Up to this day I have not given too much of my attention to all the hype around COVID-19 virus. Up until now, however not because of the virus itself, but economical and social changes it caused directly or indirectly. The changes I witness are monumental. Right this moment we live in a really-really interesting moment. Nothing like this had happened before and we are at the front row of sets in theater of life.
Before I dive into the current state of economy and all the exciting things that’s happening, I need to refresh the memory on some of the basics. To make educated decisions and fair assumptions you have to understand how the economy works. This is the first time I actually went back to the knowledge I obtained at MBA school in my ECON class.
Low Interest Rates
As of March 13, interest rates are historically low. The last time we’ve seen such numbers was in 1991. What does it mean to you, economy and society?
Low interest rates are good for the economy: they stimulate people to buy more. Spending drives the economy. One person’s spending is another person’s income. The more people buy, the more is being produced. The more real estate a person owns, the more willing a bank is to grant the mortgage to that person. (coladerall)
Because interest rates are low, people will start to borrow more money. Borrowing will set us into the short-term debt cycle. This cycle works in phases, and typically lasts 5-8 years.
The phases are:
- Interest Rates are low.
- Spending increases. People buy more stuff. Economy expands
- Income Increases. One person’s spending is another person’s income.
- Prices go up. Especially its noticeable in the real estate market. Because production of goods could not keep up with the growing demand, prices on existing houses go up. Now more people have money and are wanting to spend them, however it takes time to build the house.
- Inflation goes up. This is where the problems begin.
- Interest rates go up.
- People borrow less. Fewer people are now able to borrow.
- Spending decreases. People spend less.
- Income Decreases. Economic activity decreases
- Lower Interest Rates
Accessible Credit – Expansion
Hardly Accessible Credit – Recession
With the new knowledge in mind we can assume and expect house prices to rise. Everything happens in cycles and the short-term debt cycle is just a building block of the long-term debt cycle. Each time The Bank lowers interest rates to stimulate the economy and get back on track, we leave more and more debt behind. Debt burden slowly grows until it’s not. Economic collapse is inevitable in countries with credit. People are not good at spotting long-term patterns and it makes it hard for them to spot, even harder to predict when the next crash comes. It all eventually leads to depression…
- House prices will rise
- People will buy more
- Interest rates will remain low for some time (no need to rush)
The questions are:
- Why does the government stimulate the economy by lowering IR?
- What will be the lowest interest rate in this cycle and when will it occur?
- How long will housing prices be rising for, until we reach the ceiling?