When real interest rates is below zero, why save money in bank?

February 15th, 2009

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In “What will happen if RBA cuts to zero?,” we described the situation whereby interest rates in many countries are moving towards zero i.e. Zero Interest Rate Policy (ZIRP). In Australia, the interest rates are currently at 3.25%. There are talk in the financial market that more cuts are on the way.

Price inflation, on the other hand, is 3.7% for the year to December 2008- that is, according to the official CPI figures. As late as October last year, the official price inflation was running at 5%. But as we wrote in “What is your personal price inflation rate?,”

Inflation is also running high in the rest of the Western world. Worse still, many of the official measurements of inflation run counter to personal experiences.

As we quoted Ludwig von Mises in How much can we trust the price indices (e.g. CPI)?,

If she [a judicious housewife] ?measures? the changes for her personal appreciation by taking the prices of only two or three commodities as a yardstick, she is no less ?scientific? and no more arbitrary than the sophisticated mathematicians in choosing their methods for the manipulation of the data of the market.

Talking to some people from the US, we learnt that despite having an official falling inflation rate (based on CPI), people feel that things are still very expensive.

In other words, if we disregard the doctored statistics of the official figures, real interest rates are negative!

In Australia, interests from savings are taxed. This means that after tax, putting money in the bank is a losing proposition. If excessive debt is the cause of the global financial crisis (GFC), then this means that the solution is to slim down, cut down on debt and start saving. But if savers are punished with negative real interest rates, then the very poison (that caused the crisis in the first place) is used as the medicine. If a doctor do this, then he/she will be charged with criminal negligence. Yet, with interest rates in Australia projecting to fall further, the econocrats are doing this!

For foreigners, the solution is very simple- just pull your capital out of Australia. After all, who on earth will want to lend money below the rate of price inflation? If the government is really concerned about the foreign banks pulling out of Australia (and further tightening the local credit market), then wouldn’t falling interest rates worsen the situation? It has come to the point that even our local banks are murmuring about further cutting their lending rates to match RBA’s projected rate cuts. If the banks are politically pressured to cut their mortgage rate, then they will have to: (1) draw blood from elsewhere- see Canberra is destroying jobs or (2) ration capital.

For the hard-working Aussie savers, what are their options? We will look more into it in the next article. Keep in tune!

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