For starters, the present value of all long-lived assets will come down -- stocks, bonds, real estate, you name it.

As Warren Buffett explains:

"[Interest rates] act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That's because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. Conversely, if government interest rates fall, the move pushes the prices of all other investments upward. The basic proposition is this: What an investor should pay today for a dollar to be received tomorrow can only be determined by first looking at the risk-free interest rate.

Consequently, every time the risk-free rate moves by one basis point--by 0.01%--the value of every investment in the country changes. People can see this easily in the case of bonds, whose value is normally affected only by interest rates. In the case of equities or real estate or farms or whatever, other very important variables are almost always at work, and that means the effect of interest rate changes is usually obscured. Nonetheless, the effect--like the invisible pull of gravity--is constantly there."

Source: "Mr. Buffett on the Stock Market," November 22, 1999 -- http://archive.fortune.com/magazines/fortune/fortune_archive...

While this make sense, I must put my skeptical-of-all-economics hat on when I see this:

> People can see this easily in the case of bonds, whose value is normally affected only by interest rates. In [other cases], other very important variables are almost always at work, and that means the effect of interest rate changes is usually obscured.

In the case of bonds, it is just a mathematical identity, since the the interest rate can be nothing other than a relation between the face value and current price.

In all the non-tautological cases, Buffet admits that the effect is "obscured". Which is to say that it is just another reasonable sounding humanities-theory that is difficult to check empirically.

Is it really difficult to check empirically? It seems to be as simple as finding the number of investors and the amounts invested and checking that historically against the interest rate while controlling for things like population and GDP (or some other measure for disposable income available to be invested)

I guess it might be difficult to get numbers on how many people are playing the stock market and by how much, but you might be able to get that data from individual brokerages or looking at the number of brokerages and hedge-funds and checking their publicly filed financial reports.

The interest rate set by the government is not the interest rate on the 2/5/10/30 US government issued bonds.

> the present value of all long-lived assets will come down

we can consider 'value' but also recognize that actual market price is another thing. real estate prices can continue to go up and at times actually have gone up in environments where interest rates were rising.

as Buffet points out, there are additional important variables.

If the rate change is expected, shouldn't this be priced in?

> the present value of all long-lived assets will come down

That's not true for at least the last two asset bubbles. Interest rates were 4-5% leading up to '07 housing bubble and 5-6% leading up to '00 stock market bubble. Inflation was mostly higher than now, in the 2-4% range.

Maybe those bubbles would have risen even higher if the interest rates were lower.

I recall a time of nearly 20% interest rates here in Australia a few decades ago. As far as I can remember, it was all just business as normal for most people. It all comes down to just how much debt you own.

If I recall, people who were highly leveraged or had negatively geared property were hit the hardest. People with actual savings in the bank were actually happy with their interest returns being so high.

Household debt was not as bad back then as it is nowadays, so I don't expect it to go as well if we ever hit those levels again tomorrow.

You missed it. It's subtle but it's a really, really big effect worth understanding. You really wanted to have as much debt as you could service without going bankrupt.

Australia had a massive redistribution of wealth from savers to borrowers. As long as you didn't become insolvent the more debt you had invested the richer you got.

Borrow $100k as long as your salary kept going up so you could make the payments every year the amount you borrowed was worth less. Think salary goes from $20k to $50k over 5 years. $100k borrowed goes from 5 times salary to twice. Borrow, and invest in anything that isn't hit by inflation. In the 80s houses did that job.

Now if you had $100k in the bank (or government bonds or similar). 5 times salary saved just became 2 times salary saved. Ouch.

Unanticipated inflation is always a redistribution of wealth from lenders (savers) to borrowers.

Of course if you borrowed for a car or a holiday that's something different but you are still paying it off with devalued currency.

> You really wanted to have as much debt as you could service without going bankrupt.

This is an interesting thought. I have mostly heard this advice for corporate. Companies are encouraged to take on as much leverage as they can without affecting their bottom line. But I never thought it can be applied to personal saving and market crashes too.

I had couple of questions - how do you calculate debt or leverage at personal level?

The savings example - wouldn't the savings increase as well?

Should you look to increase your leverage in times of high interest or a low one?

And lastly, how do you find assets which aren't hit by inflation?

Do I need to point out that anyone following advice from an (anonymous?) internet poster deserves to go bankrupt and none of the following is any kind of financial advice? Well I did, sorry.

> how do you calculate debt or leverage at personal level?

Can you make the payments? Chances of not making them next year etc. So much personally specific stuff in that there can be no rule of thumb. Is your job secure? Will your wages go up? How is your risk appetite? Why do you want more money - what do you want to spend it on, when, etc.

> wouldn't the savings increase as well?

You have $100k, you buy US Govt. Bonds with a 10 year term and an expectation of low inflation. Inflation rips (surprise!), your 100k buys a lot less stuff in 10 years time. The 5% coupon doesn't cushion that blow much. If the inflation is anticipated then you would have a very high yield on 10 year us govt bonds and there is no redistribution of wealth between borrowers and lenders. You get back a sum of money that buys a similar amount of stuff.

I've just described the simplest case with fixed coupon long term bonds, you can make it more complex with variable interest rate accounts or whatever and you'll see unanticipated inflation always is a redistribution to borrowers from lenders. "Pay off your loan with worthless currency." "Remember when you could get a beer for under $100?" Sounds ridiculous now, right? $10 beers used to be equally ridiculous.

>Should you look to increase your leverage in times of high interest or a low one?

No easy answer. Depends on your circumstances and preferences. If you do increase your leverage, can make the payments and your investment is an inflation hedge, unanticipated inflation is a win for you if that's what you want. There is additional risk involved, obviously. Putting money in the bank is almost certainly a losing proposition. In addition to the redistribution to borrowers the increased interest payments are taxed so you're going backwards. think 2% real interest 10% inflation for a bank interest rate of 12%. Well you're taxed on all %12. So some part of that 10% to compensate for inflation goes to the taxman and you're losing purchasing power of your capital.

> And lastly, how do you find assets which aren't hit by inflation?

Most assets are some kind of hedge against inflation. NOT bonds, obviously. But equities will likely be so, gold, real estate, antiques & jewellery. Think of an asset's price as a percentage of the average annual salary. If inflation rips will that percentage of salary change? Much? Why? With bonds the answer is yes and the reasons are pretty straight forward. With housing, rent is likely to be a fairly fixed percentage of salary, salaries double in nominal terms, rent will likely do the same. (But do consider what else is going on in an economy when inflation takes off, will the plant shut down making that place a slum? Likely it's more subtle than that). Buying an equity of a company that has sales, will their sale prices keep pace with inflation? You'd imagine McDonalds would, for example. Will their sales qty drop in an economy with high inflation is also worth considering and is a trickier question to get right. I'm partial to S&P500 index tracking funds, they're popular nowadays too. Obviously equities can crash in value over the short to medium term.

Having lived through the 20% interest days here in Australia it was far from "business as normal". We had a massive recession shortly afterwards, house prices crashed and unemployment went over 10%.

I don't think we will ever see 20% interest rates again because the level of debt here in Australia is so much higher now. If interest rates even get to 8% it will be like 1990.

Fair point. I was still only just out of school at that point, and as a young student with little debt, my world view (and that of my friends) would have been different from people who owned property or other investment vehicles that came with interest payments.

EDIT: But I also recall that those times were when high flying business people like Alan Bond etc. were still getting banks to throw money at them even though interest rates were astronomical. A large part of the problem which probably lead to the eventual crash and burn of the economy...

It's worth noting that most Australian mortgages use variable (i.e., non-fixed) interest rates, so when rates go up, everyone's payment increases. High interest rates in the US are beneficial to mortgage holders because most people use fixed-rate loans which means as inflation increases, your monthly payment decreases in real value.

No such thing as fixed rate: fixed rate just means "variable, but in 3 or 5 year (or whatever) increments". The interest is a bar graph with bars that are several years wide, instead of a graph with one-month-wide bars.

Fixed rates are not free; you pay extra for the fixing. The longer the fixing, the more you pay.

It only makes sense to go fixed rate if you're very sure that the interest will climb over the next term. Not only that, that it will climb sufficiently enough to offset the cost of locking into the fixed rate so you still come out ahead. Once that term is up, you're no longer locked in; so you have to re-evaluate everything at the start of the next term.

(You don't have to do this upfront, either; variable rate mortgages have the option to switch to fixed for the remainder of the term.)

Anyway, people who go for fixed rate mortgages end up paying tens of thousands of dollars extra over the life of a mortgage, unless they are somehow able to game things in periods of rising interest.

When I was signing up for a mortgage, the financial institution offered to cover the lawyer's fees for all the paperwork, running into the hundreds of dollars. That offer was quickly rescinded when it became apparent that I'm declining the fixed term mortgage and opting for variable. That's obviously because the fixed term is good for them; that's why they incentivized it. When some aspect of a deal is good for you, it's never incentivized.

> It only makes sense to go fixed rate if you're very sure that the interest will climb over the next term.

That's not true. I chose to pay an extra £30 a month on my mortgage because I'm not sure rates won't rise over 5 years, and I want to be confident of budgeting for the the next 5 years. I'm confident rates won't go down, but rates going up could affect me. Think of it as insurance. I don't take home insurance because I'm confident my house will burn down, I take it incase my house does burn down

Do you apply the same reasoning for the last payment of the fixed-rate term? £30 because you're not sure that the rate won't rise over the last month and end up costing you £60; good insurance?

I think fixed rate can make sense in some circumstances, but you need to factor in the expectation of eventually refinancing. But then frankly you should expect to refinance anyway. It's highly unlikely that the same mortgage will turn out to be just a suitable to your circumstances and the competitive landscape in 20 years time as it is now, or even in 10 years, whatever mortgage you choose.

Here's my (partial) heuristic. If you see adverts on TV for fixed rate mortgages, don't get one.

From another comment below:

In the US, fixed rates are for a 30 year term. Countries like Canada and Australia have 10 year terms as a max, with most people electing for something shorter as the rate goes down.

You can get fixed rates on shorter mortgages in the US. I have been quoted fixed rates on 15 and 20 year mortgages in the past month.

> No such thing as fixed rate: fixed rate just means "variable, but in 3 or 5 year (or whatever) increments".

No, you can get mortgages they are fixed for the life of the loan.

> Fixed rates are not free; you pay extra for the fixing.

You do typically start with a higher rate, but when we shopped for loans last, the variable rate loans all had a floor very near the initial rate and interest rates were at historic lows, so either the momentary extreme lows would last indefinitely or fixed rate would be cheaper over the life of the loan.

Further, if interest rates do drop, you can refinance a fixed rate loan down, minimizing the difference between it and a variable rate, even if the latter doesn't have a floor that prevents meaningful reductions, where variable would be best. OTOH, where fixed would be best (with rising rates), variable leaves you high and dry.

If the interest rate goes down, you can just refinance. The fixed rate protects you from upward movement, and being able to refinance protects you from downward movement. What am I missing?

There are fees and process time to refinancing that acts as a disincentive to do so; and for several decades the fixed rate (by design) has been higher than what the variable rate incurs over the term (at least in Canada, where the term and the amortization period aren't the same).

Only that: TANSTAAFL.

Also: variable mortgages can also convert to fixed. If the rate is sitting flat, you're better off variable, with the option to switch to fixed if it looks like it will climb, than vice versa.

You don't have to go for all-fixed or all-variable: you can typically split your loan and fix part of it. This effectively lets you hedge against the interest rate risk - you aren't as exposed to rising interest rates, but also don't benefit as much from falling rates.

The main downside of fixed loans is that you usually can't reduce your interest payments by making additional repayments (because ultimately they are backed by long-term bonds issued by the bank).

Depends on where you live. California state law requires all lenders to except early payments, so a fixed loan holder in California really gets the best of both worlds.

I was quote young during that period (I'm 37 now) and even I remember people having heart attacks and / or defaulting on loans in Port Lincoln (highly leveraged commercial finishing outfits).

> happy with their interest returns being so high.

The "returns" were rarely above the inflation rate, plus you got to pay income tax on those illusory "returns".

Savvier people would shift their money into assets that kept or increased their value independent of inflation, such as equities and real estate.

I question the equities and real estate being independent from inflation bit: if interest rates are at 20%, imagine the interest cost of a mortgage! Prices have to come down to compensate.

Equities return, on average, 7% in real terms. Meaning they are good investments in inflationary times.

Another way to look at it is inflation means the dollar is worth less, not other things that are not pegged to the dollar.

Imagine this was done quickly:

1: everyone who's got a borderline repayable mortgage to get anything in the overheated market and hasn't increased earnings by some 20-30% since then goes bust. This creates a wave of increased supply.

2: everyone's willing to buy gets way less loan amount for same repayments. This severely reduces demand at current prices.

3: 1+2 force prices down, meaning some people end up owning banks more than their house is worth. In the US the banks are in trouble, as people start walking away from their mortgages. In the EU such people are stuck with negative equity.

Such a scenario is outright disastrous, so no sane government will try it. So, the only way out of low rates is to increase this gradually enough to not create visible waves. Which means all 3 happen, but at a magnitude where most people do not notice.

Wait, isn't your number 1 the exact opposite, unless you got a variable rate mortgage? If you got a fixed rate mortgage, inflation is your friend, since inflation will decrease your debt.

In the UK mortgages aren't fixed for the lifetime of the mortgage. Not sure about the rest of the EU. Ours are like 3/4/5 year fixed rate then revert to a bad variable rate, at which point you get a new mortgage.

In Germany, 10 year fixed mortgages are common, though shorter terms get you lower interest.

I've heard of fixed rate mortgages up to 15 years, at interest rates as low as 1.6%-1.7% if you have a secure job and an established relationship with a landesbank.

In Sweden, lots of mortgages are adjusted every three months, and I would assume (though not certain) that a majority of mortgages are fixed on no more than two-three years.

German banks have always been extremely conservative when it comes to mortgages. It’s hard to even get a mortgage when you don’t have a secure job and bring a substantial down payment (like 20-30% of the house/apartment total).

Inflation won’t do anything to your fixed-rate debt, but hopefully it will increase your wages to make the debt easier to pay.

Most US mortgages have a fixed rate for 20 - 30 years with no balance further due at the end.

It will also increase the value of your house. Fix rate debt is definetly your friend.

I disagree. If inflation is very high, the fed (aka BOC for me) will increase the interest rate, and by correlation, a higher mortgage rate ensues. Less people qualifying for mortgages attacks the demand side of the market, lowering the prices of homes.

Fixed rate debt may increase the value of your house if interest rates go up and your mortgage is assumable.

Almost no US mortgage products are assumable.

All US government home loan programs are assumable (FHA, VA, and USDA).

This Quora answer indicates that FHA loans alone alone make up a majority of new home loans in the US: https://www.quora.com/What-percentage-of-US-home-loans-are-f...

I should've said conventional loan products. Thank you for pointing out my mistake.

While they make up the moajority of new home loans, they only make up ~15% ot total mortgage originations, leaving 85% of homes being mortgaged with conventional mortgages.

I meant the inflation adjusted value of your debt.

For fixed rate, you'll get hit when you renew at the end of the term (typically 5y).

Say you've got a 5 year fixed mortgage, at 3.49%. You buy a new home, taking a $500k mortgage at 25y amortization. That's $2494/mo. At the end of the mortgage, you'll have $431,321 remaining on the loan.

Renewing, if you find the fixed-rate amount is up two points to 5.49%, your 20 remaining years now costs you $2950/mo. If you're taking a mortgage right at the edge of your expense threshold, that 20% jump in monthly payments can hurt.

The alternative is another 25y amortization for $2630/mo (and hey, inflation means you should be clear to $2730/mo to match your first mortgage) but that's just prolonging the life of the loan.

That's not a "fixed-rate" mortgage (at least in the U.S.), because fixed-rate mortgages set a fixed interest rate until the entire mortgage principal is paid down to $0.

It seems like you're describing a https://en.wikipedia.org/wiki/Balloon_payment_mortgage, where you pay a fixed (or perhaps variable?) rate for a few years, but then need to make a huge balloon payment on that mortgage at the end of the term (usually done by arranging a separate mortgage).

I think people are getting confused.

Fixed rate means the interest rate doesn't change over the term of the loan. Compare this to variable or floating rates that can change.

The difference for the US is that the fixed rates are for a 30 year term. Countries like Canada and Australia have 10 year terms as a max, with most people electing for something shorter as the rate goes down.

In the US your rate might never change. In other countries it changes when you refinance at the end of the term.

Guys, don't downvote him. Many parts of the world do it like that- your 30yr mortgage is really a series of 5yr balloon amortized for a 30 year period. They don't have the option of a true 30yr fixed.

Correct. And I know for at least Canada there are circumstances where you can be denied a renewal if you don't meet income requirements.

Let's say you refinance from 2% to 6% and your mortgage payment exceed loan to income ratios, you might have to sell your home.

I'm sure this is US-centric, but the standard fixed rate products for primary-residence home loans here are 30yr and 15yr.

For maybe 5 years, then it’ll come to hurt you when you have to re-sign at a new rate.

In your case 1, this refers to people who have variable rate mortgages, correct? What about people who have fixed rates?

They're eternally thankful for living in a country where you can get a fixed rate for more than 5 years.

It always amused me that the thing that dated Die Hard so much was this line

“When they touch down, we'll blow up the roof, they'll spend a month sifting through rubble, and by the time they work out what went wrong, we'll be sitting on a beach, earning twenty percent.

Of all of the crazy things in the film, Twenty percent seems the most unimaginable to people who have only experienced recent times.

people who have leveraged themselves to the hilt to buy expensive real estate and are just managing to pay the mortgage will be screwed, when their monthly payment doubles or triples they'll have to unload, at the same time as everyone else in the same position depressing the market - there will be crying, the gnashing of teeth, and bankruptcies among those who don't sell quickly enough.

Remember your parents bought their house and paid these higher interest rates, house prices were lower than now partly because people could only afford so much of a mortgage.

If you live in the US, where you can lock in a 30yr rate, and you haven't you need to do it now, if you live in the rest of the world where mostly you can't you're screwed

Me neither, but I tend to think we'll not find out very soon. The article is heavily biased towards the US economy, meanwhile the EU, Japan still struggle with ~0% yields. Hell, Japan's been doing it since 1992.

All of a sudden the idea of having a "savings account" along side your "checking account," and buying "CDs" will make a whole lot more sense.

The average savings account interests are currently around 0.02% APY. Those kinds of numbers make savings accounts meaningless--people just use them as a second account to help their budgeting. CDs are not much better, at 2.5% for a 5-year.

Compare that to 8% APY for savings accounts and 12% APY 5-year CDs in the 1980s, and you'll understand why they exist at all. People actually had a reason to chose interest-bearing savings accounts.

It's almost guaranteed we are not leaving a world of low interest rates (vs historical norms of the past 30 or 50 years).

Most of the global economy is loaded up on debt: Japan, China, the US, large parts of Europe. These days it's the exception when a country has a modest debt context, whether at the government level, corporate level, or household level.

Countries that we normally think of as very well off, such as Denmark, Sweden and the Netherlands are among the most indebted people on earth in terms of household debt to income. They can't afford much higher interest rates at all, it would collapse their housing markets and shatter their household finances.

Australia is in the same boat, two years ago nearly 1/2 of all new Australian mortgages were interest only mortgages; over the last 10 years, the average has been about 35% of all new Australian mortgages have been interest only (in a nation where their housing market is 4x the size of the economy; by comparison, the US housing market is 1.5x the size of its economy). As of a year ago, in total around 39% of all outstanding Australian residential loan balances were interest only. [1] For those that recall the US real-estate bubble, that's a terrifying figure; the US interest-only share of the market during the crazy years of the real-estate bubble was single digits (5-8%). Australia is currently taking action to try to counter this, which is rocking their market presently. [2]

The solid gains Canada made in their household wealth figures over the last decade? Almost entirely from their real estate bubble, which has produced a housing market that as a % of GDP is 2/3 larger than that of the US (the Canadian housing market is 2.5x the size of their economy, up from about 1.6x in 2007). They also can't afford significantly higher interest rates.

New Zealand is similar to Australia, their housing market is 4x the size of their economy. The UK's housing market is 3x the size of their economy, or twice the ratio of the US. These countries are all fragile when it comes to higher interest rates on mortgages.

Even the Swiss are in terrible shape, their household debt as a percentage of GDP is 50% higher than the US ratio.

In the US, its households are in reasonably good shape on debt; US household debt to income figures are the best they've been in decades, essentially the lowest the US has on modern record. Its corporations have loaded up on debt over the last ten years, and of course the Federal Government has taken on immense debt over the same span of time. The US Government simply can't afford 4-5% interest rates on its soon to be $30 trillion in public debt; which is another way of saying: in the US we are never returning to normal interest rates, not under any circumstances. The Fed will go into perpetual QE mode, as Japan has, to guarantee that.

Germany is a particular stand-out among high income nations when it comes to having low government debt, no real estate bubble, and no serious household debt to income ratio problem.

[1] https://i.imgur.com/2Z0mzou.png

[2] https://www.bloomberg.com/news/articles/2018-04-15/tougher-l...

> Countries that we normally think of as very well off, such as Denmark, Sweden and the Netherlands are among the most indebted people on earth in terms of household debt to income. They can't afford much higher interest rates at all,

That's a little mixed up. The effect of inflation is to reduce the effective size of debt, not increase it. So if you owe someone $500US(which has a barter value of ~100 lattes), and a burst of inflation hits the dollar such that the price of a latte doubles, then you only need to pay back 50 lattes to the lender. You win!

Obviously it's the holder of the debt that ends up on the hook for this. Which is why interest rates of lots of debt get indexed in some way to adjust with inflation (or things like the prime rate, which itself tends to track inflation). So the net effect is complicated. But on the whole it's the lenders of money who stand to lose the most when inflation rises. Those who have borrowed come out ahead, on average.

So the net effect of inflation (assuming no second order effect like a global crash, yada yada yada) is to effect a wealth transfer from the lenders of money (e.g. banks and institutional investors) to the borrowers of money (consumers and governments).

There are some very smart people who think this isn't necessarily a bad thing at all.

> Those who have borrowed come out ahead, on average.

I once stayed in a hotel room where the shower had the heat I wanted on average, it was horrible.

But when it comes to real estate, as long as you can afford the increase in interest you'll probably be fine. My concern, here in Sweden at least, is that given the current real estate prices here, I can't see how people with average incomes can afford a more normal interest rate like 4-5%.

In America, most people get fixed-rate 30 year mortgages, so if you buy now, even if interest rates rise subsequently, your monthly payment doesn't change for the next 30 years.

That is not quite what he is saying. People in the big cities in Scandinavia have so much debt and variable interest loans that they will be hit hard by an increase in interest. It'll eat away disposable income and in general lower economic activity.

My debt in the house has fix interest for 5 year periods, so if the interest at the start of next period is higher, it's going to cost me disposable income.

In Chile mortgages are denominated in a separate currency UF which is inflation adjusted. So the wealth transfer goes the loan holder.

But if the borrowed can make the payments right?

Because in Canada people are often taking the max amount banks approve.

"Collapse of the housing market" is a funny way to talk about affordable housing. It assumes that everyone already owns a house and will have a problem if / when the value drops below the remaining debt.

In the US around 65% of households own their home. A collapse of the housing market would be catastrophic for their finances. I'm sure this is true of other countries as well.

You might argue that many people don't actually own their home since they still have a large mortgage, but this just makes the situation worse: now you have a mortgage that's more than your house is worth.

It wouldn't make any difference to those who own their homes outright, unless they were planning on trading up, in which case is it would be a positive, or down, a negative. Those who overleveraged could indeed find themselves in difficulty, however I fully expect they will get bailed out by the very people they priced out of the market by overbidding.

Well, if they were planning on trading up, now the home they were going to sell to purchase a new home is worth less too, so it comes out in the wash. In either case, it makes their net worth look worse on paper.

funny?

when housing markets collapse, the economy goes down and people loose jobs. when you dont have a job, you cant buy a house. one of the many reasons why housing market collapses are not refered to as affordable housing.

don't need to look further than 2007-2009 to see an example of this.

You can see here that home ownership did not go up: https://en.wikipedia.org/wiki/Home-ownership_in_the_United_S...

> when housing markets collapse, the economy goes down and people loose jobs.

I believe the causality goes the other way around. Economy goes down, people lose jobs and then the housing market collapses. It's funny to keep a bubble inflated to protect people from their mistakes.

People always get overleveraged (encouraged by the government and the banking sector) to buy real estate when the economy is doing fine, what else could one expect to happen when things go south?

it does go both ways, but drops in housing price also cause the economy to go down. like a lot. This is already a well established fact

I tend to have the same outlook, i.e. the US govt will be hard pressed to "afford" high interest rates, but I struggle with your statement about QE. QE does not reduce inflation - QE,i.e. printing money to buy debt that is not productive - would devalue a currency and increase inflation. QE is only made possible by deflationary pressures existing elsewhere. Such as Japans shrinking population and lack of productivity growth.

Inflation is how a debt load becomes affordable again.

Is that not correct?

> As of a year ago, in total around 39% of all outstanding Australian residential loan balances were interest only. [1] For those that recall the US real-estate bubble, that's a terrifying figure; the US interest-only share of the market during the crazy years of the real-estate bubble was single digits (5-8%). Australia is currently taking action to try to counter this, which is rocking their market presently. [2]

At least for myself, I have an interest only loan; but it comes with an offset account. In a day-to-day sense it's not very different to a normal mortgage with free redraws. I think this gets confused when comparing stats across countries, as offset accounts in the USA don't seem to really exist (while they are common in Australia).

I'd like to give my thoughts on unsustainable interest rates in Canada. Living here, I see it as yes, a raise in interest would be catastrophic for many home owners and their mortgage payments. But we are tied to USA's Fed. If they increase the rate, and we do not, our dollar will plummet in USD CAD terms. So in my eyes, it is a trade of between devaluing the CAD, thus every Canadian absorbing the blow, or home owners taking the interest rate hit. I am not sure which is the best outcome :)

edit to clarify why CAD will drop, is because CAD will be given up at the lower rate for USD which offers higher rate.

Why does loaded up with debt imply interest rates will be low? Most debt is fixed-rate and not inflation-adjusted so there is a strong incentive to drive up inflation and interest rate with so much outstanding debt. This may fail in which case you get a deflationary collapse, but a priori it's not clear at all which direction things go.

If the stagflation era of the 70's is any guide, the world will undergo a significant bout of inflation to clear the plate and the holders of USD (playing the role that gold played then) will be wiped out and it will no longer be the reserve currency.

> Why does loaded up with debt imply interest rates will be low?

adventured seems to think that "can't afford interest rates to rise sharply" implies "therefore interest rates won't rise sharply". That seems a bit naive. (Though in fact the Fed can make that happen, with QE. But the results could be pretty disastrous in non-interest ways.)

However, there is a bit of a negative feedback loop. Interest rates rising hurt those who owe variable-interest debt. (Side note - if you have a variable-rate mortgage, you should seriously look at refinancing with a fixed-rate one.) Those who are hurt in this way spend less. This slows down the growth of the economy, which slows the rise of interest rates.

> If the stagflation era of the 70's is any guide, the world will undergo a significant bout of inflation to clear the plate...

That seems likely. Those who owe variable-rate debt will get crushed by this, though. Those who owe fixed-rate debt will be relieved over time.

> ... and the holders of USD... will be wiped out and it will no longer be the reserve currency.

Depends on whether the Euro and the Yuan hold up better than the USD. I find it hard to believe that China will let the Yuan be significantly more solid than the USD; it has found it commercially helpful to have the Yuan be weak. The Euro might be the winner, or it might become as weak as everyone else. If it's the latter, then the USD likely won't be very significantly hurt - it has the advantage of incumbency, and if it's no worse than everyone else, it will be fine.

> USD (playing the role that gold played then)

Gold didn't play that role in the 1970s - at least not in the second half. Once the US let the price of gold float, gold was a rocket. It went from $35 to $200, dropped back to $100, and then went up to $800 (though this started in the 1970s, I don't remember what year it hit $800). Those holding gold were very much not wiped out in the 1970s!

> Most debt is fixed-rate

While technically true, the term of the loan matters. The government (and most companies that issue bonds) have revolving debt. I.e. they are continuously issuing new debt as existing debt expires. So while inflation theoretically makes your existing debt cheaper, it might not matter that much if you still need to rely on the debt markets in order to fund operations.

Isn't QE just injecting more money into the system? How can that not result in inflation, eventually and if done excessively? It's the classic "more money chasing fewer goods." It's not just where the fed pegs the discount rate that drives inflation, it's also the money supply.

...and if inflation goes up, so does the cost of borrowing, unless banks are planning on loaning people money at below the inflation rate. There's no free lunch, unfortunately.

I suppose if the the additional demand instantly translates to near immediate provision of supply? Most manufactured goods would fit in that category nowadays?

Only things like housing do not as they can't be easily provisioned to meet demand as quickly.

Correct, in that if supply increases you've either increased productivity, or the workforce. It cannot come on line otherwise.

I think it generally lags, and does not quite close the gap, outside of other deflationary pressures being present.

>The Fed will go into perpetual QE mode, as Japan has, to guarantee that.

And many other countries as well.

The very few ones who can "afford" high rates are, ironically, the frontier markets. Gulf kingdoms, *stans, banana republics, Vietnam, and much of Africa. And yes, ... Germany.

Frontier market bonds has never looked so attractive in my lifetime.

Germany is joining the club at the moment with a real estate bubble.

I hope so as I just signed up for a mortgage after years of waiting for prices to drop.

Do you know how Poland is doing compared to the others you mentioned?

Debt becomes more expensive. If interest rates go very high, that can be crippling. That's probably unlikely.

There will likely be less money pursuing assets (real estate may be affected), and business ventures (start-ups). Given trends of the past decade, both are likely healthy changes, though SV types may be impacted.

We live in weird time. If rates were to hit 80ies era level, 1 out of every 3 countries will default.

For this reason they wouldn't.

I thank myself for making a decision in my teenage years to keep half of my savings in metals. It was unbelievably wise for a 15 years old me.

> If rates were to hit 80ies era level, 1 out of every 3 country will default.

Huh? Are you saying 1/3 of mortgages are variable rate?

I'm talking about government debt, not private. Though, a chain reaction , if it is to happen, will reach pretty much all and everything including private mortgages.

If you have a fixed rate one, you may well read the fine script better. Quite a few banks put a no reservations callback clause in the loan agreement.

If an individual gets his mortgage called back, for an average Joe the only way to get through that would be to get another loan, and at a higher rate.

Loans cost more. The interest rate on my first mortgage (in the 90's) was 7%.

Back in the 1970's a 12% interest rate on your mortgage was considered pretty good!

It basically reduces buying power for real estate. Using the google mortgage calculator and assuming a $1500 max monthly payment.

At a 3.92% (today) rate you can borrow ~$320K At an 8% rate you can borrow ~$200K

A 38% decrease in buying power. It's already happening in Canada as the gov't is trying to slow down the real estate market by making buyer qualify at a rate 2% higher than what it is today.

It also made the idea of a starter home more meaningful. Your monthly payments quickly became meaningless especially if you got any kind of a promotion.

At 5% inflation if you pay 1000$/month in year 0 it feels like 614$ / month in year 10 and 377$ / month in year 20.

At 1-2% inflation the loss of the interest tax deduction over time as you pay more principle and less interest means home lone feels about as expensive in year 0 and year 20.

Right, but isn't the distinction that you are paying principle, which in essence buying equity? It isn't free cash flow, but there's a big difference between putting money towards principle and paying a bank interest.

I am not saying it's reasonable or unreasonable for home interest to be tax free. Just that the difference impacts your disposable income.

> as the gov't is trying to slow down the real estate market

This is not the reason for mortgage stress test, just one of its effects. The main reason for the regulation is to avoid a tsunami of bankruptcies when interest rates eventually increase.

These are not fixed rate loans?

You can't really get a rate fixed over the entire amortization period in Canada, our 'fixed rate' mortgages are a 5 year lockin typically.

When those fixed rates end and they have to refix a ton of overleveraged people will force mortgagee sales.

In Auckland there's been talk of that for at least 5-6 years. For example, people I personally know only earn $80-90k/yr and yet own a $500k house (absolute entry level livable house in Auckland). They also got in under our old rules which meant they only needed 5% deposit instead of the 20% required now.

They're only being propped up by their record low interest rates. If those interest rates went up 2-3% they'd be in serious trouble.

EDIT: for more context the average fixed period for any home loan in NZ is roughly 2-3 yrs. The term is a 30 year term typically.

In USA it’s common for loans to be fixed rate for life of loan.

> It basically reduces buying power for real estate.

But real estate is unlike a lot of other goods in that it's value is significantly driven by what other people are willing to pay, rather than what it intrinsically costs to produce. Thus, as your buying power goes down, so does everybody else's.

Much higher mortgage payments. Run the math on a mortgage with 4% interest vs 8%.

However during the years when the baby boomers were buying that house and paying 15%+ interest, that house sold at a 1/4 of today's prices, adjusting for inflation. There were mortgage tax relief schemes so it wasn't that hard to buy a house for that generation. They cheerfully tell their younger children to save up for a deposit like how they did.

My intuitive sense is that it should destroy the real estate market. Anything that I'm missing in that analysis?

When interest rates rise, prices fall. New buyers have a certain amount of money they're willing to pay each month and the market adjusts to that, so it makes little difference there. Existing owners would be the ones getting hit by rising interest rates, just as they were bagging outsized profits when rates were falling.

Existing owners wouldn't really be affected if they plan to live in their house as it's just paper wealth that they can't access until they sell anyways.

Those that downsize just after interest rates rise in order to spend the value locked in their house might lose a bit depending on whether any of the money is reinvested in something else after they sell.

People who will lose the most are house builders. Their revenue is directly tied to house prices. However, for a rate rise to be sustainable there has to be other good ways to make money out there otherwise rates will likely quickly go down again.

Yeah, I guess I meant that house prices would crater. Obviously some people benefit from that and some don't.

My intuition is that it would also precipitate an economic downturn. Many households will see a drastic deterioration of their balance sheets, which should act as a damper on consumer spending. Which would, in theory, have 2nd order effects on the real estate market...

People won't be able to borrow against their lost wealth either (or only at very high rates). Builders/Flippers will stop spending and so the construction trades will suffer a lot... ditto RE sales people and their 6% commissions. I don't think inflation would be high for long.

History.

In the late 1970s you could get 17% return on your savings account and mortgage rates were well above 10%. People still bought houses.

I'm not talking about a steady state. I'm talking about the transition from a low interest rate regime to a high interest rate regime.

If someone barely qualified for a mortgage in a 2% environment, and now suddenly is faced with 10%, that's a bit of a shakedown.

Nobody, anywhere, ever, in the history of this topic, has suggested the fed would raise rates such that rates would 'suddenly' jump to 10%. That's the straw-iest of straw-men.

Depends on how fast it rises, and if wages can keep up. Obviously the slower the better. But yeah, the optimal time to buy RE is when rates are high and then refi when they drop.

High rates and inflation tends to reflect an overheated, strong economy. This usually signifies higher demand for real estate and lower cap rates (higher valuations). Nothing happens in a vacuum so it depends on relative opportunities elsewhere too.

A lot of misinformation and propaganda about the cause of it. See the 1970's in America.

(Usually, greedy businessmen, greedy unions, and speculators are blamed.)

> inflation aren't low

Inflation is only low if you trust how the Federal Reserve is calculating it. Personally, I think the weightings they assign to various categories are intentionally incorrect.

Anyone who lived through 2008 knows better than to think inflation was sub-2% -- yet many savings accounts have been paying 0.01% interest for over a decade.

The fed's monetary policy is taxation without representation.

The Fed doesn’t calculate CPI, but CPI ‘adjustments’ are indeed fundamentally cherry picked to lower the rate. There are a bunch of crazy mechanics like “hedonistic substitution”, min() functions, and adjustments that by definition can only adjust the rate down and not up (eg ‘quality increase’ in basket of goods = adjust CPI down by the ‘quality increase factor’, but quality decrease does not adjust CPI upwards).

People use the million prices project to argue CPI is correct, but misses the point that the project uses a regresssion model to automatically multiply their index by an adjustment factor to match CPI - and that adjustment factor has only gotten smaller and smaller (ie their index reports higher inflation growth than CPI) as time went on.