When Central Banks Blunder
Incredible as it may seem, Central Banks currently believe that a very low interest rate does no harm. Lowering the rate to near zero is viewed favourably. Whatever strange theory leads them to believe this ….well, that theory is truly nutty.
Who would want to invest in bonds carrying a very low rate of interest? Who would willingly risk such a purchase knowing almost any rise in interest will significantly impact the value of that bond? Who wants to lose money in that particular way?
No one, obviously. So people forsake buying interest bearing certificates and bonds and such, and instead put their savings into something likely to appreciate in value. A mutual fund of stocks is often favoured. ..More money pouring in simply reinforces the stock market’s common propensity to rise.
“Nothing wrong with that,” one might think. And as the markets continue a generally upward trend, they will continue to think so. Yet, there is a consequence to this which is not so rosy.
In an upward trending market, a large majority of stocks rise in price, though earnings per share might not be keeping pace. Generally, in a rough sort of way, the price of a company’s shares should be some usual multiple of the company’s earnings per share. But when a company’s shares are increasing in value simply because most shares are, then that earnings ratio can fall behind.
This does not go unnoticed by managers of large pools of invested money, who are apt to badger the top executives of these companies to bring their earnings up, however they can — often resulting in price hikes for their products. ..Such price increases are a component of Inflation, here due in part to a rising stock market, a trend bolstered by too low an interest rate regime resting on the foolish action of the Central Bank.
Housing Prices
Another area where inflation becomes obvious due to low interest rates is the price of houses. For most home owners, their abode is the largest single investment they have, and it is usually by design. ..Price appreciation is expected, so the typical strategy is to get the most house they can finance in an area expected to be good value for years to come. This will yield a large capital gain.
A low interest rate on mortgages allows a much larger mortgage to be financed due to the monthly payment being still affordable relative to the incomes of the buyers. ..Never mind that it may cease being affordable if income drops or interest rates on mortgages rise.
Until recently that latter prospect did not seem likely. After all, the Central Bank was deliberately keeping interest rates low and thinking itself clever in doing so.
Consider: _that explosive growth in house prices has kept many people renting when they would rather not be. And in consequence rents have been rising and supply of units to rent has often been tight. …Mortgage payments and rents are components in the basket of goods tracked for Inflation. Surprise, surprise.
Did Central bankers realise they were pushing up the rate of inflation by having interest rates too low? ..The short answer is no they did not. Too focussed on modelling with aggregate data to see the trees for the forest.
Now those bankers deluded economists are raising interest rates rapidly in order to “combat inflation”, by inducing a business slump. And it’s their own damned fault they believe they must do so. Demand will be reduced because household incomes are being squeezed by higher payments on mortgages, car loans and so forth. ..Yet, prices are unlikely to retreat. ..Stagflation is most likely to be the result for 2023 once unemployment becomes an issue.
And a Happy New Year to us all.
- written in January of 2023…. and becoming real in 2024.