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What will rising interest rates mean for wealth inequality?

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Australia’s Reserve Bank mainly concentrates on keeping inflation within an acceptable range and maintaining a high level of employment. Social equity has never been considered to be part of its mandate.

It should be. Interest rates have been the biggest cause of economic and social division in Australia, not just between rich and poor, but also between older and younger generations. The falling interest rates since the global financial crisis of 2008 have created an enormous gap between those able to profit off cheap debt and those who cannot. 

Interest rates are rarely considered by those examining issues of social equality. The usual focus is on the extent to which wealth should be redistributed through some sort of government intervention, funded by taxation revenue. That is critical for providing safety nets, but it is only part of the picture. People who bought houses last century have enormous wealth, at least on paper. The stock market is just over $2 trillion and superannuation is about $3 trillion. But the housing market is nudging $10 trillion in an economy that produces just under $2 trillion annually — a massive financial distortion that heavily favours middle class older people. Younger generations who want to buy houses now must earn very high incomes just to qualify for a mortgage. 

Even the pandemic did not slow down the rampant asset inflation. Instead, it accelerated due to extremely easy monetary conditions, yet more demonstration of how unpredictable markets can be. Last year, Australia's stock market finished the year up 17 per cent and homeowners saw the value of their properties jump more than 20 per cent. It seems asset prices are no longer reflecting the underlying economic activity. They are more a purely financial phenomenon that is becoming detached from the ‘real’ world. 

There is a joke about an economist who lost his keys at night in a dark forest. He starts anxiously looking for them under a streetlight. When asked why he is looking for the keys under a streetlight when he knows they were lost in the forest, he replies: ‘Because I can see what I am doing here.’

This is why the Reserve Bank simply throws up its hands when asked about asset inflation. It is harder for them to see what is happening; asset price inflation is more difficult to measure than consumer price inflation (CPI). CPI measures apply to things that are constantly transacted, such as food and energy so price rises can be tracked easily. Asset prices can rise when there are only occasional transactions, making inflation more difficult to quantify. Consequently, economists resort to circular arguments that assets are justifiably worth whatever people are prepared to pay for them and so the price therefore must be fair and not inflated. They are determined to stand under that streetlight and ignore the dark woods, in other words.

 

'Any increase in rates will put severe pressure on anyone with high levels of debt. Instead of having a society of the asset rich and the asset poor, we may well end up with a society of the heavily indebted and the debt free.'

 

Back in the real world, it is obvious, especially to anyone under 40 or who is older but does not own their own home that we live in a society of the asset rich and the asset poor. The situation has occurred because the cost of debt has been so low, entirely due to the policies of the central bank.

Things may be about to reverse. CPI inflation in the United States is at a 40 year high, and the war in Ukraine is likely to make things worse. There is intense pressure on the US Federal Reserve to increase rates, and suggestions that Australia’s rates may soon follow suit. Although Australian inflation is manageable for now, local interest rates do tend to follow overseas rates.

CPI inflation is something that happens under that streetlight, so central bankers, believing they know what they are doing, inevitably react by raising interest rates in the belief that it will restrict the amount of money in the system, which will in turn cause prices to ease (to say the least this is overly simplistic, given how complex the monetary systems are now).

Should there be stagflation in the US: negative growth and soaring prices, then rates in the Western economies could soar. Last time that happened in the US, in the 1970s, they went up to 17 per cent, although the financial systems were very different then and the amount of aggregate debt much lower. Central banks have much less room to move now, so cannot be so aggressive.

What seems certain, however, is that over in the dark woods, where asset prices reside, any increase in rates will put severe pressure on anyone with high levels of debt. Instead of having a society of the asset rich and the asset poor, we may well end up with a society of the heavily indebted and the debt free.

 

 

 

David JamesDavid James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.

Main image: A man looks on outside the Reserve Bank of Australia headquarters. (Mark Metcalfe / Getty Images)

Topic tags: David James, Reserve Bank, Inequity, Interest Rates, Inflation

 

 

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Existing comments

"we live in a society of the asset rich and the asset poor. The situation has occurred because the cost of debt has been so low, entirely due to the policies of the central bank." Don't forget the blame both major parties deserve for negative gearing etc. - there are many government policies that have created this mess.

The house-owning older folk didn't have a lovely time of it either - for the first dump that I bought I had one mortgage at 17% plus a second mortgage at 21%. There were years where I lived in fear of something going wrong with the car because I didn't have a cent to spare. But at least I didn't start adult life with a big HECS debt. Why are we doing this to our children?


Russell | 02 March 2022  

While governments continue to endlessly print money and run up debt, inflation will rise, and those hurt most are the poor and middle classes. US inflation is the highest in 40 years with no end in sight.
Australia’s December quarterly growth was a healthy 3.4%. One economist noted that there had been real wage growth which coincided with low immigration rates during Covid. The big end of town always wants large immigration flows. But moderate, rather than large immigration, seems to benefit ordinary wage earners much more.


Ross Howard | 02 March 2022  

To be sandwiched between rising interest rates, soaring fuel prices, skyrocketing land prices, GST imposts , super contributions, ASIC review fees, company tax, planned giving at church, fund raisers, good causes, stamp duty, insurance premiums, crippled by credit cards, whacked with rising school fees. Drowned by floods, seared by bush fires, ruined by rising rivers, having to give a bit more here, a bit more there. Brings to mind the adage that in the lucky country, debt is the worse form of poverty.
I wonder how our aloof august pontificating Cardinals and finger pointing lecherous Bishops deal with these mundane minor problems?


Francis Armstrong | 04 March 2022