Burrrr! Do things seem a bit chilly? Well, there’s good reason. Interest rates are not typically an exciting topic of conversation; however, today it’s worth mentioning that rates are at an unprecedented level. We have interest rates in negative territory, which means you do not pay interest when you borrow but get paid to borrow. It is kind of like getting cash back for buying a car.
If you hold financial assets, then you are getting squeezed because you are paying someone to hold your money. You are accepting devaluation of part of the overall return. Economists like to point out that interest rates are really the sum of one variable known as the “real rate” plus another variable “the inflationary expectation rate.”
These two variables theoretically add up to what is known as the “nominal interest rate.” Real rates often go negative especially at the beginning of an economic recovery. However, we are now getting nominal interest rates in the negatives – which is very strange and potentially dangerous.
When nominal rates go negative, the real rate is even lower assuming we have inflation around 2% or there about. With such low rates, you would expect there to be a lot of growth and investment in the global economy. Surely, borrowed money where you get paid to borrow has some productive uses where you can generate positive returns.
The fact that we do not see strong global growth amidst this interest rate backdrop is a sign that business and consumer confidence is lacking. Let’s hope the U.S. can avoid the deflationary debt trap that has afflicted Japan for the last 25 years, and that negative rates do not find a long-term home in our treasury yield curve.
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