Inflation September 2022 | Page 2 | General financial discussion | Discussion forum

Loonie said
I have lived over 75 years and was born in Canada. I have
NEVER been offered a free loan. The idea that borrowing is or has been free is so much BS.
The only things I have EVER borrowed for are a modest mortgage and post-secondary education.
My first professional job required a car; I rented a used one until I could afford to buy a used one outright, about 8 months in those days.

Car loans are a money pit. Most of the people I worked alongside in those early years always bought new cars and always had hefty car loans that they complained about incessantly. They thought my approach was at best curious, but my used rental cars cost about a third of their monthly car payments and my used car purchase would have only financed about four months of their car payments. I drove that car for several years until I could afford to buy a new used car outright, and so on until I finally bought a brand new car of my choosing for cash.

You can blame consumers if you want, but , to quote George W Bush, the advice from the top is "go shopping". The peculiar organization of our economy requires it as a kind of patriotic duty.  

If the bank charges you 1% while inflation is 2% then the bank is paying you to borrow. In real terms. So, you are right. It wasn’t free. It was better than that. That’s what they call “stimulative” rates when central banks “stimulate” borrowing and spending.

The argument that people are wrong to borrow and spend as a response to bank of Canada trying to get them to do just that isn’t very strong.

I take a less black & white view, i.e. if liquor is $1 litre thus triggering higher alcoholism rates I'd say the cause is partly the low price setter and partly the consumer, i.e. you can't ignore the fact that many people refrain from increasing their alcohol intake even if the price drops.

Long-term debt for individuals' discretionary consumption is generally not a good idea, that's obvious, true, but debt incurred to buy assets or investments that end up increasing in value by a greater amount than the costs of the debt is sweet. Especially, as is the case (examples) for some investments or when small businesses incur debt to grow into bigger ones, if the debt is also tax deductible. Or if you take out a mortgage in the 1960s for $20,000 on a cottage north of Toronto which your heirs end up getting when it's worth a few million, extremely sweet!

mordko said

If the bank charges you 1% while inflation is 2% then the bank is paying you to borrow. In real terms. So, you are right. It wasn’t free. It was better than that.

  

This is just economics hocus pocus. If you take on debt, you have to pay interest, period, and you will have to pay it at the prevailing rate regardless of whether inflation goes up or down. People are not borrowing because they already have capital that is depreciating; they are borrowing because they don't have the capital. There is no such thing as a loan at 1% and I doubt there ever has been, certainly not in my lifetime. And the guy who has no capital is not going to get a loan at the lowest rate anyway. If he can get a loan, he will pay at or above inflation. Think credit card debt and used car loans, which is where most discretionary overspending takes place by people who are short on capital. If the rate is lower, it's typically because purchase and loan are intertwined and the car is overpriced.
The fact remains there are no free loans. It's an illusion. Suggesting that there are just fuels the fire of overspending - and that is the current problem. We have a precarious economic system that depends on overspending. That will have to be recognized before anything will improve significantly. We are just spending ourselves into a hole.

Loonie said
The fact remains there are no free loans. It's an illusion.

I disagree. My brother managed a free loan before the 2008 crisis. They offered him a sub-prime rate which he astutely took and re-invested in some short-term GIC or bonds. When the rates rose and the loan was called, he sold his investments and re-paid the loan. It was literally free money. Sadly, I wasn't bright enough to repeat the same scheme.

Some people are confusing interest rates with returns on investment.

Borrowing is one thing; what you do with it after that is another. You might win (which you have interpreted as a negative interest rate); or you might lose, which will cost you even more.
The interest rate is the same in both cases, as your contract will indicate.

What is at issue right now is consumer spending. Borrowing on credit cards or lines of credit, whether frivolous or essential, is going to cost you.

mordko said
This article explains the basics quite well.

https://www.businessinsider.com/personal-finance/what-is-real-interest-rate  

The article is wrong.

The cost of a 5% loan is 5% per year. Lenders don't care about the real rate of a loan because they earn on the spread between the nominal rate of the loan and the nominal rate of the deposits that fund the loan.

Bank will make 2% on a 5% loan funded with 3% deposits, no matter what inflation does.

The real rate is not the difference in the nominal rates. Real rate of an investment paying 7% nominal with inflation of 3% is actually

(1+ 0.07) / (1 + 0.03) - 1 = 0.0388 = 3.88%

mordko said
The article is 100% correct. The term its using is “real interest rate”. The dictionary defines it as follows:

Real interest rate = nominal interest rate - rate of inflation (expected or actual).

Source: https://www.investopedia.com/terms/r/realinterestrate.asp

The key statement is this:

“The possibility of negative real interest rates in an inflationary environment leads shoppers to prefer buying goods today instead of waiting to make the purchase. This is commonly referred to as the time-preference theory of interest.”

Both those are garbage.

In an inflationary environment, shoppers prefer buying goods today instead of waiting because the goods will cost more later. It has nothing to do with interest rates, real or nominal.

In fact, some shoppers prefer buying goods today. Period.