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Economics-101

Low interest rates: Beware

Artificially Low Interest Rates, part 2

In my last article, I wrote about the ways that government intervention and central bankers have artificially suppressed global interest rates below their natural free market levels.  

This has significantly punished the savers of the world, as the returns on savings have essentially fallen to zero and below when inflation is factored in.  

In this article, I want to address the misallocation of capital that has flowed into the real estate market, as well as the consequences resulting from these manipulated interest rates, especially in Canada.  

There exists an inverse relationship between interest rates and real estate prices. Generally, as interest rates fall, the price of real estate rises. More first-time home owners and investors are treated to lower mortgage payments, which ultimately brings more buyers to the market, which precipitates upward pressure on home prices.  

The reverse also holds true. With the global economy not being too hot of late, governments and central banks have lowered interest rates in a misguided attempt to revive the economy. Canada has not escaped this trend. 

We presently sit at record low rates for borrowing money, which has resulted in capital being redirected from more needed areas of the economy into the real estate market, thus creating a housing bubble.  

Generally speaking, housing prices across this country are significantly higher than their true market value. Whether it be a bursting of the bond market, further depreciation in the value of oil or a stock market crash that is the catalyst, an economic correction will be visited upon the housing market in this country, and globally, in the not too distant future. 

This is going to leave many home owners ‘under water’, which means that they will owe more on their house than what the house can be sold for on the market.  

One of the benefits of lower interest rates and higher property values to municipal governments is the increased revenue. One of the largest sources of funding for cities is property taxes. 

Now, even with this windfall of rising property tax revenues, it’s still not enough to feed the insatiable beast of City Hall. Take a look at our own city. We are staring down the barrel of a 4.1% property tax hike next year, even with rising property prices. 

Now here’s the rub: When we experience a real estate correction - and we will, just as sure as politicians will make campaign promises that they cannot keep, what happens to city revenue?   

There is going to be a massive shortfall of what the city has grown comfortable in receiving to finance their overinflated budgets, and what they will actually receive. Watch for either property taxes going through the roof, putting further downward pressure on real estate prices. Or, they will come out with a slew of new taxes to collect tax revenue. 

Who knows, you might be looking at a swimming-in-Lake-Okanagan tax, or a chewing-gum-on-Tuesday tax. Because somehow, some way, the piper will need to be paid. And as usual, it will be the tax payer who gets the bill. 



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Artificially low interest rates

We presently live in an environment of global artificially-low interest rates.

What does this mean? 

Well, governments and central banks around the world are actively engaging in the bond markets to suppress interest rates below where the free market equilibrium would have these rates today.

Why are they doing this?

Well, they are trying to kickstart the global economy by lowering the cost to borrow money. 

So, is it working?  

Hell No!

It is distorting the allocation of capital, and punishing savers. I will look at the misallocation of capital at a later date, but in this article I would like to address how this action is penalizing the savers in society.  

Let’s reach back to the days of big hair, shoulder pads, and Duran Duran: The 80’s ~

Without argument, there was an interest rate spike in 1980-81, but for the most part, interest rates averaged about 10%. I can remember my dad saying that if he won a million dollars he would simply put it in the bank and live off of the interest. $1,000,000 x 10% = $100,000, which would provide for an extremely comfortable lifestyle throughout the 80’s.

Let’s fast forward to today, with our artificially-suppressed interest rates ~

By doing some quick research, 1.3% is the best interest rate that I can find on a simple high rate savings account. At that rate of interest, one would have to deposit $7,692,308 to achieve the same $100,000 return that a simple million dollar investment would yield in the 80’s.  

This, of course, is separate from the fact that, in 2015, you would need $200,000 to purchase the equivalent basket of goods that one could buy with just $100,000 in 1985. This is the cost of inflation, which is a result of government expanding the money supply.  

To be accurate, one would really need to deposit $15,384,616 to achieve the same purchasing power as $1 million deposited back in the 80’s. For those individuals who are saving for the future, these manipulated interest rates are killing you. 

Not to mention that the real rate of interest is actually negative. What does this mean? Well, the real rate of interest accounts for inflation. The government states that the core rate of inflation is above 2%, but as we all know, the actual rate of inflation is closer to 10%. Regardless of which number one uses, the real rate of return on your deposit today is negative, because inflation is greater than the 1.3% rate of return.  

Do I see interest rates significantly rising any time soon? 

Nope.

Governments around the world are drowning in debt, and this debt has an interest payment attached to it. Sovereign nations around the world can barely pay the interest on the debt they presently owe, never mind adding larger interest payments to the equation. 

The manipulated interest rates may look good, but . . . they're really not. 



Stock market not the worry

Three weeks ago, I penned a column, It’s Later Than You Think, to discuss what I felt was a significant economic event likely to occur before the end of this calendar year. It appears that things are moving faster than I expected, as the unwinding of our global financial system is underway already. 

I’m surprised to see this in the last couple of weeks of August. Typically, the Powers That Be do not allow significant events to unfold until we are well into September or October. I’m not going to list all the statistics here: these can easily be accessed by doing a little research on your own. Suffice to say, the Chinese stock market is down 40% since June of this year, the U.S. stock market is down 10% in ten days, and Canada just announced that we are officially in a recession . . . that was shocking news.

So where do we go from here? 

Well, I think the future is clear. The U.S. Federal Reserve will defend the stock market to the bitter end. A sinking stock market is the final sign that an economy is imploding, therefore we will likely hear an announcement of further quantitative easing out of the U.S..

Now, I doubt they will simply call this QE4, since QE1, QE2 and QE3 all failed miserably. The Powers That Be are likely working right now on a fancy new patriotic name for this new round of money printing. I should mention this new injection of money will probably be bigger than all of the previous rounds of money printing combined.  The result will be a rallying stock market, at which point the U.S. Government and U.S. Federal Reserve will point to the stock market and say, “Look, all is well, the stock market is rebounding . . . aren’t we brilliant”? 

Of course, the unintended consequence of all of this money printing will be hyperinflation. Sure, the DOW may be be trading at 20,000, but that 20,000 will buy you less than a 10,000 DOW would have bought you ten years ago. 

Yes, the final battle of the global financial meltdown will be fought in the currency arena. Who will win? Simple:  The U.S.. But remember, the winner of a currency is the biggest loser, as the central bank has depreciated the currency more than all other central banks. 

Many people and financial analysts will argue that hyperinflation simply cannot occur in the U.S.. The funny thing is, what the U.S. Federal Reserve is doing right now with money printing is exactly what Germany did in 1923, Zimbabwe in 2008, and hundreds of other countries have done throughout history. 

Each time resulted in the same outcome: Hyperinflation. However, when the U.S. repeats these same actions, for some reason it is supposed to result in a different outcome. This logic is like saying that combining magnesium and water in any country in the world will have an identical chemical reaction. However, if you combine these elements within the borders of the U.S., there will be no reaction whatsoever. 

That's financial logic for you.



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It's later than you think

I’ve been writing about the potential for an upcoming financial crash for the past two and a half years. It would appear that we are closer than ever to this event; we may even experience it before year end. On Monday of this week China experienced its second largest stock market crash in history; falling 8.5% in one day. This is just shy of the largest crash of 8.8% on February 27th, 2007. Remember what followed that? The truth of the matter is that Monday’s fall would have been far greater had the government not intervened and let the free market rule.

A couple of weeks ago the New York Stock Exchange halted trading in the middle of the day. The official story was this was due to technical issues. Yeah right, this market was in free fall. It didn’t happen on a calm day or even an upward trending day. To add to this, the vast majority of open sell orders were wiped out when the market reopened.

OK, let’s turn our attention to Greece. The Greek stock market is closed. That’s right; closed. And will likely not reopen until next week. This marks a five week shut down for the Greek stock market. In addition, capital controls have been forced upon the Greek people. Government imposed capital controls have banned foreign bank transfers. Greece is running out of medicine as Greece relies almost entirely on foreign imports for its pharmaceutical supplies. Thus supplies of medicine to Greece have significantly decreased. Greek credit is no longer accepted outside of the country. This has stranded Greek tourists outside of Greece. Food shortages are on the horizon. I’m not just talking about grocery store shelves. The Greek Association of Fodder Industries has warned animal feed shortages within days as Greek farmers depend greatly on imports to feed their animals. Basic agricultural products such as cheese, eggs, milk and meat could become scarce within a few weeks.

Global commodity prices are nearing a 45 year low. Global sovereign debt is at an all time high and grows significantly by the day. Personal household debt to income ratios are at their highest levels ever. This is all the result of a global Ponzi scheme spawned by worthless currency. Central banks around the world have been printing currency out of thin air at unprecedented levels for the past eight years. The time to pay the piper draws nearer.

This article is not intended to scare people. Goodness knows our media and government do a good enough job at that. This is simply stating facts that will precipitate an outcome. Is the outcome pretty? No! Is it real? Yes! What can one do about this eventual outcome? I can only state what those who are aware of the global financial situation are doing; paying down debt, owning things that have more value than paper and holding a significant portion of their wealth in precious metals.



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The views expressed are strictly those of the author and not necessarily those of Castanet. Castanet does not warrant the contents.

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