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

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…

Greg Canavan
for Markets and Money

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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 is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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