Recently, the Dutch Financial Times published an article stating that interest levels have been going down for 700 years. This article is based on a study by American economist Paul Schmelzing: Eight Centuries of Global Real Interest Rates, R-G, and the ‘Suprasecular’ Decline, 1311–2018. Currently, Paul Schmelzing works for the Bank of England.
Yesterday’s blog and article on the approaching fourth debt wave states that “[o]ver the last decade, the world economy has experienced a steady build-up of debt, now amounting to 230 percent of global GDP. The last three waves of debt caused massive downturns in economies across the world. The first of these happened in the early 1980s.”
Nevertheless, articles rarely link the ever-increasing rise in global debt to these ever-decreasing interest rates. Often economic growth and/or new financial instruments are used as an explanation for increases in global debt. Slowly, both trends are being viewed as a problem.
Moreover, interest payments (eg, to banks) are often a tax-deductible cost, unlike dividend payments to shareholders. Nevertheless, debt and equity are both used to finance a company’s assets (eg, land & buildings, debtors, stocks). Hence, using debt is (much) cheaper than using shareholders’ equity. Hence, nations’ corporate income taxes are a driver for debt increases.
Similar arguments apply to tax-deductible consumer mortgage interest on residential properties versus non-deductible housing rents. Governments introduced this difference in tax treatment in order to boost housing ownership; especially in view of our future retirement and the related drop in our income.
Decreasing mortgage rates, favourable tax treatment, and inadequate housing supply for a growing (and increasingly single living) population, have caused a long-lasting boom – despite several temporary busts – in housing prices, unlike people’s salaries. The resulting mortgage debt to income ratio is causing distress amongst young and/or new buyers.
In my July 2019 blog, the inflation conundrum, I showed that asset price inflation is viewed as a profit unlike consumer price inflation. I’m relieved that the European Central Bank is currently investigating this anomaly in the review of its monetary-policy strategy (eg, Economist-2020).
Obviously, a resulting (much) higher consumer price inflation (CPI) should – and probably would – have an impact on ECB’s extremely low interest rates. Increasing interest rates would, however, have a devastating impact on debt sustainability: when interest goes up, debt must come down.
‘Cause what goes around, comes around
What goes up, must come down
Note: all markings (bold, italic, underlining) by LO unless in quotes or stated otherwise.