Interest Rates Go Lower and Forever

The Reserve Bank, in cutting cut interest rates by 0.25% to 1.5% is the first move in 3 years by a bank that could not provide answers to the following 2 questions.

With unemployment at 20-year lows why is there no wages growth?

With interest rates at 50-year lows why is there no inflation?

To answer the 2 questions (and help the RBA with their dilemma) we go back 90 years to 1929, the year of the ‘Once in a Century’ Depression. Following on from that the world had to endure WW2 from 1939 – 1945. Over that 15-year period the world economies ground to a halt and pride and prosperity were non-existent. Normal consumption habits and family creation were significantly retarded until 1946 when another ‘Once in a Century’ event occurred in the form of the Baby Boom. Officially the Baby Boom extended for 18 years from 1946 – 1964. Cautiously, and over time, the world started to return to normality and by the end of the Baby Boom in 1964, the world was ready to inflate. For the next 40 odd years all sectors of the free world economies boomed and inflation in the 1970’s reached 12%. This inflation effect was not the fault of poor Government but more a symptom of an over demanding Baby Boom bubble. The first real estate boom occurred during 1972 – 1975 when house prices rose by 30%.

Prices rise when there are more buyers than sellers. The RBA used interest rates as a tool to curb over-consumption and out of control inflation. For a short time, interest rates rose to a high of 19% but that didn’t worry the property investors of the time because they were enjoying compound growth rates on their real estate investments of 10 – 12% per annum. But like all bubbles they eventually burst.

That’s the historical bit – now let’s look at some facts.

Demographics is the study of human behaviour and it is demographics as much as anything that can explain why interest rates are now down to 50-year lows. It goes like this.

On average, Baby Boomers (BB) retire at age 66 but become risk adverse 5 years prior to that at age 61. This means that first born BB (in 1946) started to withdraw from the investment markets in 2007 (1946 + 61). Just as the baby boom started slowly so too did the withdrawal of BB investors from risky investments such as real estate and share markets. Add 18 years to 2007 and we can say that by 2025 most Baby Boomers will have withdrawn from making risky investments. So, we are beyond half-way through the 18-year BB cycle and the RBA is wondering why interest rates are at 50-year lows. In a large part interest rates are at 50-year lows because there is no inflation because the era of over-consuming BB, which began in the early 60’s, is now over.

To answer the second question, it is simply a matter of fact that even though the unemployment rate of 5% is at 20-year lows, the under-employment rate is at 8.5%. This means that 13.5% of our population is now under worked and therefore underpaid. With the introduction of Robotics, Digitisation and AI, the contribution of the human input into the production cycle is now being substituted by programs that work 24/7 and don’t take sickies, holidays or maternity leave. The single focus of the Techno Revolution is to eliminate labour costs and in turn lower the cost of goods sold. We are in the midst of the biggest deflationary event in history which adds to the reason why interest rates will go lower as inflation tends to zero.

In explaining the absence of wages growth, contemplate this for a moment. A boss says to his staff that he is prepared to sustain their 5 day salaries and if they can do the 5-day work load in 4 days then they can have a long weekend every week. What employee would say no to that – all they have to do is increase their productivity by 20%. A 4-day week across the work force by 2025 is under way and in fact Richard Branson is predicting a 3-day week by 2030. Even though new jobs will be created with the Techno Revolution, there is no doubt that jobs in certain industries will/are being substituted. Examples – Mining, Banks, Insurance, Retail.

A drop in interest rates benefits borrowers over savers by a ratio of 2 to 1. As wages continue to stagnate, lower interest rates will provide relief at least to marginal borrowers. The losers in this scenario are retirees who are risk adverse and rely more on the interest on no risk fixed income investments. It is noted however that, perhaps due to the scare of the GFC, retired BB are holding onto their oversized, high maintenance family homes. Perhaps lower interest rates will motivate them to sell up and out of the proceeds move into a lower cost, minimal maintenance retirement dwelling and put any overage into their superannuation accounts. In a low interest rate environment that is bound to persist for at least the next 20 years, there is no place for inactive investments.

And, a message to the Banks who persist with applying affordability tests based on 7% interest rates. This is the stuff of Troglodytes and is limiting a lot of marginal borrowers from participating in the property market. The sooner they give up this behaviour the sooner the banking system will be part of assisting Australia’s economy to get up and growing once again.

If by raising interest rates was the tool used to bring high inflation rates down, then to lift inflation back up to the archaic 2-3% range will require interest rates to go to zero. Who is going to be so bold!

The paradigm shift that is occurring with this 4th Revolution will present a new set of economic parameters that will revert the focus of wealth generation to be based on yield, not capital gain.

Low interest rates will mean net returns on property of 3.5 – 4.5% will become more competitive, even without capital gains. When borrowing rates go under 3%, negative gearing will be no longer.

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