27 March 2007

Good for you - suicidal for banks

Apparently Nationwide are starting to offer mortgage deals whereby you can lock into a fixed rate for 25 years. So you could be paying 5.5% until 2030 and beyond.

Unless they have found some foolproof way to hedge the risk, this strikes me as insane.

If current trends (money supply growth, commodities getting scarce, Asian expansion) continue, I can easily see inflation above 10 per cent by the end of the decade. And interest rates have to keep pace with inflation.

Of course, some people are saying inflation is already at 10 per cent, and that the official figures are misleading. The problem is, when you average two very different values the result is sensitive to your method of averaging. And we have two effects at the moment in different directions:
1) cost of Western labour has been going up (school fees, medical fees, taxi fares, etc.)
2) cost of Eastern-produced goods has been going down (TVs, pots, computers, socks, toys, mobiles, shirts, etc. etc. etc.)

Thought for the day: what happens if the West wakes up one morning and finds China has decided to revalue the renminbi by (say) 8 per cent? What is the impact on the prices of imported goods? And hence on inflation? An overnight hike?


Bill said...

I'm sure the real inflation rate is a lot higher than the official figures would have us believe. However the Chinese are not likely to allow the renmimbi to float any time soom and see its value rise dramatically against the dollar - they hold a great deal of dollar debt and would see their investment drop overnight; they also need the west (and the US in particular) to keep buying to keep their economy growing and the lid on political dissent there. Many in the US criticise the Chinese for keeping their currency artificially low, blaming all of the US's problems on this; possibly it's a contributory factor, but I think the main problem is that the US has for many years been comsuming much more in imports than the country generates in foreign revenue and that your average US citizen is very heavily borrowed. The crash, if and when (unfortunately I fear it is when, not if) it comes will have lot more to do with the underlying fragility of the US economy in recent years than with anything the Chinese might do - they have as much to lose from a US/Western crash as anyone else.

As for the Nationwide one imagines they have hedged their risk.

Fabian Tassano said...

"The Chinese are not likely to allow the renminbi to float any time soon and see its value rise dramatically against the dollar."

They may not want to, but how long can a country buck the fundamentals? We tried and failed back in 90-92.

"As for the Nationwide one imagines they have hedged their risk."

My point was, is this really feasible? Unless they have permanent short positions on 30-year gilts to the full value of those mortgages, which I don't see them doing, how can they completely insure themselves against upward spikes in rates?

Bill said...

We tried and failed back in 90-92.

Yes, but we didn't have the ginormous foreign currency reserves the Chinese do; the Americans need the Chinese at least as much as the Chinese need the Americans (economically speaking) and whatever the political rhetoric coming out of the US they caanot afford to push the holders of all those T-Bills too far. Moves by some of the Asian major holders of US debt to diversify into Euros for a proportion of their FEX holdings are already having an effect I think.

You are probably correct about the inherent risks in the Nationwide strategy; my guess is that they are betting that the UK will eventually join the Euro, which would likely change UK interest rate structures fundamentally; the fixed rate they have used might then come to seem pretty expensive for borrowers. I don't think UK mortgage borrowers are attuned to long-term fixed rates so I would imagine that the take-up will not be huge, at least in the early period.