Tuesday, 16 February 2016

A flaw in negative interest rates.

I left the comment below after this Financial Times article on negative interest rates.

There’s a glaring flaw in negative rates: they make possible negative output – that is forms of “production” which actually destroy wealth rather than create it.

To illustrate, if I can borrow at minus 10%, I could buy 100 houses with borrowed money, leave them empty for a year, burn down 5% of them just for fun, then sell the remaining 95 at the end of the year and come away with a profit.

Of course no one would engage in a BLATANTLY pointless activity like that. But in most businesses, it is not obvious whether the activity is worthwhile or pointless, other than by looking at the bottom line. E.g. if a firm consumes ten different chemicals and produces three end product chemicals, how does it know that's worthwhile other than by looking at the bottom line? Under a negative interest rate regime, the value of the chemicals produced could be less than value of the chemicals consumed, and the firm could still come away with a profit.

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