Central Bank Announcements – Understanding Low Borrowing Cost and Other Fiscal Policies

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Central Bank announcements indicating significantly low borrowing costs across the world have created a lot of confusion about the lending environment and what it means for investors and home owners. There’s a lot that is going behind the scenes that general members of the public never get to see, let alone comprehend the impact it has on everyday life.

So lets start off with unpacking some of the recent announcements across Australia and New Zealand. Even though we are only looking at AU and NZ in this article, readers in the UK, USA, Canada or elsewhere, will find that the outcome is identical for most countries where central banks are engaged in some form of quantitative easing programs (QE).

Before I begin, I want to put a question out there for you. Most of you would know that the central bank of a country is meant to operate as an independent body in cooperation with the government.

It is not a revenue generating body, to the extent that it has the amount of revenue or purchasing power to engage in elaborate asset purchase programs. So the question is this:

Where does the central bank get the money to buy those assets that they talk about in the asset purchase programs?

The answer to that will become clearer as you continue reading this rant.

For most countries, when a central bank talks about an asset purchase program, they’re referring to the purchase of bond-type assets, mainly treasury bonds that are used by governments around the world to raise debt to fund various economic activities.

This is fairly common and a typical symptom of a capitalist market where debt is merely a consequence of progress – or at least, that’s how it is sold to the general public. You have to have debt in order to create capital in order to grow, in order to pay back the debt (never happens like that), in order to borrow more, in order to grow more – you get the picture.

However, in all this borrowing, the interest applicable on the debt created during the cycle, is never accounted for. Hence, at least theoretically, there’s never any chance of debt being completely paid off – which is the reason why the debt ceiling constantly needs to be raised.
Nearly all the countries in the OECD have had to raise their debt ceilings rather frequently.

So does that mean there’s never a chance of being debt free? Well, for a country, no. For an individual, sure, there are ways you can become debt free, but on average, the majority of people will never truly be debt free, unless you are willing to give up the idea of progress and arrive at a point in your life where you’re satisfied with what you have. From experience, I can tell you that the basic human quest for progress is the biggest hindrance in arriving at that utopian destination called “the land of no debt”.

Back to the question.

So where does the central banks get the money to buy these treasury bonds? For the most part, it comes from simply “creating” that money, or as it would be called back in the day, “printing more cash”, to pay off the debts (by creating new debt).

Needless to say that this is a dangerous exercise, the most important aspect that needs to be understood by the masses is the obvious consequence of such an exercise. If you look closely, every time QE is implemented by central banks, they also talk about an “inflation target”. This is because inflation is a direct consequence of printing all that free cash that isn’t backed by anything of value (such as gold or silver).

If inflation runs amuck, that leads to a severe devaluation of the local currency in an economic episode called hyper inflation. It has happened at least 17 times in the last 100 years and when it happens, the proverbial truly hits the fan in a matter of hours.

However, we have nothing to worry about (wink wink), because our beloved central bankers are doing a stellar job keeping inflation at below 2% (in most countries).

In New Zealand for instance, current inflation is at 1.5%. In Australia, its at 1.7%. Europe has committed to keeping it below 2% and the story is identical across other similar economies.

That seems pretty manageable… right? I mean, we should all be happy with 1.5-2% increase in prices over time in order to fund our current standard of living… except, when you compare this “inflation” rate with another important, but never talked about indicator, called the “purchasing power”.

Take a look at this inflation calculation from the Reserve Bank of New Zealand’s website.

RBNZ Inflation Calculator

A basket of goods and services that cost $1.00 in the second quarter of 2015 would have cost $1.07 in the second quarter of 2020. Not too bad. But look closer and you will soon realise that even an inflation of 1.4% does not come up to an increase of 7 cents on the dollar (7%). So where’s my money? What happened to my dollar?

The answer lies in the decline in purchasing power of 6.5% for this period. Now this is what they don’t talk about and unless you’re a numbers nerd like me, you’ll never ever discover this for yourself.

So while they have been printing money, buying back government treasury bonds and other assets to pump more “liquidity” into the market, and doing so whilst valiantly keeping inflation down to below 2%, what we don’t realise is that our purchasing power is eroding exponentially faster than we can compensate it with a relative increase in income.

A graphical representation of how the Reserve Bank of New Zealand illustrates the operation of its QE programs.

So inflation is below 2%, but purchasing power is declining at at least 3-4 times that while income isn’t increasing even to match inflation. Do you see how it is an impossible scenario unless you understand how to use these numbers to get ahead of the curve?

Almost all developed countries have some form of QE in place. New Zealand calls is the LTAP (Long Term Asset Purchase) Program. UK calls it the APF (Asset Purchase Facility), the ECB has a handy term for it too called the Pandemic Emergency Purchase Program or PEPP – essentially, they all mean the same.

Print money, buy bonds, push money into the market and control inflation with the hope that the people never find out what’s really going on.

You know the biggest problem in all this? The academics and so called experts that are quoted in the media are in favour of this madness. Yet none of them raise this question about the disparity between inflation and purchasing power. What’s the point keeping inflation down to below 2% if I’m going to spend $6.50 to “acquire” something that should only cost me $1.

So last week RBNZ announced its glittering Funding For Lending program, whereby the RBNZ will provide loan facilities for banks so they can lend that money out to the people.

RBA in Australia has had that program in place for some time and so does the UK and ECB.

However, what started with a question about buying back bonds, now becomes an even bigger dilemma. Where’s the money coming from to “lend” to banks?

Not only are you printing more money to buy back your own product (not really but when you consider that central bank is buying the country’s treasury bond, it kinda feels like the fish and chip shop buying back its own snapper and hoki because no one else is willing to), you are now also going to print more money so you can lend it to your lenders?

What happens when the lenders don’t lend that money out? Sure, the central bank is removing the stops (LVR requirements and Responsible Lending Rules etc.), but without a specific dispersal mandate, banks still have the final say on whether or not they will lend that money out to consumers or simply use it to grow their own capital investments.

Central banks, do have the “power” to enforce how banks operate, however, the decision to lend will still sit with the banks – so the true impact of all these policies is yet to be fully seen in practice.

Banks are (by nature) disingenuous

You don’t have to be a rocket scientist to understand that banks are crooks. Some of them bankers are so crooked that they can’t even lie straight in bed.

Given the way lending works and the absolute cover of “responsible lending” bullshit funneled down from the central banks to the lenders, they never tell you their exact assessment criterion when processing a lending application.

If they told you, you’d be too smart and almost always get the funding because you’ll know exactly what they need and you’ll be able to challenge their decisions if they decline your application.

So what do they need? Among a plethora or ratios and percentages, the one thing they will want to see is your serviceability. You know that. But that is not calculated on the basis of the interest rate you’d qualify for.

For instance, if the top shelf interest rate offered by a competitive bank is 3%, your serviceability won’t be judged on 3%. It will be judged on 3%+an adjustment/buffer rate (usually between 2-3% above the retail mortgage rate you’re applying for) to see if you can meet their serviceability criterion.

As a rule of thumb, you should calculate serviceability on the following basis.

Official Cash Rate + 2.5% + 3% = Serviceability Assessment Rate (SAR).

In New Zealand that would be something like this:
0.25% + 2.5% + 3% = 5.75%.

So even if you’re applying for a loan at 2.55%, which is a 12 month fixed rate advertised by many banks, or 1.99% (latest announcement by Heartland Bank), you’re serviceability might still be assessed at 5.75%.
The only exception in this rule is the non-bank lending space because they are not subjected to the same standards as a tier 1 bank and have discretion in how the serviceability is assessed.
Things you should be asking your bank

If you’re a business owner, you must have a firm conversation with your bank to see what they are willing to do to extend some of the Funding for Lending program money (in NZ) or the Term Funding Facility (TFF in AU) money or the Term Funding Scheme with additional incentives for SMEs (TFSME in the UK) money to you.

If you never ask, you will never get it. 

If you’re a salaried individual and looking to get onto the property ladder as a first time buyer or looking to expand your portfolio as a seasoned investor, you have to push back on the banks and drive a hard bargain with them.

Don’t be afraid of borrowing in the current environment. There is money flowing from the tap. If you have the will and ability to put that money to good use, either through building a portfolio of cashflow rental properties or by using it to capture dividends from the Real Estate Investment Trust market, then you’ve got to assess the viability of such an opportunity with objectivity and without fear.

Most importantly, time is of the essence. You can’t sit on this knowledge forever and hope to gain something from it. The time to act is now. Call your bank, find out what you can borrow.

Lastly, you also need to take the time to educate yourself about ways you can make the most of whatever cash you can spare to invest in the market. Not just the property market, but other markets.

And if you’re in a position to get onto the property ladder, and are cashflow positive, then you’ve got to consider how you can get into 15-20 high rental income properties in the next 7 years or less – how? Well, firstly, using the free-flowing tap that’s been turned on by central banks. But the rest, is explained in this webinar.

As always, my final question to you as I end this rant:

How far are you into building your ark? It’s going to start raining soon.

No money down real estate

15-20 Properties in 7 Years or Less



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