The Bank of Canada raised its interest rate for the second time in less than two months. Financial institutions of all types will increase their rates to their customers – you and me – before the sun rises tomorrow morning.
Why does this move by the bank signal trouble?
Consider this: In British Columbia, real estate prices have been rising at a much faster pace than income. This increases the level of debt compared to income. This has created an illusion of affordability.
People have used the low interest rates to buy bigger, better, and newer homes than they could have qualified for at a higher interest rate. Looking forward, we will see that as interest rates go up, people who may have qualified for mortgages at the lower rates, no longer qualify for the same amount of money. This slows the economy. The number and amounts of transactions begin to dwindle, which also interferes with the earnings of all participants down the line – realtors, inspectors, lawyers, moving companies, utility companies, perhaps even furniture stores, and the list goes on.
Warnings of trouble don’t end with the exponential increase in real estate prices. Shopping with credit has also escalated over time.
For example, people who are on the edge of financial trouble may begin to default on contractual (requiring regular payments) debt, which include mortgage payments, taxes, utilities, car payments, credit cards, etc. This financial pressure causes small and increasin
gly more defaults leading to financial failures. These are followed by other restrictions such as borrowing from more costly lenders with only hopes that things will improve and/or spending in hopes of weathering the collapse.
At that point, there are two major movements. Those most seriously restricted are forced to stop participating in the economy in hopes that all wealth can be salvaged so long as the debtor continues earn or receive a relatively stable income .
The other path is for merchants of all sorts who now realize their revenues are reduced. These ‘slowing’ symptoms cause lay-offs of employees, delays in paying suppliers, and a lack of capacity to cover fixed costs. Only the wealthiest will survive and flourish as they attain more wealth as prices drop. When the sun rises again, the already rich will be richer, the poor will be poorer, and the cycle continues.
The Bank of Canada uses this tactic of raising interest rates to force businesses and individuals to slow (or stop altogether) borrowing money. This slows the money coming into circulation, and at the other end, it continues taking money out of circulation as the continual interest on the money already in circulation decreases as interest is being paid to the lender.
The aftermath of all this results in a transfer of wealth, and one could also say ‘assets’ from those who can least afford it to those who already have more than they will ever need or use. Meanwhile, the ranks of the homeless grow larger, seniors on fixed incomes and those living on the lowest of incomes are forced to make tougher decisions as prices inevitably rise due to merchants attempting to compensate for the dwindling revenues.
The term they use to encapsulate the entire process is ‘recession’ and it is presented to the public as a method of stabilizing the economy, followed by the economists’ pat on the back while saying they “did what they had to do given the seriousness of the situation”.
To say the solution is to pay as you go or to avoid using credit has never worked in the past and won’t work now. When economists refer to people having confidence in the economy, they really mean that people are willing to borrow money to spend. This may be through loans, credit cards, lines of credit, and other financial schemes. The fact is that ALL money comes into existence as debt. Once in circulation, it transfers from one to another and may appear to be debt-free to those who have an abundance of it, but it means that others simply cannot repay their obligations. That’s how the system really works, and there is no fixing this system. Sooner or later, it must be abolished and replaced by a debt-free system created and distributed without encumbrances against it.