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I saw a comment on LinkedIn which stated that interest rates should be about equal to AEG% p.a - the rate at which Average Earnings / Incomes are growing.
Here is what I wrote in reply: -
Connel - I used to say that the most neutral interest rate would be one that is equal to AEG% p.a. - the rate at which average earnings were growing, and without taxation of course.
But this would allow people to borrow and invest in property whose value would be propelled by AEG% p.a. plus rentals on top. For one example.
Anything less than AEG% interest would mean that a person could borrow three years' average income and only need to pay back two and a bit years' income, or less, depending on the actual marginal difference, or negative true interest rate.
True interest is not real interest. It is the margin above AEG% p.a. and which rate of growth carries with it the real rate of economic growth, or similar. True interest rate is added on top, and normally averages around 3% for Housing Finance in the UK.
These interesting facts give rise to a new perception of the meaning of wealth - stored income. If interest rates are below AEG% and this means that you repay less income than you borrowed then you take spendable income away from another person or entity. The saved income hangs around. It is wealth. It transfers from lender to borrower.
You can find illustrations of this on my Blogs. I have a new Blog about ILS 'Dream' Mortgages which is going to be the world's first safe-to-borrow mortgage model, as clearly explained on my website, dream mortgages -
This AEG% p.a. interest (zero true interest) is not enough to discourage borrowing and it would lead to a shortage of funds to lend, or to inflation until the interest rate rose to balance supply with demand. Pre-crisis the USA Mortgages were sold at -1% true which was 4% below par. This gave rise to swollen mortgages that were going to cost something like eight years' income to repay by the time that the 3% mid-cycle true interest rate was restored.
If you read Adam Smith's Wealth of Nations you will find that an economy, to grow fast, has to balance the supply with the demand using the pricing mechanism, which in this case is partly the interest rate and partly the entry cost for a new mortgage or loan.
As I wrote earlier, based on data that I have obtained for the UK this appears to require interest rates to be around 3% more than AEG% p.a. Hence the need for the Fed to raise rates by 4% and a bit to get above average.
A slightly higher rate of return is earned from property and equities, but not much higher.
These facts give rise to Siegel's constant, an under-pinning to that rate of return which I am not sure that the academics are aware of yet. Siegel's constant is the long term rate of return from USA Equities of 6.6% p.a. in real terms or around 3.6% p.a. true return. If it were less, people could lend for Housing Finance and do better.
I might publish a paper explaining all this on my websites.
A page on Siegel's constant and expected real economic growth:
Finding the Mid-Cycle Rate of Interest - a page on this Blog -