Why it’s Going to Get Ugly When Interest Rates Rise Again

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So, the monthly interest rate hype has come and gone for, well, another month. Boss Stevens, of course, left interest rates on hold yesterday, at 2.75%. If anything the absence of a cut saved us from the hysteria about how it will be good for consumption/housing/building/retail and whatever else presumably benefits from more credit creation and less saving.

Commentators like to ignore the fact that a long term campaign waged against savings destroys the economic system. They don’t see it, until it is too late.

While the decision by the RBA board to keep rates on hold was not surprising, the vibe of the RBA’s statement was. We struggled to make out what it said because of the muffled tones emanating through the sand, but it appears as though interest rates are on hold for the time being.

There was no mention of the drop off in mining investment expected to flow through in the next few years, and no mention of China. Not that there needs to be we suppose, but given the past contributions to economic growth from these areas, their subdued future doesn’t seem to be much of a concern to the RBA.

The statement noted the effects of past interest rate cuts and said it expects more benefits of those cuts to flow through in the future. In other words, ‘we’ll keep rates around here until we’re proven wrong’. It seems the RBA is sticking to the old adage that there is nothing to fear except fear itself. Good luck with that.

Getting back to the topic of interest rates, Australia hasn’t yet completely destroyed its class of savers. Official interest rates at 2.75% aren’t great but they’re not zero. And don’t expect them to get there by the way. Our foreign creditors will take their cash and run long before the RBA can hit the ‘zero bound’.

How much cash? Well, according to yesterday’s update to Australia’s international investment position, we have a net foreign liability as at 31 March of $877.1 billion. Put simply, that means that foreigners have lent us, on a net basis, $877.1 billion. This is up from $697 billion in the June 2008 quarter, just before the GFC hit.

Clearly, Australia’s credit is good. And no doubt robust iron ore prices and our proximity to China have helped us to maintain such a good financial standing in the international community. But this credit card tab doesn’t come cheaply. It cost us $8.5 billion to service during the quarter, which is an annualised cost of just under 4%.

It’s going to get ugly when (not if) interest rates start to rise again.

And if Bill Gross’s latest investment outlook is any indication, we need higher interest rates sooner than later. Gross argues that low interest rates are killing the Australian economy. This is not a particularly stunning insight. It’s pretty obvious really. But Gross clearly explains why this is happening…how low interest rates and the distorted price signals they send lead economic actors to make decisions that are to the long term detriment of all.

It may just provide a window into why the Fed is all of a sudden talking about ‘tapering’ its bond purchases, when the US economy is clearly no stronger than it’s been at any time since the Fed began its QE monetary madness back in 2009.

The law of unintended consequences is poised to strike again. It could have major repercussions for markets and your portfolio. More on that tomorrow…

Regards,
Greg Canavan
for The Daily Reckoning Australia

Join me on Google+

PS. Good luck to the NSW Blues tonight in the first State of Origin. As the only New South Welshman in the office, we have to put up with disinterested Victorians, bewildered Yanks, Canadians and Poms, and a completely smug ‘Queenslander’ (born in Germany) in the form of Nikolai Hubble. He asked us around to his place tonight to watch the game and we made up some excuse about having to put the kids to bed around kick-off. Truth be told, after seven straight series losses, your editor can’t bear to watch the game in the presence of a Queenslander, pseudo or not.

But maybe I should…after all, we’re going to win! Really, this is it.

From the Archives…

Why You Should Keep Your Portfolio Grounded in Cash
31-05-13 – Vern Gowdie

China’s City in the Sky
30-05-13 – Dan Denning

House Prices First, Stocks Second.
29-05-13 ­– Dan Denning

Why Natural Gas Could be the Next Crucial Industry for Australia
28-05-13 – Dan Denning

The Japan’s Nikkei is Starting to Crack
27-05-13 – Dan Denning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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5 Comments on "Why it’s Going to Get Ugly When Interest Rates Rise Again"

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Ross
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As always with Gross it is the self serving timing of his statements, and the lack of them at other times, that is notable.

Lachlan
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“Commentators like to ignore the fact that a long term campaign waged against savings destroys the economic system.”

Exactly Greg. However the sort of financial system people think should be there, is not there. The system is not there to foster strong local economies.

Jeff
Guest
I’m starting to get the impression that you guys are like central bankers who put a wager on both sides of the war.one article says high aussie dollar is killing the local economy the next one says interest rates are to go up soon. How do you propose the housing market is in the middle of a boom cycle if the interest rates were to go up? As soon as interest rates go up every one will cash up, the house loan slaves will struggle to pay to their mortgage while they’re loosing their job & aussie exporters shutting shop.… Read more »
Brian
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Don’t forget, at the height (or low, depending on perspective) of the “GFC”, say about April 2009, which IMO was just a practice round for what is going on now, the cash rate then hit a 49 year low of 3.0% and the press went beserk. 19 months later it rebounded to 4.75% 2.5 years later and now it’s 2.75% but the silence fom the press this time is ear shattering. Mortgage holders are the bedrock of our society. They aren’t “slaves”, I would be sure they all have plans. If Plan A at current circumstance were to be cut… Read more »
jingelic
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Low interest rates are ‘killing the Australian economy’? You must be joking. Let’s consider what will happen if they double. Most mortgage holders won’t sell-up and move on. They’ll either curtail whatever discretionary spending they’re doing at the moment (owner occupiers) or try passing on the costs to their tenants in the form of increased rent (landlords). Either way, you have a whole bunch of people with less money to spend and therefore a whole bunch of businesses making less. That would kill the Australian economy.

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