Friday, May 18, 2012

Financial repression for the long term?

While much of the world's economic attention is on Greece and the country's possible/likely/inevitable exit from the failed Euro experiment, it's worth remembering that many of the world's developed countries continue to run deficits at levels which can only be labelled as fiscally unsustainable - Japan, the United States and most of Western Europe come to mind.

Given that the ruling politicians and the entitlement classes that they are beholden to are unlikely to ever make the cuts needed bring their out of control spending down to sustainable levels it seems quite possible that financial repression in the form of negative real interest rates may well be with us for quite some time. In effect the central banks will (i) keep interest rates nominally low not just in an attempt to stimulate the economy but because the debt burden is so high that higher nominal rates could easily become unsustainable and (ii) keep pumping in money to keep official inflation at a positive number to gradually erode the real value of their debts.

If this logic proves to be correct then borrowing to invest in real assets which have sustainable yields which are higher than the cost of funding is the best strategy for the longer term - inflation should eventually push the value of the asset and its income stream up while the nominal value of the debt remains unchanged. Of course there is a lot of short term between now and the longer term and individual assets and whole asset classes can, and often do, fluctuate wildly in value meaning both that the strategy is not for the faint of heart and that considerable safety margin needs to be maintained.

This makes a pretty good case for not paying of mortgages early. In fact, I am considering going further and borrowing to buy another small flat in Hong Kong in the middle of next year. One of my mortgages will have been completely amortised by then and I will be able to offer both the existing property and the new property as collateral and the combined rental income will comfortable exceed the mortgage payment on the new flat. Of course, I will still need to get over the hurdle of whether  the bank will lend to me when I no longer have any employment related income.


Anonymous said...

Isn't it better to buy a property stock with good portfolio selling at big discount than going all the trouble to buy a flat?

traineeinvestor said...

If I was just utilising cash, then I would absolutely prefer to buy good property stocks rather than property at today's prices.

In this case, I am looking at using borrowed money. While I am sure I could get a credit facility against the unmortgaged flat, I would not be able to borrow as much and (last time I checked) would have to pay a higher interest rate than if I purchased two properties and could offer them both as security.