Tuesday, April 5, 2011

Why Interest Rates Are Going To Stay Low!

The panic is on. China is raising rates. Portugal is paying 8% on their bonds. Ergo, rates must rise in Canada. Ain’t going to happen.

The economic recovery in Canada and particularly in the USA is very fragile. It would not take much to put these economies back into recession. We have democratically elected governments. Inflicting economic pain on the voting population is not a wise idea. Especially when the USA is gearing up for Presidential elections in 2012 and Canadians are in the middle of an election that is likely to produce another minority government. This makes significantly higher rates very unlikely.

The USA has a massive debt. Canada has debt but Canada is far closer to balancing its budget than the USA is. As goes interest rates in the USA, Canada follows. The USA is Canada’s largest trading partner. Canadian’s can not allow their currency to become uncompetitive with the USA dollar. Canada can not buck interest rate trends in the USA.

It would be financial suicide for the USA to raise their interest rates and thus the amount of money that they pay. Large powerful sovereign governments (e.g. USA, China, Germany) get to decide how much money they are going to pay in interest. Why, would they increase their interest bill, especially the USA?

The USA will only raise rates, as a very last resort, and only if they face a flight of capital out of the country. This may happen in the USA. Not today but perhaps in 2 years if they don’t get their financial house in order. My prediction is interest rates are not going to rise appreciably over the next 2 years.

So, what does this mean to purchasers of real estate? Stay variable for now. You will save a ton of money. Keep your eye on the budget discussion in the USA (and Canada). If the Republicans (read Tea Party) make significant headway on reducing spending and putting the prospect of a balanced USA budget as a near certainty, then interest rates will continue to stay low. If they don’t do this, then the USA will face a loss of confidence and I would not have debt for all of the tea in China.