Post Covid Prices and Revenues - Revenues - Interest and Rent

Interest and Rent 

Interest 

I've already set out why interest rates are set to surge, as massively increased borrowing meets falling realised profits and savings, but what about the actual amount of interest? The rate of interest is the price of money-capital, whereas interest itself is a revenue to the owner of that money-capital.  If you put your money in a bank savings deposit, the matter is straightforward. A £1,000 deposit, with an interest rate of 1% gives you £10 of interest, whereas, if interest rates rise to 10%, it gives you £100. However, things are not so simple when it comes to the interest on bonds and shares. A £1,000 bond, for example, may have a £10 coupon. i.e. it pays you £10 of interest each year. If you bought the bond at par, i.e. for £1,000, that is a rate of interest/yield of 1%. Now, if interest rates rise, the amount of coupon you get from this bond remains £10. So, for example, if interest rates rise to 10%, and the government or companies issue £1,000 bonds, they would have to pay a £100 coupon on these bonds. The consequence is that all of these older bonds have to fall in value to just £100, in order for their £10 coupon to represent a 10% yield. That is what their owners would get for them if they sold them in the secondary markets. Its a bit like the moral depreciation on fixed capital. Given that the total mass of bonds already in existence far outweighs the mass of new bonds being issued, this is how a rise in interest rates causes a crash of bond prices. The owners of all these existing bonds do not get any additional interest, and the only way their rate of interest/yield rises is because the value of their bonds is itself slashed, inflicting a capital loss on them, if they sell those bonds prior to maturity. 

The same applies to shares. The equivalent of the coupon on a bond is the dividend on a share, except that the amount of dividends is not a fixed amount. In theory, the dividend should only be a market rate of interest, risk adjusted for the additional risk in owning shares as against risk free bonds, i.e. AAA rated government bonds. However, in practice, shareholders appoint company boards and executives, and these directors determine how much should be paid as dividends. As these directors are themselves usually shareholders and get additional shares through share options schemes, they have an incentive in paying out high levels of dividends in excess of this risk adjusted rate, and these higher dividends also act to boost share prices providing additional capital gains for shareholders. That is why dividends have risen from 10% of profits in the 1970's to 70% of profits today. 

However, there is a limit, especially when profits have been used to boost share prices in other ways, such as buying back shares so as to reduce their supply and inflate the earnings per share figure. Its for that reason that, as QE artificially boosted bond prices, and depressed yields, big companies issued bonds to get money to buy back shares and obtain cash to pay as dividends. But, as interest rates rise, and bond prices crash that option no longer exists, and as realised profits are squeezed by rising costs, including rising wages, the mass of profit available to pay as dividends falls. So, the amount of dividends is likely to fall, and as yields on equities also, thereby, fall that provides an incentive to sell shares and buy bonds. That means that share prices also fall, along with bond prices. Again, therefore, the amount of interest does not rise, and the only way the yields rise is by share prices falling. 

But, as the lockdown ends, those businesses still operating will need to expand, and the only way of financing that is by additional borrowing, whether from banks, bond issuance or share issuance. As well as Ford drawing down on its credit lines, many companies are proposing share issues. The additional supply of bonds and shares will again depress those prices, and with lower prices they have to issue a greater volume to obtain any given amount of capital. Unlike QE, used to inflate asset prices, the money-capital required cannot come from money printing. It would simply result in higher commodity price inflation requiring even greater amounts of borrowing. The additional money-capital could only come from additional saving, including a diversion of all of the saving from rents and interest that was previously spent on speculation in existing assets. However, in the conditions already described, where savings have been run down, it will require much higher interest rates on savings to attract these deposits. One source of that may be that many of those who speculated in property, particularly buy to let property, will sell up in favour of a guaranteed return on their money without the risks of being a landlord, especially as land and property prices fall. 

Rents 

Last year, a number of property funds became closed, as redemptions threatened to force them into a firesale of commercial property. The problems of the high street were already leading to falling commercial property prices and rents. Now, as a result of the lockdown, all property funds have closed their doors, essentially telling speculators in them that they cannot take their money out. If they allowed such redemptions, they would have to sell property to raise funds, and, in the current climate, that property would sell at knock down prices, provoking a property market crash.  Property developer Intu has already gone into administration.

House prices are already falling sharply.  According to Nationwide, UK house prices have fallen on an annual basis for the first time since 2012. In June they fell by 0.1% compared to a year earlier. They fell by a whopping 1.4% between May and June, but that is not as much as the 1.7% fall recorded in May compared to the previous month. As an average monthly fall of around 1.6% that is equal to a fall around 18% for a full year, if it continues in coming months.

But, rents themselves will come under pressure. One use of commercial property will be conversion to residential accommodation. That will increase supply acting to put downward pressure on rents. In Britain, Brexit is another factor, as the tens of thousands of EU workers go home, and their replacements no longer come. In addition, as buy to let landlords sell up, able to get guaranteed returns on savings, large amounts of property will come on to the market reducing property prices. Rising interest rates will also cause falling land and property prices, reducing the price of new houses, and enabling builders to build more of them profitably. So, millions of people, still in work, but currently forced into private renting, will be able to buy a house, reducing the demand for rental property, and, thereby, causing rents to fall.  Again, this will widen the divide between a, generally, better educated younger population, able to obtain the jobs that will grow, as against a poorly educated older population, concentrated in decaying towns, whose unskilled jobs will be in decline.

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