Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
The Price of Time - Outside View by Nitin Gregory
  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

The Price of Time
Feb 23, 2016

Would you ever pay your banker to store your savings? The scenario is almost unthinkable. The old-world view of a banker is a man who will take your savings and deploy them where they can get a decent return.

Recently, the central banks of Japan, Sweden, and Denmark have taken their rates negative. While the effect may not have hit retail consumers yet (bank profits will be hit), this is a watershed moment in history.

Interest rates and you

When the world was a simpler place, the joke was that bankers lived by the rule of '3-6-3': Take money at 3%, lend it at 6%, and go home at 3pm.

The numbers have changed, and so have the investment options. Surplus liquidity has many more avenues today. Stocks, bonds, and real estate remain the primary investment areas. But the risk profile has changed dramatically. We have mutual funds, PE funds, venture capital, debt funds, etc.

Banks deposits are now one many possible investment options for surplus liquidity. A bank provides a slightly better risk profile, ease of access, and safety for your deposits. This means that most households will opt for a portion of their savings to sit in banks. But if that portion suddenly started to dwindle every year, they may opt for another option.

The Austrian economists define interest rates as the minimum reward required for postponing consumption. Would you be prepared to forego the reward and even pay a penalty instead?

Interest rates and the economy

Economic theory suggests that interest rates have an inverse relationship to GDP. Lower interest rates should spur investment. That's because more businesses can generate returns in excess of the lending rate.

During the great crash of 2008, central banks - most notably the US Federal Reserve - reduced interest rates to provide an 'accommodative' environment for businesses and consumers. Interest rates in the developed world have been low (close to zero) for an unprecedented amount to time. Yet, this zero interest rate policy (ZIRP) has not produced tangible results. What do the banks expect to achieve with negative rates?

Interest rates also have a correlation with currency. A high interest rate correlates to a strong currency. High interest rates create demand for your currency, causing capital to flow into your economy (assuming your country has low political and regulatory risks).

Lower interest rates typically put downward pressure on your currency. A weaker currency is like a trade policy to boost exports. Weakening your currency indicates that you want to boost investment in export-related industries. We have seen China and Japan use this growth model. They have kept their currency undervalued to create large trade surpluses compared to their trading partners.

But in today's demand-deficient scenario, this can be a tough sell.

A weak currency is like an implicit import tariff. Imports become costlier for foreign countries but provide a shot in the arm for exports. Import demand from other countries is how many developing countries generate growth and employment. However, these policies can create imbalances for the trade partners. The debt-fuelled consumption in the US and Europe is a great example.

Financial repression

Financial repression is policies that cause savers to earn returns below the rate of inflation. A key feature of financial repression is the transfer of wealth from savers (primarily households) to borrowers (primarily corporates).

Keeping interest rates fixed below the growth of productivity (the real GDP growth rate for simplicity) is a common policy that results in financial repression. Such a policy essentially subsidises the corporate. In his book, The Great Rebalancing, Michael Pettis terms this a massive transfer of funds from the household sector to the state and corporates. These funds are then reinvested either in unproductive investments (asset bubbles) or exported abroad (debt-financed consumption of trading partners).

Bringing it together

There are two key considerations for today's investor trying to navigate this strange environment. First, are your savings fetching an acceptable return? Remember, savings are nothing but delayed consumption. If your money is growing at a rate lower than inflation, you are necessarily destroying your future consumption power.

Second, while it is difficult to predict future trade policies and political outcomes, we can be sure that this will be a difficult period for international trade in general (weak exports). The consumption engines of the world are saddled with debt and are looking to set up trade barriers. Meanwhile, the export engines of the world are looking at unconventional measures (currency wars).

An investor looking at companies with significant export exposure must acknowledge the heightened risk to those revenue streams.

This column is authored by Nitin Gregory. Nitin, who graduated from IIM-Calcutta, is currently pursuing a finance role with an automotive major. He has a deep interest in Macroeconomics and pens a blog at Gregonomics.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "The Price of Time". Click here!


More Views on News

What They Forgot to Tell You About Sensex at One Lakh (Smart Contrarian)

Nov 29, 2017

Stocks that could beat Sensex returns in the long term.

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

The Technological Marvel That is Ethereum (Outside View)

Feb 23, 2018

Have you been wondering what the hoopla about Ethereum is? It commands the second highest value among virtual currencies and its popularity is rivalled only by bitcoin. Let's break it down.

A New Quest for the Stock Market's MOST Profitable Ideas... (Smart Contrarian)

Feb 23, 2018

If you want to receive the best ideas in the Indian stick markets...you need to heed this important announcement.

Ramesh Damani is Bullish on Niche IT Stocks and I've Found One for You (The 5 Minute Wrapup)

Feb 23, 2018

This IT Company can be a huge wealth Creator for Smart Money Secret's Subscribers.

More Views on News

Most Popular

The Foundation for Sensex 100,000 is Laid(The 5 Minute Wrapup)

Feb 17, 2018

Top three reasons for Tanushree's presentation at Equitymaster Conference to be centered around a possible 30% correction.

India's Rs 1,66,276 Crore Problem(Vivek Kaul's Diary)

Feb 15, 2018

That's the loss, the government owned public sector enterprises are expected to make this year.

The Big Gamble(The Honest Truth)

Feb 15, 2018

Once you accept the fact that elections are round the corner and that this budget is geared to reach a 40% target, everything makes sense.

How I Beat the Index by 2x... And Why I Believe This Could Happen Again(Smart Contrarian)

Feb 12, 2018

Will Microcap Millionaires be able to replicate its past performance of beating the index by 2x?

NPAs Set to Rise Further with New RBI Rules(Chart Of The Day)

Feb 15, 2018

The RBI overhauls bad loan framework. Banks may come under additional pressure due to rising NPAs and increased provisioning.


Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms


Feb 23, 2018 (Close)