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Escape from QE

Jan 15 2014 06:50
*Edward Ingram
THE problem faced by the central banks like the US Federal Reserve and the Bank of England, Japan, and others where interest rates and inflation rates are low is that as economic recovery takes place, interest rates will rise and property and bond values will fall.

There is the further fear that inflation may take off because so much new money has been printed. When there is too much of anything its value falls, and if the value of money falls then incomes will rise and the cost of everything will rise proportionately.

Except that this is not what happens in reality. In actual fact, confusion reigns and everyone feels vulnerable.

The new ILS mortgages and the wealth bonds are designed to put an end to most of that confusion and hardship. Broadly, they all increase in value or cost or price, 1% faster p a for every 1% faster growth in the rate of Average Earnings Incomes Growth (AEG% p a plus the interest coupon). 

Borrowing costs and lent wealth are both relatively stable. Instead of giving people their money back, these products are designed to give them their wealth (saved income) back plus the market rate of interest.

These new debt models can withstand stress tests which current mortgage finance, business, and government finance cannot. Current debt models create their own distortions which make them either crash or become horrendously expensive.

Figure 1: The sensitivity of costs and mortgage sizes (thus also property values) takes mortgages and house prices off this path.


Figure 2: American property prices were inflated by low interest rates and they plummeted when interest rates rose and confidence was lost.

Most people know that mortgages are still too cheap and they are timid about further borrowing.

Figure 3: Brought forward from the essay on Wealth Bonds as the safe alternative.


As for fixed interest bonds, remember this earlier essay explaining how  they cost the USA taxpayer something equivalent to 9% of income tax in the 1980s, and also redistributed wealth in a craze of instability.

Escape from quantitative easing

To escape from this QE/Low Inflation/Interest Rate trap, bond values, house values and mortgage costs all need to remain stable as well as safe from the threat of inflation as QE (printing more money to keep interest rates low) is wound down, economies recover, and interest rates rise.

A large part of the reason why economies do not recover even after a massive stimulus is simply a lack of confidence in wealth and costs. If those worries are removed, almost any economy would recover even without a stimulus.

Confidence in wealth and budgets allows everyone to get back to work and make things happen.

And that allows a government’s revenues to rise so that it can manage its debt.

The remedy

With that in mind, I suggest that almost everyone, when confronted with an unavoidable loss of wealth from holding fixed interest bonds, would be happy to exchange those fixed interest bonds for wealth bonds, even if wealth bonds cost more.

That ‘haircut’ (loss of value) in making a swap will never recur; it could be a popular choice that may even reduce the government’s debt without needing the confusion and economic disruption of inflation to do that for them.

Being index-linked to AEG% p. a. such wealth bonds will keep their value whatever interest rates and inflation rates may do. As average incomes rise, their purchasing power will also increase at about the rate of real economic growth, plus the interest coupon.

Any investment that does that will look good to investors, compared to taking a drubbing in fixed interest bonds or equities as interest rates and average incomes rise.

Remember what I wrote about that when I explained How to preserve wealth.

What about house prices and mortgage costs?

Rising interest rates threaten both of these. Currently worries on this front are also getting in the way of a sustained recovery and a confident way forward.

Mortgages come in many forms. As I explained in previous essays, the maths of safe lending says that lenders can only lend a certain amount of wealth if they are to be able to protect borrowers from payments that jump up or incomes that do not rise, both of which are risks that the borrowers currently face.

If borrowers cannot be safe then neither can lenders, property prices, nor the economy.

I suggest that around 3.5 times the borrower’s income might be a suitably safe amount to lend, on the basis of my tests.

What we have now, as a result of the table in Figure 1 above, is too cheap and too large mortgages and too high property prices.

Next week I will explain how the new ILS Mortgage Models can be used to bring significantly greater security to borrowers and house prices, despite their mortgages being too big to be safe in normal circumstances.

 - Fin24

* Edward Ingram has a strong and growing support base. One American has started a petition asking President Barack Obama and/or his senate committees to look into these ideas. Ingram says: “Why not here in South Africa? The ideas are universal.”











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investments  |  money

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