Home Loans

Part 2: Government Spending, Inflation and Interest Rates

16th Jul 2021 | Ben Pauley


In our previous blog, we spoke about global money printing, New Zealand’s printing, and the effect it has on house prices. We left the blog on the prospect that the average punter is spending more, and that you guessed it, this is what leads to inflation. Today we wanted to start with some background on what inflation is.

Inflation Explained

There is an old theory posited by a Polish mathematician in the 16th century referred to as the Quantity of Money Theory (QTMT). The premise being that as the quantity of money in an economy increases, so does the prices of goods (inflation). More money for the same amount of stuff equals higher prices. In that respect, the growth of the money supply itself is inflation, not the increase in prices. It is simple and easy to understand, something we like here at Lateral.

In the last 12 months, there has globally been an unprecedented (who else is sick of that word?!) level of money printing by the worlds reserve banks totaling USD$10 TRILLION.

The result of this has been a vast increase in money supply and therefore, an increase in the velocity of spending. You might wonder how this money from the government has found its way to your pocket or how it has affected inflation, and this is a fair question. There have been some direct payments in the form of an increase in beneficiary payments for each country, bailouts of businesses, stimulus checks and many other creative ways of getting money out. The primary result, however, has been the expansion of cheap and available credit, fuelling asset growth and a wealth effect for many.

This increase in money supply has found its way into all types of assets – property, gold, shares, artwork, wine, cryptocurrency and much more. Most of these are junk investments, they don’t produce real wealth (the creation of new stuff), but they have all seen huge increases in value over the last 12 months. This investment, as well as that in more productive asset classes, has seen a flow of capital into people’s pockets and the perceived balance sheet strength of the average punter increases. They feel richer and they spend more. Money flows.

What does this all mean?

Demand for goods increases. More people want Range Rovers, barista-made coffees, boats, date nights, helicopter rides, new clothes and everything in between. Only, the production and supply of these things have not increased. The costs of acquiring these goods has; coffee beans cost more, food costs increase, transport costs go up. When was the last time you bought a coffee? I would encourage you to cast your mind back 12 or 18 months to what the cost was then. I pay $5 each morning for a coffee and recall buying them for $4 not even 2 years ago. That is a 25% increase in prices!

Inflation is a real cost of living. It costs everyone more to do what they have always done. The issue is that the increase in costs does not correspond with an increase in real wealth, real production and a real increase in wages. Without those, everyone is worse off. Sure, you may have a home that is worth more, but so does everyone else. It is your income that is really important and in real terms, with high inflation, that will diminish.

Until next time….

Please read our Disclaimer Statement for more information.