a cap to fit the home boom

Is there anything or anyone that can stop Reserve Bank governor Ian Macfarlane from his mission to raise interest rates and cap the housing boom?

What do you think of this Report?

http://www.theaustralian.news.com.au/common/story_page/0,5744,7937526%5E16946,00.html

Bill

When someone borrows money from a bank does someone else's account go down? No. So where does the money come from?

All increases in purchasing power are reversed. Either
1: The loan is paid back. Everybody back to square.
2: The borrower goes bust. The bank loses.
3: The currency is devalued. Savers lose.

As nobody has any intention of reducing debt or going broke. That leaves 3. McFarlane does not want to go down that path but eventually we will. Speculative capital is moving into A$ pushing it up further. This will eventually be reversed and the A$ will follow the US$ down relative to gold.

The US appears to be aggressively pursuing option 3. That is why gold and commodities have been going up.

Now should McFarlane care about someone who has their life savings in cash and no idea about whats coming down the line. Should he sacrifice their savings or your property values?

Billvals,

Let's face it- interest rates are pretty low. Low interest rates and a property market out of control means that it's harder and harder for anyone- even many property investors- to continue to buy. If an IR rise chills the market out a bit, then it's not such a bad thing.

If people are completely stretched and overcommitted with their finances, then something has to stop them (if they won't stop thmselves). For those who have reasonably conservative financial strategies with a bit of room to move, all will be well. It is helpful to invest with a contingency plan anyway, and people need to have been doing their sums with a RI hike in mind.

Cat

I guess people with savings would welcome interest rate increases but these increases are boosting our $ and therefore are hurting our exports. So we may see unemployment rise in some industries.

There is no easy answer to this problem.

However, the RBA is not thinking of people's savings.
They want to stop people from borrowing too much
and the house prices from going up too fast.

Instead of raising interest rates,
Perhaps a more sensible approach would be to
modify negative gearing or depreciation rules.

For example, to slow down the market they could take away negative gearing but ONLY from FUTURE property purchases and monitor the housing market movement to see if they should introduce it again.

Bill

Originally posted by Mr Turkey
When someone borrows money from a bank does someone else's account go down? No. So where does the money come from?

All increases in purchasing power are reversed. Either
1: The loan is paid back. Everybody back to square.
2: The borrower goes bust. The bank loses.
3: The currency is devalued. Savers lose.

As nobody has any intention of reducing debt or going broke. That leaves 3.

Click to expand...

This isn't actually how it works

I'm trying to say this using no economic terms at all, so others with economic experience out there bear with me

Banks are magicians who create money out of thin air - to a limit controlled by the central bank (in Australia the Reserve Bank).

When banks lend money they lend amounts from their 'vaults' - the collective savings of everyone who has money with the bank, retained profits and amounts they borrow from the money market at lower rates.

They are legally required to keep a small amount of cash available on hand to cover withdrawals from savings accounts - This % is set by the central bank. Of course banks also manage their cash reserves for operational & other costs.

They are then repaid that loan amount plus interest. The INTEREST is actually an increase in the money supply, though not the paper money supply, purely the electronic supply. Remember that the interest is paid over many years so has only a very slight effect on the money supply or currency valuations.

If borrowers go bust banks take the assets over which the loan was secured & sell it. They don't always get all their money back, but often have insurance (such as LMI) or other mechanisms available to claim back their money. Rarely, banks end up in positions where they cannot get all the money back & lose out, but this is severely outweighted by the number of situations where they can recover the cash.

Currencies have demonstrated a tendency to devalue over time (called inflation) due to many factors other than bank lending. Bank lending is a responsible means of allowing people to lay-by big purchases, paying for the cost of borrowing the money.

To go into more depth I really have to begin using economic terminology, so I'll stop with the point that banks do lend the money from the savings deposited in their bank & legislated bank lendings is largely not a major inflationary cause for economies.

Cheers,

Aceyducey

Originally posted by Aceyducey
If borrowers go bust banks take the assets over which the loan was secured & sell it. They don't always get all their money back, but often have insurance (such as LMI) or other mechanisms available to claim back their money. Rarely, banks end up in positions where they cannot get all the money back & lose out, but this is severely outweighted by the number of situations where they can recover the cash.

Click to expand...

Hi Acey

After default interest rates and high legal fees debank may end up out of pocket and the borrower minus property but still in debt.

80% LVR loans should have enough fat in them to recover all costs, as should loans that are a few years old.

bundy

Hello AceyDucey,

Thank you for a straight forward explanation for us economic newbies. Could you clarify the part about how interest is added to the supply of money in the system, albeit only electronically?

I realise the local economy is not a closed system with cash flows in and out continually. However, is not the payment of interest likely to be paid to the bank from the results of the borrower's work/productivity/investment? Which in turn has come from someone else in the system paying for the work/production etc. ?

The more I think on it, the more muddled I get.

Help.

Regards,

Kenny

PS. I think banks probably build in a little buffer for their profits also from the fees they sometimes (okay, all the time) charge for somethings (okay, all things).

Originally posted by Aceyducey
This isn't actually how it works

I'm trying to say this using no economic terms at all, so others with economic experience out there bear with me

[snip]

They are then repaid that loan amount plus interest. The INTEREST is actually an increase in the money supply, though not the paper money supply, purely the electronic supply. Remember that the interest is paid over many years so has only a very slight effect on the money supply or currency valuations.

[snip]

Currencies have demonstrated a tendency to devalue over time (called inflation) due to many factors other than bank lending. Bank lending is a responsible means of allowing people to lay-by big purchases, paying for the cost of borrowing the money.

[snip]

Cheers,

Aceyducey

Click to expand...

Saves me having to type it all.

The attachment is the outlines of a lecture concerning the money supply, the multiplier process and the role of banks and the RBA (for those who are interested).

With appropriate acknowledgement to Associate Professor Glenn Otto of UNSW.

http://www.economics.unsw.edu.au/courses/econ1104/gotto/

MB

Pitt St,

That's an excellent document

it should answer your questions Kenny.

Cheers,

Aceyducey

This rise in interest rates is a necessity.

In recent years the government has done a very good job of keeping the interest rates at a good level. Never too low, and never too high. They have learnt from the mistakes of their predecessors, and the management of the RBA rates must be commended over the last few years.

Especially because we're on a property forum, I feel it is paramount to say that the interest rates don't just relate to property. While they are one of the biggest areas effected because of interest rate fluctuations, there are a whole heap of other reasons why interest rates change, (employment, exports/imports, current account balance, domestic currency, I could go on..).


These rises are just to put a slight cap on the market so it doesn't spiral out of control. The bigger the rise, the bigger the fall.