• 2 hours Tech Billionaire Takes Aim At Google
  • 4 hours Chinese Police Bust Largest Ever Illicit Crypto Mining Operation
  • 7 hours Expect A Pullback Before Gold's Next Major Rally
  • 9 hours Why Interest On Gold Matters
  • 1 day Ten Extravagant Food Items For The Wealthy Only
  • 1 day Why Saudi Arabia Won't Give Up On The Aramco IPO
  • 2 days $32 Million Crypto Heist Halts Tokyo Exchange
  • 2 days Is A Gold Selloff Looming?
  • 3 days Central Banks Are Stashing Gold And Dumping Treasuries
  • 3 days Three Cannabis Trends Flying Under Investors’ Radars
  • 4 days $1.3 Billion In Cocaine Found On JPMorgan Vessel
  • 4 days Amazon Teams Up With Lady Gaga To Win Over Generation Z
  • 4 days Dollar Falls As Powell Teases Rate Cuts
  • 4 days Will The World's First Trillion Dollar Company Ever Bounce Back?
  • 5 days Many Americans Will Never Stop Working
  • 5 days Mozilla vs DarkMatter: The Cyber Espionage End Game
  • 5 days Chile Cracks Down On Environmental Infractions
  • 5 days Warning Signs Emerge For Boeing
  • 6 days First Amendment Stands Strong In Trump vs. Twitter Showdown
  • 6 days Musk Bullish On Tesla Despite Executive Exodus
Billionaires Are Pushing Art To New Limits

Billionaires Are Pushing Art To New Limits

Welcome to Art Basel: The…

Market Sentiment At Its Lowest In 10 Months

Market Sentiment At Its Lowest In 10 Months

Stocks sold off last week…

  1. Home
  2. Markets
  3. Other

Negative Rates Attempt To Inflate Away Government Debt

Negative Interest Rates Unpopular

Confused guy cartoon

With the European Central Bank (ECB) getting ready to take center stage Thursday, the concept of negative interest rates has many investors scratching their heads from an economic benefit perspective. From The Wall Street Journal:

Banks and insurers don't like it, borrowers are seeing little or no benefit from it and savers and pensioners fear their money is being eaten away by it: The policy of negative interest rates is as unpopular as it is mysterious. The European Central Bank looks likely to cut rates further into negative territory this week and yet no-one really knows exactly how it is supposed to help.

In this article, we will explore the following question:

Why are governments considering negative interest rates, given the many negative ramifications?


An Extreme Example To Illustrate Concepts

Looking at simplified and extreme examples can help us understand economic concepts. Assume I borrow $30,000 from you interest free to buy a car. The terms of the loan are for repayment to be made in a lump sum five years from the date of the loan. I borrow $30,000 and pay $30,000 back five years later.

Cost of Borrowing

If prices for cars remain constant over the five-year period, I end up paying you back for the value of one car. However, if car prices drop by 50% over the five-year period, what was previously a $30,000 car will now retail for $15,000. Therefore, as a borrower, I will have to repay the value of two cars instead of the value of one car. Said another way, deflation makes my debt burden increase in purchasing power terms.


Debt Needs To Be Inflated Away

The same concepts of "purchasing power burden" apply to government debt, or any debt for that matter. Deflation is a nightmare for those carrying a lot of debt. From The Wall Street Journal:

Inflation is a vital part of the effort to reduce the heavy burden of debt in European economies. This applies most obviously to the strained government finances of southern Europe, which are vulnerable to another downturn, but also relatively high private-sector borrowing in countries including France, Belgium and the Netherlands... Low inflation, particularly if it proves persistent, means that debt burdens aren't being eroded as borrowers might have expected. That can force them to devote greater resources to deleveraging, hampering growth.


Consumer Debt Also Worrisome

Consumer debt - credit cards

U.S. consumers have been consuming, but with the assistance of plastic. From The Street:

Consumers have been racking up credit card debt at a pace not seen since the period leading up to the 2008 credit market collapse. And that has experts worried. "This is a huge red flag," said Odysseas Papadimitriou, chief executive of CardHub, a credit card comparison and personal finance company. Americans appear to be spending like it's 2007 as they charged up $70.9 billion in new debt on their credit cards in 2015, according to CardHub's 2015 Credit Card Debt Study, released this week. The lion's share came in the fourth quarter, when consumers charged up $52.4 billion in new debt.

 

Back to homepage

Leave a comment

Leave a comment