Don’t forget about Inflation! How it can either be your best friend if you have debt, or your worst enemy if you are building wealth

Welcome to Finance and Fury, 

Inflation and interest rate – real rates

RBA update – Inflation and interest rates

• RBA – cash rate unchanged at 1% – following two consecutive rate cuts – past ep, talked about loans and property pieces
• Today – Look at the hidden wealth killer – inflation – loss of real values in relation to loans –
  1. Low rates with low inflation can be worse than higher rates with higher inflation
• saying it will take longer than earlier expected for inflation to return to the 2% target while economic growth has been lower than previously forecast
  1. The RBA is seen cutting interest rates later in the year as escalating US-China trade war tensions would pose a mounting risk to the economy – Make currency cheaper for exports
• Quick update – Excerpt from the statement by the governor Philip Lowe: 
  1. Economic growth over the first half of this year has been lower than earlier expected
     1. household consumption weighed down by a protracted period of low-income growth and declining housing prices, higher levels of income needed to meet debt
     2. Looking forward, growth in Australia is expected to strengthen gradually from here- around 2½% over 2019 and 2¾% over 2020.
  2. The recent inflation data were broadly as expected and confirmed that inflation pressures remain subdued across much of the economy. Over the year to the June quarter, inflation was 1.6 percent in both headline and underlying terms. The central scenario remains for inflation to increase gradually, but it is likely to take longer than earlier expected for inflation to return to 2 percent. In both headline and underlying terms, inflation is expected to be a little under 2 percent over 2020 and a little above 2 percent over 2021.
  3. It is reasonable to expect that an extended period of low interest rates will be required in Australia to make progress in reducing unemployment and achieve more assured progress towards the inflation target
  4. But to what effect? Low interest rates with low inflation creates a mass misallocation of resources
     1. The outlook is being supported by the low level of interest rates, recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some housing markets and a brighter outlook for the resources sector.
     2. The main domestic uncertainty continues to be the outlook for consumption, although a pick-up in growth in household disposable income and a stabilisation of the housing market are expected to support spending.

Talk about the difference in property markets over time – different environments

1. Higher average interest rates – with higher inflation – pre-90s
2. Lower average interest rates – with lower inflation – post-90s
3. Not going to do the generational debate – Boomer v Millennials – creates tribalism

Why choose 1990 – monetary policy in Australia since the early 1990s changed – inflation target of 2-3% –

1. Reason for change –1960s-70 – 5% – then USD 1971 – 1983 rates started going up 5-13% in 13 years – inflation on lots of currencies previously backed to USD, and by proxy gold – lead to higher cash rates which needed to curb
2. With the floating dollar – rates in 1983 went up over the next 7 years to 17% – 1989 to 1990 – 2 to 3 years it was expensive
3. By 1997 – 7% rates were back – 10% lower – so borrowings went up massively
4. Inflation – 1976 – 14%, inflation dropped to 7% by 1990
5. Inflation today – 1.6%, been trending lower since the 1970s

Early 1990s to 2019 –

1. Interest rates in the late 1980s did not stay high for long
   1. home buyer back then got to enjoy the benefit of a massive drop in mortgage rates over subsequent years and a corresponding massive rise in house prices.

2. Average income growth is expected to be the weakest in at least 60 years over the coming decade – paying off a larger mortgage much harder
   1. Drop in annual income from terms of trade – interest rates
   2. Labour utilisation down – working less – underemployment

3. Average levels of mortgage size and initial repayments
   1. Mortgage Size – At 20% – $94k vs $520k
   2. Price values v wages – 5 to 10
   3. Repayment as part of household income –
      5. Average wages $24k v $64k – compounding 5.6% p.a.
      6. Average prices $117k to $648k – compounding 10% p.a.

Contribution to annual income growth

Adjusted for inflation – This is important with Debt –

1. If interest rates are 10% p.a., but inflation is 20%, the real value of mortgage drops a lot over time
2. Also – real mortgage rates would be -10%
3. Currently Above levels that existed prior to the 1980s
4. Example – 6% vs 2% – $520k in 30 years
   1. $293k to $92k in real value assuming IO over that time
5. Previous example – Average wages down to 3.5% and prices to 8% compounding in real terms

Purchaser in the 70s 80s and 90s – fortunate position to have had their debts inflated away via high inflation

1. Centrally indexed wage rises that outpaced the cost of credit. That versus today’s mass immigration wage crushing future which means none of the loan principles will get inflated away.
2. The important thing to remember – making additional repayments required to pay off the debt in real terms
   1. Especially with larger mortgages – make sure you can afford
3. From here – Built to rent, high population growth through immigration, low rates = property won’t be likely to drop – but don’t expect same growth as seen over past 20 years for a little while until conditions normalise to sustainable

Summary –

1. Don’t forget inflation –

Graphs – https://www.macrobusiness.com.au/2019/06/another-idiotic-boomer-versus-millennial-housing-debate/

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