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Rising rates are transferring wealth to older people

This is an edited transcript of a webinar hosted by Schroders. Part I features Natalie Morcos, Head of Product, Solutions, and Client Service, with Martin Conlon, Head of Australian Equities. We’ll have Part II next week.

Natalie Morcos: Martin, I'd like to really just start off by setting the scene. We're at a multi-decade turning point in inflation. We've seen the sharpest rise in interest rates. And this reporting season has been touted as being one of the most interesting. What can you share with us and how are you responding to this current season?

Martin Conlon: Thanks Nat. Well, I'd start by saying that turning point issue you raise is potentially, in our eyes, one of the most interesting. And the reason I say that is that bond markets have changed pricing pretty aggressively over the last year or two. And you can now get 4% yields on treasury bonds in the U.S. and 10-year government bonds in Australia. Interestingly, that is … signifying a fairly different outlook on the future.

You contrast that with equity markets and the way we'd really characterize things is that it's a lot about more of the same. Everything that's worked for the last 10 years, people are still implementing those same strategies and same behaviors. That sets the scene, if you like, for a pretty sharp divergence in the views of those two markets. And a cynic would suggest it's unlikely both of them are going to be right.

… Since the start of the year, obviously things like artificial intelligence have infatuated people and provided another leg again to that tech dominance. That really, again, is re-emphasizing that more of the same type of argument where people are used to the success of these stocks, they keep on implementing those behaviors. I'd argue it's a little bit the same as real estate in Australia. People are so used to being on a good thing that they're really not giving up on those things lightly.

Morcos: We'll come back to that point a little later on because I've got some questions on that for you, Martin. But this concept of bifurcation and wealth inequality is a concept that you first raised during COVID. You touched on it in your most recent commentary. It seems to be a theme that you touch on quite often. Can you give us some insights into what you actually mean by that and what you're seeing in this reporting season in particular?

Conlon: Sure, Nat. I'll use this slide from CBA because I think it really encapsulated a lot of those underlying issues that the economies are facing.

It's not just the Australian economy, but the point you raised on bifurcation and what's happening with interest rates, the economy that we're facing today is arguably very different than times gone past. The reason I say that is, again, on this slide, that 10, 20 years of declining interest rates and booming asset prices have had a lot of impact on the economy in terms of wealth transfer. You can see on this slide that the home loan balances are owned by young people; the deposits are owned by old people.

So, what happens? When you put interest rates up, effectively what you're doing is transferring wealth from the young to the old. That's what interest rates do. People often forget that actually they don't create growth, they don't do anything, any of that stuff. What they do is transfer wealth within the economy. And with all the assets having been transferred to the old, to then put interest rates up and say to the youth of the economy that again, you've got to transfer more of your wealth to the elderly is really in our eyes increasing the tension. That increase in tension and income inequality and wealth inequality around the world is a massive issue, and we think it will be a big one for the next 10 years.

You're seeing it again on the right with the change in spending over recent months. What's happened? The younger cohorts have retraced their spending very significantly. At the older end, they're feeling better than ever. Actually, their spending is stable to increasing. So, that issue and the underlying impact of interest rates, I think is one that we've got to be very careful with. Also, it's why we really side with the RBA and say you've got to be careful how hard you push interest rates in this context because the economy you're facing is different, the impacts are pretty severe, and we're really only just starting to see the impacts of those interest rate rises now given fixed rate loans, et cetera.

Morcos: And beyond the housing sector, what else, what other patterns are you seeing in terms of consumer spending and the impact that these rising interest rates and inflation has had on consumer spending?

Conlon: Again, the obvious ones are nearly all results you saw those demographics coming through in the spending. So, depending on which cohorts you're facing, there were tougher times for some, and a lot of others were relatively unimpacted. So, interestingly, things like hardware stayed pretty buoyant. Again, they're really appealing to homeowners. Some of the older demographics, not so much to the younger ones. Travel, again, incredibly strong given that that tends to be disproportionately the older part of the community.

The other thing we'd point out and one of the things we found interesting in results season was Coles raised the fact that theft is going up a lot in supermarkets. So, you've had huge amounts of investment in front office or the technologies that we all see in terms of automated checkouts at the supermarkets. That's uncovering a whole other list of problems in terms of needing to combat theft. But again, the other thing that we took out of it was that a lot of those demographics most impacted by interest rates are really doing it pretty tough. You only resort to theft when you really have to and that says something about what interest rates are doing and perhaps some of the hidden and underlying effects that interest rates are having that really suggests that even though the overall economy we suggest is still really healthy, unemployment super low, most of the indicators really good, this is not a weak economy, certain cohorts are really doing it tough.

Morcos: Now, Martin, you talked about valuations in some of the areas, particularly in the tech stock has been somewhat crazy. We often consider ourselves thoughtfully contrarian. Can you share with us, I guess, your current views and whether you think things will change in that field?

Conlon: I'd probably have to summarize it as saying very little has changed so far. As I said at the outset, one thing that's obvious is that tech is going on with it. The dominance of technology companies around the world, they're still putting price up, the enthusiasm around cloud, et cetera is still providing enormous revenue strength for most of those companies. And because investors are so used to momentum paying off, they are very reluctant to leave behind those behaviors.

So, we're still seeing a situation where if you've got a good story, people can get excited about the growth runway over long periods of time. They are very reluctant to care much about valuation at all. They will pay extremely high prices. You saw that with Altium and so on in results here. Conversely, where there's any semblance of bad news, and that was the case with WiseTech Global and Iress, the price has suffered a little bit from downgrading those expectations. So, severe and arguably overreaction to a lot of short-term news, as is often the case in stock markets, but still a lot of enthusiasm with those infectious long-term good news stories.

Morcos: With China's economic slowdown, it's easy to be bearish on China, but does that also mean we're bearish on resources?

Conlon: China, I honestly find a fascinating economic story at the moment, because you're totally right to say it's not difficult at all to find bad news in China. I've got a few charts up here which really highlight how perilous the situation is in some areas.

You can see there that land sales volumes, the key property indicators in China have in general been decimated. Consumer confidence given obviously the severity of COVID lockdowns and the lack of largess that the Chinese citizens saw from their government relative to what we saw in the West, and very high and arguably destabilizing levels of youth unemployment. It's easy to look at that Chinese picture and say this looks awful.

Underneath that though, we think that the long-term picture is probably a little bit more nuanced in that their starting point is they've got plenty of housing. So, yes, property prices are going down. What they don't have, unlike Australia, is a housing shortage. They can supply property for most of their citizens. They've also spent enormous amounts on developing infrastructure over recent decades. So, the quality of their underlying infrastructure, it's modern, it's good.

So, the starting point is that they're facing a challenge stimulating the consumer. It's really in stark contrast to Western economies where we are super-reliant on services and consumption to fuel our economy. China is very much in a situation where their economy probably has the basis of good housing for all good infrastructure. They are really struggling, particularly in the face of an ageing population, to get those consumers to spend and to take the economy to the next level in terms of services.

But if I stand back from it, it's not really that clear to me that if you were to pick one as a starting point, that starting in the west with very services intensive economies, lots of debt, and very little in the way of goods manufacture, and in Australia, housing shortages, high immigration, a lot of tensions developing, that that's necessarily a much better starting point than where China is, where they're struggling to stimulate that consumer.

That's not exactly the picture you get when you look at the data and it's easy to be bearish on China. But we would suggest that actually the reason de-globalization is happening is that most Western economies are way too services sensitive and they're also too dependent on debt. In China, you've got very much the reverse situation where they're struggling with an ageing and declining population and perversely, they're losing most of their high-net-worth citizens to other countries. I always find it somewhat ironic that in Australia, we're sitting there trying to sell the benefits of becoming a larger country with lots of population growth. You go to most countries with a lot of people, what do they want to do? Leave. It is always ironic to me that companies and government are always preaching high immigration and the reason they do it is because it's easy growth for them. What we really should be worried about is GDP per capita, standards of living, productivity gain, some of those things that were raised in the Intergenerational Report recently and really are the secret to our living standards, not just growing the size of an economy.

 

This is an edited transcript of a webinar hosted by Schroders, a sponsor of Firstlinks. Part I features Natalie Morcos, Head of Product, Solutions, and Client Service, with Martin Conlon, Head of Australian Equities.

For more articles and papers from Schroders, click here.

 

19 Comments
Goronwy Price
September 18, 2023

Raising interest rates does not transfer wealth from old to young as the writer argues. It does the opposite because it forces down the price of assets including property. The rich have assets so their wealth reduces. The time that wealth inequality rocketed was after the zero interest rates of the GFC which continued through Covid. That did save the economy and save the living standards of the poor by protecting jobs, but it led to a huge inflation in asset prices, which benefitted the old and rich over the young. Australia’s property prices have stayed high even with rising rates, but that is because of low supply compared to demand. Property prices are falling in Europe and US.

Dudley
September 18, 2023

"does the opposite because it forces down the price of assets including property": And low interest rates slows compounding savings.

Mr Brian Pretty
September 17, 2023

Surely there is an easy way out of the housing dilemma. We keep hearing about the poor mortgage holder suffering at higher interest rates but never a comment on the huge tax free gains made on the property purchased. Why not tax these tax free gains. If done at a high rate with all proceeds used for affordable housing, people would be much more inclined to treat property as a home rather than a quick way to riches. As so many say, you cannot compare the the huge sacrifices of the old to create wealth with the apparent belief of the young that they are entitled to everything now without any real effort. I personally remember a time when we had to suffer double digit interest charges. We survived so please will all these so called whinging experts wake up to life as it really is.

Hampton Mar
September 15, 2023

"When you put interest rates up, effectively what you're doing is transferring wealth from the young to the old."
TOUGH ! what a load of C***. Does that mean when interest rate is nearly Zero for the past 5-10 years, the old are transferring wealth to the younger generation ? I'm 86 and wealth is what you make of it . work and save. This intergenerational tension is BS. I start work at 15 and I enjoy spending my moeny. Its all part of a life cycle.

les
September 18, 2023

exactly !!

Trevor Stewart
September 15, 2023

“ It is always ironic to me that companies and government are always preaching high immigration and the reason they do it is because it's easy growth for them. What we really should be worried about is GDP per capita, standards of living, productivity gain, some of those things that were raised in the Intergenerational Report recently and really are the secret to our living standards, not just growing the size of an economy”

I couldn’t agree more.

Eric
September 15, 2023

I think it’s disturbing that the media and a number of commentators and so called experts seem to enjoy trying to hype up stories about the young having their wealth transferred to older people. Of course older people often have greater savings than young people. It’s the culmination of a lifetime’s work and saving for their retirement is exactly what governments have wanted people to do. Naturally, having ceased work and with a limited number of years left with good health and mobility, it’s common sense that older people are going to spend their savings. As for interest rates, savers have been through more than a decade of pitiful returns on their savings, well below the rate of inflation, and even now, with higher rates on offer for savers, the real rate of return, taking account of high inflation, is arguably worse. Please stop trying to set one generation off against the other. The current difficulties have been largely created by greed and corruption that led to the GFC and government and central bank incompetence (Australian and International) over a period of at least 20 years. This, compounded by Covid19 has led to a horribly complicated situation that demands much more than simplistic arguments that encourage cheap shots between young and older sections of our community.

B2
September 18, 2023

Likely reasons for this
1. media creating news
2. Innate jealousy
3. softening up the Boomers for more taxes in the name of fairness and equity.

spend more time preparing for no. 3 as it is the only one that matters.

Andy
September 15, 2023

Even more reason to significantly raise GST rate and on the other side lower tax on income derived through physical effort..

Trevor Stewart
September 15, 2023

Raising the rate of GST would make everything more expensive and devalue savings just like inflation. But preferable to some sort of universal land tax imo. At least with a consumption tax you have some degree of control. You can cut back on nonessential spending.

John
September 15, 2023

Us retirees paid our income tax (at up to 60%) saved our money, and now when we spend it (the whole reason we saved it in the first place) you want to raise the GST so we can be taxed yet again (on spending our after tax savings).

Yeah, that sounds fair (NOT)

Jan H
September 18, 2023

GST is a regressive tax, which means it hurts those on lower incomes (young and old) more than those on high incomes. That is why when Howard/Costello introduced the GST they had to compensate those on lower incomes but this was only a one-off payment. The GST is payable on services, e.g health, insurance, car rego etc, which are hard to avoid and are not "nonessential" expenses. Meanwhile, the wealthy don't worry about GST because it is a minimal tax compared to the price of the luxury goods they can afford to buy. GST is also refunded to business through the BAS system. No wonder the Business Council wants a rise in GST. It won't hurt them because they don't pay GST!

Will Wallis
September 15, 2023

What is the "neutral" rate of interest, that is fair to both savers and borrowers? I guess it may be in the range of 4 to 5 %, where savers are adequately rewarded, and borrowers pay for the advantage of having extra funds.

In the last decade, the Reserve Banks have gone way off course to implement an unreasonably low interest rate, stealing from savers to reward borrowers. This foolishness lasted for so long that some people regard this unreasonable transfer as "normal". It is not - if it became a permanent feature of the economy, most people would have minimal savings.

The very low interest rate has fueled excessive housing costs (and a few other bubbles). The solution is not to return to unreasonably low interest rates but to be patient as the bubble slowly deflates during a long period of neutral interest rates.

George B
September 15, 2023

What inflation environment have you assumed in your estimate of a "neutral" rate of interest that is "fair" to both savers and borrower - for example is an interest rate of 4 to 5 % "fair" compensation to savers when inflation is more than 4 to 5%?

Elaine McCartin
September 15, 2023


The age groups for 18 to 64 are in 9 yearly sections. The 65 year-olds who first access their Super would naturally have higher deposits and spending patterns. But what of the 74 to 83 year-olds and the 84 to 93 year-olds. What are their assets and incomes looking like? Which still leaves the 94 to 103 year-olds. It would be interesting to know whether inflation and medical costs change the outcome. I do believe that age pensions paid to people with millions of dollars tied up in personal exempt assets should be recovered from the sale of the assets when they pass on to beneficiaries.

Rhyno
September 14, 2023

Simple solution to all the tension. Older Australians spend all their wealth and let the young pay for their aged pensions through higher taxes. Also with lower savings, the banks will have to source increased funding from overseas at higher interest rates and charge higher home loan rates to meet costs.

Dudley
September 14, 2023

China Price = global deflating goods prices = no manufacturing work in more expensive labour economies = smaller inflation = minuscule interest rates = large price of homes and investments = young savings return negative real yields and priced out of homes and investments.

Larger interest rates good for young savers and reduces home and investment prices. Too larger and saving reduces spending and demand for labour reduces.

China Price.

William Jones
September 14, 2023

When the reverse was happening several years ago, there was not the same level of commentary on intergenerational "tension".

Seems that most commentators and writers have a short attention span, or are influenced by political spin.

John
September 14, 2023

While you may be correct in saying rising interest transfers wealth from younger to older in nominal terms (reported dollars) in real terms what we have seen recently is the opposite

Inflation has been higher than interest rates. A long term unsustainable situation. Therefore people with deposits may be getting higher interest but inflation has been eroding the value of their savings at a higher rate

Borrowers have been experiencing the opposite with real interest rates being negative

So what we have seen in recent history is a transfer of wealth to the borrower's on real terms

It's unsustainable because this situation will lead to those with savings spending their accumulated wealth. After all what will happen is that the price of goods in the future will be hard gher than the value of their savings plus interest earned so there is no motivation to postpone consumption

 

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