Why Should Investors Understand Global Debt and Interest Rates?
“In other words, QE certainly benefits investors/savers (i.e., those who own financial assets) much more than people who don’t, thus widening the wealth gap.”
― Ray Dalio (Founder of the hedge fund, Bridgewater Associates)
Interest rates are the most critical economic driver, and their movements (up or down) can have ripple effects through the global financial markets. Stocks, bonds, commodities, and currencies are all directly affected by the actual and anticipated directional move in interest rates, but not always in a linear manner. The cost of borrowing money, as determined by interest rates, can have a profound effect on the economy as leverage (debt) is the basis for the majority of worldwide economic growth.
The U.S., Europe, and other developed countries continue to increase deficits (the annual difference between how much the government spends and what it receives in revenue). The U.S. federal budget deficit for the fiscal year of 2020 is $1.10 trillion. Each year’s deficit adds to the national debt. U.S. government spending at 17 percent of total GDP has become a sizable component of the economy. Therefore, politicians of both political parties are incentivized to increase spending as this artificially creates jobs and grows the economy.
Total global debt continues to increase, and by the end of 2019 is projected to surpass and make a new record level of $255 trillion but, more importantly, this trend is not expected to slow down any time soon. The global debt translates to approximately $34,000 for each person on earth. These record debt levels are occurring at the same time as a zero interest-rate policy (ZIRP), or a negative interest rate policy (NIRP) is being implemented by the central banks of many developed countries. Approximately 30 percent of the developed world’s government debt is yielding negative rates, and almost 100 percent of the debt is zero or negative-yielding when factoring for inflation. The stated goal of these central bank policies is to increase economic activity by encouraging both businesses and consumers to spend rather than save. The phenomenon of negative-yielding government debt might be another “subprime” bubble, but this time it would be in “subprime governments.”
In addition to policies like ZIRP and NIRP, some central banks have engaged in several rounds of quantitative easing (QE). When interest rates are near zero, central banks are limited in affecting interest rates even lower so they may implement QE to increase the money supply by purchasing from banks securities such as government bonds. These purchases provide banks with liquidity and effectively increase the money supply. QE is done to promote lending and investment, but eventually, it loses its effectiveness. As monetary policies like QE, ZIRP, and NIRP become ineffective, governments feel compelled to further expand the monetary supply via fiscal policy (i.e., more government spending), thus, increasing government deficits and the cost of servicing this debt.
In the next economic slowdown or recession, the Federal Reserve and other central banks will likely engage in more aggressive QE, ZIRP or NIRP to promote spending and economic growth, especially given these statements:
- Former U.S. Federal Reserve Chair, Janet Yellen, stated, “If it were possible to take interest rates into negative territory, I would be voting for that.”
- U.S. President Donald Trump tweeted on September 11, 2019, that “The Federal Reserve should get our interest rates down to ZERO, or less, and we should then start to refinance our debt.”
But what do central bank policies like ZIRP or NIRP mean for real estate investors?
- Today’s historically low interest-rates have reduced the cost of servicing the enormous debt accumulated by Subprime Governments and makes it fairly difficult for central banks to substantially raise interest rates given governments need these low rates to fund increasing debt. Low rates may likely be commonplace for many years to come. This means real estate investors may have access to low borrowing rates to fund fruitful opportunities.
- The U.S. status as the preferred safe haven means that foreign capital will continue to flow into assets like the highly desirable commercial real estate market.
- Declining yields worldwide mean that investors will continue to invest in opportunities with favorable cash flow and price appreciation. This will further spur appreciation of commercial real estate assets.
It is important to note that interest rates cannot be considered in isolation because interest rates affect various markets and asset classes. It is conceivable that the anticipated positive effect of falling interest rates may be partially or completely negated by how other markets react to falling rates in the near and intermediate terms, but over the long-term, ZIRP and NIRP will be extremely bullish for commercial real estate assets and other income-producing assets. Also, it should be noted that central banks have embarked on policies that have never been implemented. Regardless of the corresponding uncertainty, commercial real estate, especially multifamily assets, will continue to experience superior investment returns as compared to other assets.
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