"Quantitative Easing" now, may mean inflation later...
Brett Alegre-WoodChairman, YPC Group
Hey guys,
This is just a quick blog that to express my concern that some investors feel they are out of the high interest rate danger zone. This is not the case -- you need to be aware that rates can easily jump back up.
Yes, low interest rates have been great for most people's portfolios. In my case I have stopped having to fund my portfolio and am now making money a profit each month which I can tell you is a great feeling. But it's not a permanent arrangement.
Let me explain...
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The Bank of England has pretty much used up the value of dropping interest rates so quickly. It hasn't resulted in a hoped-for turnaround and it's commonly believed that it won't safe us from a deepening recession either. So the government has to turn to other forms of stimulus -- the main one being something called quantitative easing. In lay person's terms it means printing more money.
But they don't actually print more money...
If the government starts the quantitative easing process they don't print more bank notes. What they do is borrow money through offering Treasury Bills (effectively taking on more debt) which is injected back into the economy. In the USA they are planning of splitting it two ways: tax cuts of 36% to individuals and government spending (normally in capital works and social programs) 64%. This money paid to families (tax cuts), and suppliers (construction workers etc) re-enters the economy at some point.
So the essence of QE is that all this extra money floating in the economy starts to stimulate the economy and the government gets about 60% of it back through taxes and other means.
The lag effect...
The problem with all action like this is that you get a lag effect, which means that the money being paid out doesn't hit the streets for some time. The construction projects don't finish straight away, etc. The recovery period can take months if not years.
The danger of inflation...
The problem created by QE is more money in the economy lessens its value, so it therefore buys less over time, and therefore we all need to earn more in order to keep up. This means wages, prices, everything begins to rise. And presto: we have inflation. And once we have inflation then the Bank of England will need to respond by raising interest rates which obviously will mean we pay more for our mortgages as investors.
Now I don't think this will be a problem in 2009, but I do think 2010 or 2011 could see rates rising. It's not certain when it's going to happen, but it will, so you had better be prepared -- especially if the economy starts to bounce back quickly.
The solution to all of this is to count all your mortgages as being at 6% interest rates or thereabouts and be putting the extra money you are making aside into your provision account, so that when rates to head back up you are sitting on a nice little buffer.
So, to sum up -- this is not the time to be celebrating you survived high interest rates. That time is coming very soon. For now though, this the time to consolidate and prepare for the coming boom. It might be 2, 3 or even 4 years away but just as you can trust human nature (or human greed) you can trust that we'll have another boom.
I have raised a lot of questions here, probably more than I have answered! Naturally, if you'd like to talk to the team about how the coming 2 years are going to affect your portfolio, don't hesitate to give us a call on 0207 812 1255 and they will be happy to guide you in the correct direction.
Live with passion,
Brett Alegre-Wood
PS. I have recently dropped my MCA rate to be 5.5% because I felt this was a truly reflection of what actually happen in my own portfolio. It actually worked out at 5.15%ish so i rounded up. Now this doesn't mean that you should change your rate as you may want to consider a larger provision or buffer.
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