Back in December the Federal Reserve in the US raised interest rates a quarter of a percent. They’ve been promising to raise rates for some time but have held back because of weakness in the real economy. The idea was that they would raise rates once official US unemployment went below 6.5%. But they held off until it was down to 5.5% citing weakness in the recovery.
Many commentators believe that holding rates at zero, or near zero, has had some damaging effects on the economy. Back in the 1990s, Alan Greenspan held interest rates too low for too long, and it caused the value of Dotcom stocks to inflate rapidly. The in the 2000s, Ben Bernanke, held interest rates even lower and pumped up an epic housing bubble. Prices escalated well beyond what incomes could support.
This time, we have had record low interest rates for nearly seven years. So what prices have been pumped up this time? Right now housing prices are back up to their historic highs. For further info click here. It’s as if the correction that we had in 2009 never happened. Central banks all over the world ramped up the printing presses and made sure that the bubble was reinflated at all costs.
It’s easy to see why they did this. Most people’s savings and wealth is tied up in their houses. When their homes lost value during the financial crisis of 2008, people lost their real wealth at the same time. This led to foreclosures and a decline in spending, which in turn put the economy into recession.
But now that interest rates are at record lows, the market can once again support high house prices – just. This time, though, it seems like even small increases in the interest rate may cause prices to come crashing down once again. Just ten days ago, we got news that the Bank of England was considering negative interest rates. In other words, they’d get the banks to pay them for the privilege of depositing their money.
Clearly something is wrong here. Zero interest rates are strange enough. But paying somebody to borrow your money is like paying them to rent out equipment. It’s total madness. It might mean that housing commands a high price right now, but what happens next.
If central banks raise interest rates, they’ll bankrupt millions of people unable to pay big mortgages. House prices will collapse and foreclosures will soar. If they lower interest rates, they risk destroying the value of the currency through inflation. In other words, central banks are between a rock and a hard place. And that makes working out what homeowners should do tough indeed.
If owners believe that central banks will raise interest rates, then they should sell now and buy back when prices are lower. In this situation, they believe that the banks will raise interest rates to defend the currency.
But equally, central banks might not care about the declining value of their currencies. Instead, they might continue printing as they have been. And who knows where we’ll be as a result of that?