- Borrowers can get a mortgage for 3% while the CPI is also at 3% and actual inflation running at 5%. While their underlying asset - ie their home retains its original value. That is to say, they can always get their $100k investment back whenever they decide to sell their home. Plus even more, should real estate prices rise faster than inflation.
- However the poor investor - gets but 1% on their investment in the face of 5% inflation - so each and every year their investment declines in value by 4 % ( 5% minus 1 %). Over 5 years, that amounts to at least 20% (4% x 5 years) or $20k. In other words, at the end of 5 years their original $100k nest egg would have the buying power of only $80k.
- From this I hope you can see that the Investor, in reality, is subsidizing the Borrower.
- This can last only until the Investors have money left to invest - which as you can imagine, is not forever.
Galagher
BIG TIME !!
Do you ever wonder how the youth of today can afford big homes, big cars and all the toys?
If you are a Boomer - like me, it is thanks to us.
How so, you ask?
The following example should suffice:
Let's say a Young Couple (YC) buy their first home for $100k (as if, but let's just pretend).
YC go to the bank and arrange for a five year mortgage @ 3% per year so their interest payments over the next five years totals $3k per yr x 5 years or $15,000.
Now Old Couple (OC) go to the same bank with their $100k nest egg to invest and they get the princely sum of 1% interest - if they are lucky. Over five years that interest accumulates to $5k ($1k x5) so their nest egg is now at $105k.
So YC is down $15k and OC is up $5k. Right?
Not at all.
Permit me to shine some light on the real situation.
While trying hard not to bore you.
The Consumer price index (CPI) states that our annual inflation rate is roughly 3%. (Which is not true since economists believe that the real rate is twice or even three times that figure).
But let's for argument sake take the official government 3 % rate. (as an aside, the gov't understates the CPI because its annual social payment increases are based on that figure).
Let's deal with OC first.
Each year their $100k nest egg declines in value by the CPI rate so if the rate is 3% over 5 years it declines by $15k ($3 k x 5 yrs). Since they are receiving 1% from their Bank - this drop in value is mitigated by their interest earnings or by $5k ($1k per year x 5yrs).
So their net loss over five years is $10k ($15K - $5k). In other words, their nest egg is now worth only $90k in real dollars.
Now let's look at YC. They borrowed their $100k @ 3% which also reflects the gov't sanctioned CPI at 3%. So they end up neutral re their borrowing. In other words their borrowing has cost them nothing.
But as a result of inflaton, their home has increased 3% per annum for their 5 years of ownership so what was purchased at $100k is now worth $115 k in inflated money (3% x 5 yrs) or $100k in constant dollars.
Bottom-line YC at the end of 5 years has an asset valued in constant dollars of $100k while OC has a nest egg valued at $90k in constant dollars.
In a fair economic climate, the YC should be borrowing at approx. 10% - double the actual rate of inflation and the OC should be investing at approx. 7.5% - 50% above real inflation.
That would mean, on a $100k mortgage, YC should be paying interest at the rate of $10,000 per annum or $5,000 after inflation and OC should be receiving $7,500 per annum interest on their $100k investment or $2,500 after inflation.
What we have here is an inter-generational transfer of money which has gone on far too long and in the long run will benefit neither YC or OC since YC can only keep up their spending as long as OC has the money to loan them.
As I see it...
'K.D. Galagher'
