BIG ‘I’S’, INTEREST AND INFLATION

The two big ‘I’s of the economy have a close relationship, however, as the world moves into recession territory, a number of countries have such low interest rates that it is difficult to see where they could go, moving onwards.

 

Australia’s economy is being kept afloat thanks to the current property and construction boom. At the moment we have low interest rates. The current cash rate is just 1.5 per cent.

 

At the same time, we also have a low rate of inflation – the lowest since the second quarter of 1999.

 

What does this mean for interest rates? Will they go even lower in order to bring up inflation and keep the economy strong? And, just how low could they go if they are already at 1.5 per cent?

 

Personally, I believe rates may be heading for ZERO per cent – a change that would boost the economy from the bottom up and alter the way we think about money and debt big time!

 

If this happens, higher inflation and sustained low interest rates will make debt irrelevant. In fact, debt (tied to an appreciating asset) will be the new best way to build wealth.

 

And, if using debt to build wealth is the savvy way forward for ordinary Australians, then what will this mean for savings accounts?

 

You guessed it – savers will be wasting their time and getting poorer!

 

 

WHAT IS INFLATION?

Inflation occurs when the cost of goods and services rise over a period of time. Things are generally more expensive than they were ten, 20, 50 years ago and so on.

 

In order to gauge just how much things have gone up in price over the last few decades, check out the RBA’s inflation calculator. It will tell you how much a “basket of goods and services” costing x amount would have been worth during two different periods of time between 1901 and 2016.

 

Say you had purchased goods and services valued at $100 in 1985. To purchase these same goods and services today would cost you $276.35.

 

This is a general guide – it doesn’t take into account the effect of different technologies, modes of production, greater access to a wider range of brands due to the globalized economy and the internet – but it does give an indicator of inflation at work.

 

With the inflation of goods and services comes the devaluation of money. That $100 you spent in 1985 will not buy you as much today as it would have back then.

 

 

SO WHAT GIVES MONEY ITS VALUE?

Much of the global economy is backed by the US dollar. This is a heavy load for the greenback. So, what is backing the US dollar then?

 

The answer is… nothing, really. The US dollar used to be representative – that is, it used to be backed by gold. In 1944, the Bretton Woods agreement fixed the value of 35 US dollars to one troy ounce of gold. Other currencies were pegged to this at fixed rates.

 

In 1971, US President Nixon deleveraged the gold standard from the US dollar. In other words, from this point on, the US dollar had nothing solid backing it making it a fiat currency.

 

According to Investopedia:
“Instead of using gold as the power behind the money, the government is the strength and the reason the fiat money has value. The money has value because the government says it does. In turn, people want the fiat money.”

 

“If the government fell on hard times, or if people everywhere suddenly did not want a form of currency such as the US dollar, it would lose all of its value because there is no physical gold behind it.”

 

 

 

NEED MORE MONEY? PRINT MORE MONEY

Fiat money is marked by the fact that governments can print more of it if they need to. The consequence of printing too much money is inflation. The more money there is, the less value it has.

 

WHY ARE INTEREST RATES BEING LOWERED?

The official cash rate in Australia is currently at 1.5 per cent. This is a record low.

 

Inflation has hit a 17-year low, with consumer prices rising just one per cent over the year up to the June quarter of 2016.

 

When it comes to economic policy making, interest rates and inflation have a tight relationship. In order to boost the economy and cause consumer prices to rise through increased spending, policy makers will drop interest rates.

 

Not only does this save people money on their mortgage repayments, allowing them to spend it on goods and services (boosting various industries), it also offers an incentive for increased borrowing…putting more money into circulation. 

 

 

THE ROLE OF FRACTIONAL BANKING IN CREATING MORE MONEY

Fractional banking is the practice whereby a bank will lend out money while keeping only a fraction of its depository money as a reserve. While regulators in different countries set different standards, the Reserve Bank of Australia sets minimum capital requirements rather than cash reserve rates.

 

Fractional banking basically allows banks to lend out money that isn’t 100 per cent backed by cash. The more lending, the more money is created out of thin air. It’s a bit like turning on the printing presses.

 

 

ARE WE HEADED FOR ANOTHER GLOBAL RECESSION?

In 2014 American entrepreneur and author of “Rich Dad, Poor Dad”, Robert Kiyosaki, predicted that the world would suffer another GFC in 2016. The cause? Hyperinflation of the US economy caused by “printing” too much money through quantitative easing – a policy the Federal Reserve used during and following the GFC of 2007 – 2009.

 

Quantitative easing saw more than $US 3.5 trillion (created out of nothing) pumped into the US economy to ensure its survival.

 

If this band-aid solution does cause hyperinflation and an economic collapse in the US, the rest of the world’s economies will crash with it since most other currencies are backed by the US dollar rather than gold.

 

 

WILL AUSTRALIA BE PROTECTED?

Australia was fairly sheltered during the GFC thanks to the mining boom. Now that this is finished, our economy has been kept afloat by the property and construction boom. As a nation with a severe undersupply of housing, we have been playing catch up over the past five years.

 

The construction boom has had a flow on effect through the economy. It has created jobs, more competitive wages for tradespeople and allowed this wealth to be spent more freely at a consumer level.

 

I believe the Australian economy will stay buoyant throughout the next global recession because we have the capacity to grow our population of workers through migration. The more workers we have, the more tax money the Government can collect. This will enable the development of better infrastructure to cope with the growing population as well as counteract the expense of our aging population.

 

A larger population means we will still have a need for more housing to be built. This will keep the construction boom booming and the economy running by creating more jobs and greater wealth that will be circulated on a consumer level.

 

In the long term, Australia needs to increase production and boost industry in order to sustain its economy.

 

For now, in order to keep people spending on goods and services, policy makers will find it in the best interests of the economy to keep mortgage repayments low by ensuring rates stay down.

 

 

WILL RATES NEED TO GO EVEN LOWER?

I believe rates will drop to zero per cent in Australia. At 1.5 per cent, Australia is still facing below target inflation. There isn’t really anywhere else for rates to go other than down.

 

If you look at other developed nations around the world, zero per cent and even negative rates are already operating. The European Central Bank has set rates at zero per cent. The US Federal Reserve has them at 0.5 per cent. Great Britain is at 0.25 per cent. Switzerland is at -0.75 per cent and Sweden is at -0.5 per cent.

 

 

WHERE TO FROM THERE?

Once rates hit zero, there isn’t much else policy makers can do to boost spending other than offer bailouts and change policies. At the moment there is a lot of scope for changing policies and it will be interesting to see where we are headed if this happens.

 

 

WHO CAN GAIN FROM ZERO PERCENT INTEREST?

We can. If interest drops to zero percent, the money being created will be in the hands of the borrowers – in the form of cheaper repayments and greater spending capacity. This means the economy will be fed from the bottom up rather than from the top down.

 

 

WHAT ABOUT INFLATION?

Keeping interest rates low for a long period may be exactly what is needed to feed the economy. It may also mean higher inflation and the risk of hyperinflation. While hyperinflation is not necessarily on the cards, it is likely that inflation will increase at a quicker rate than what has happened in the past.

 

HOW WILL THIS CHANGE THE WAY WE THINK ABOUT SAVING?

Cycles of inflation may shrink from 50 to ten or 20 years. If this happens, savings accounts will be worth nothing. With no interest attached, term deposits will equate to losing wealth rather than gaining it.

 

Quicker cycles of inflation will mean that if you spend ten years living like a miser and saving every spare cent, inflation by that time will mean those hard earned savings won’t be enough to buy anything valuable.

 

 

DEBT WILL BECOME IRRELEVANT

If inflation cycles shorten, property value cycles will too. Rent and income will both increase to keep up with inflation. This means people who have purchased properties with an “old money” debt attached will be able to pay it off with new, inflated money.

 

If this happens, it will be possible to pay down property investment debt at a much quicker rate than ever before. At the same time, investors will be left holding onto something that has retained both a capital and cash flow value (their property) rather than monetary savings that won’t buy them much anymore.

 

 

WOULD YOU RATHER SURVIVE OR THRIVE?

If our economy goes down this track there will be many winners and losers. People without assets who have worked hard to save their money will be hit the hardest. Not only will they have no wealth for their retirement, they will have no opportunity to buy assets such as property as prices will have inflated beyond the scope of their savings. 

 

Homeowners, and those with one or two investments will find it much easier to survive. They will have one or two assets to back them up and hopefully be able to pay down any remaining debt with an inflated income.

 

Those who have educated themselves about the transfer of wealth and taken action before it is too late will be the ones who will thrive in the new economic landscape. By taking advantage of debt and neither under nor over leveraging themselves, they will be able to build a strong asset base that they can pay off over a shorter time frame with inflated rental income.

 

WHAT WILL IT TAKE TO SUR-THRIVE?

In order to “sur-thrive”, people need to change their mindset about wealth. If all of this plays out, just surviving alone won’t cut it. The old ways of finance are dead, so why hold onto old beliefs? Those who can learn to see past the idea that debt is bad and should be avoided will have a better chance of surviving. But, only those who can learn how to use debt in a smart and responsible way to build wealth generating assets will be the sur-thrivers of the new economic age.

 

 

Exit The Matrix Australian domestic property investment positive real estate