Payment of services in the second maturity, payment in installments by credit card, loans that adjust by UVA and self -saving plans are just some of the personal-finance items where the interest rate plays a fundamental role. On the other side of the window are also fixed terms, money market funds, letters, government bonds, corporate debt securities, loans granted to other individuals and a long etcetera.
The problem is that the majority of the population shuns everything that involves learning the nature of those interests. People consider the issue to be very complex and prefer to pay the cost of ignorance or financial ignorance, although, in reality, it does not take on how high that cost is.
In today’s column, we will analyze how interests originate to achieve a better qualitative and quantitative relationship with money, in a scenario where understanding a few concepts can make a real and positive difference. Ours is a financialized economy and we must learn to live with it.
The historical conception of the interest rate
At the beginning of the Christian tradition, charging interest was a sin. Unlike what is happening today, the fault pointed to the creditor (the lender) and not the debtor (the debtor). It was considered that, if the rich man had his needs covered, the rest of the money was no longer his property and he had an obligation to transfer it. Those who accumulated surplus capital were debtors of society and had to donate the extra money.
Then, in the Middle Ages the doctrine was maintained, although the arguments took a curious turn: since interest is directly linked to time and time is considered a divine property, charging for the temporary use of foreign money was considered lucrative with God’s property. Therefore, charging interest was prohibited under penalty of ex-communication.
During the Renaissance, the situation began to change. The loans ceased to have consumption as their only destination and began to play an important role in the prosperity of cities and regions. In the School of Salamanca, it was argued that if the one who received the loan obtained benefits with the money, who granted that loan had the right to keep a part of that benefit, since not only did he run a risk when lending it, but he also lost the opportunity to benefit using that capital. Thus was born the concept of “opportunity cost of capital.”
These new looks lay the basis of money as the merchandise that can be bought, sold or rented like any other. Since the individual will always prefer to receive a certain asset in the present and not in the future, postponing that desire of the creditor obliges the debtor to pay a value in exchange for the loan.
At present, interest rates (guiding or rate guides) are fully institutionalized, to the point of becoming one of the most important tools for central banks, which raise or reduce rates with different objectives, such as encouraging or slow down economic activity.
When an economy is growing at rates considered excessive, the Central Bank raises the reference interest rate to slow down the expansion and avoid unwanted effects, such as inflation. On the contrary, when an economy is stagnant or in recession, the monetary authority interest rates to stimulate investment and boost growth.
Although we can sin of being linear, the reasoning is simple: higher interest rates theoretically decrease investment in the productive sectors, since, on the one hand, economic agents prefer to place their money in banks – which ensure high profitability in that currency – and consumers postpone part of their purchases to increase their savings. On the other hand, high rates discourage the taking of loans for consumption and for productive investment, since taking debt implies paying much more than what is requested in the immediate future.
On the other hand, low rates stimulate the request for loans for consumption and productive investment because economic agents are not attracted by the interests paid by financial institutions and it is low the opportunity cost of not allocating capital to speculative investments.
What is happening in the world with interest rates?
Internationally, what is happening today is very curious. Most of the major powers, with Germany and Japan leading the way, are going through a situation of negative interest rates. Their central banks not only do not pay for the money they receive, but they charge a percentage of what is deposited by economic agents. This phenomenon of negative interests occurs in a context of economic stagnation or monetary contraction.
The United States, on the other hand, lives up to its reputation as a “locomotive of global growth” as it is one of the few powers to give back to economic agents who buy their 10-year Treasury Bonds with a positive, albeit low, interest. Currently, they pay around 2.50% annually in dollars, practically the same rate that Argentina pays for 3-month placements.
What interpretation can we make of the global context of interest rates? As we saw a few months ago in the column “ 5 key indicators that every investor should know“, The rates of return offered by US bonds Depending on their expiration period (one year, three, ten, etc.) they are an interesting indicator of potential risks of economic recession. If as the term increases the annual rate they pay increases, we can say that the market understands that the economy is healthy.
If, on the contrary, the rate remains the same or even low as the maturity terms of the bonds are extended, the forecast of the market players indicates that a recession is coming. We see it, for example, when the annualized rate of the three-month bond exceeds that of the Treasury at 10 years.
This performance contradicts the logic since it is assumed that whoever lends his money in the long term to another will demand a higher interest per year than if he lent the money in the short term since the money is withheld for a longer time and the risk of non-collection is greater. The fear of an imminent crisis explains this phenomenon: in the short term I fear that I will not collect what has been agreed, but in the long term I think that everything will be solved and I will normally collect the money invested or borrowed.
On the other hand, the fact that several of the powers offer negative interest rates makes the US Treasury Bonds demand. increase (because of the few that pay positive rates), which raises its price in the market and, at the same time, reduces its interest rates in relation to that price.
In summary, the current scenario of interest rates tells us that there is a serious possibility that the global economy will enter into recession over a horizon of six months to a year and a half.
What is happening in Argentina with interest rates?
In July of last year, I warned about the risk of living in the country of the highest interest rates in the world. At that time, the reference rate was “barely” 40% per annum, while now it seems to be on its way to doubling that figure and what is worse: there are no prospects for it to fall in the short term.
When it comes to rates, we are against the world: while outside there is a tendency towards neutral or negative values, borders inside are found by clouds. While outside they worry about deflation, here we border on hyperinflation. The bad news does not end there: if indeed the world goes into recession, it will increase the probability that the only source of financing we have left, the IMF, will be cut off.
The problem of interest rates leads us to propose a daunting panorama, but it is the reality that we have to live and deny it would be the worst thing we can do.
Are there people who deny reality? As it does? Taking any type of loan, for example. He agrees to pay usurious interests and invents magic formulas to pay them dreaming of a future that will not come quickly, less if he chooses the path of indebtedness. This harmful behavior is observed in mortgage borrowers, consumer and single-signature loans, minimum payments by credit card, installment payments without rigorously reading the contract, current account advances, overdrafts and more.
Knowledge is power. Inform yourself and use your analytical power with a critical spirit to move as soon as possible from the debtor’s position to that of the creditor. High rates scream for you.