Not because RR is of my age, but somehow I seem to be liking this guy!
Speaking at Frankfurt RR made one statement saying ‘I am not sure whether keeping interest rates at zero or such low figure is a good idea’ . Agree with him. Completely agree.
If today I were to get money at 1% p.a. the chances are I will OVER LEVERAGE and borrow to my fullest extent and invest in all kinds of assets. That would be simply because such a low threshold level I would ‘assume’ would be easy to earn.
Exactly what people thought about equity markets in the period 2003-7. Here is an example…by a person who was then a Relationship Manager.
A client walked into the bank to pay Advance tax of Rs. 25,00,000. This RM was aghast that he was losing such a chunk of Casa. So he said ‘Sir Invest Rs. 25L in xxxx mutual fund equity scheme..I will get you a loan against this of Rs. 24L…use that money to pay the Advance tax.’
Absolutely ridiculous thing to do, but the client did it. So instead of losing Rs. 25L this RM had created a relationship of Rs. 49 lakhs. Obviously he got rewarded. Today he is a CXO in a bank. Cannot name him or the bank, he will lynch me.
So all such stupid strategies worked, and worked well.
Similarly Bernanke keeping the interest rate low in the US (and therefore around the world) the threshold investment rate – or the hurdle rate is very low.
When interest expectation is low asset prices are high. (Please read this sentence enough no. of times, you need to understand this mathematically) .
So low interest rates all over the world is a terrible background – this creates bubbles. We have no clue where all we are creating bubbles – real estate, gold, oil, commodities, ….and that is scary. We start to believe that this is the new normal!!
So RR talking about increasing interest rates makes a lot of sense. Also it makes sense for senior citizens to be compensated for some part of the loss that they are making to inflation!
So keeping the threshold a little higher, paying a reasonable return to the saver, giving partial compensation due to inflation loss – all this makes sense Raghuram Rajan, thanks…
Post Footer automatically generated by Add Post Footer Plugin for wordpress.