Monday, September 27, 2010

Negative real interest rates

Hong Kong's official CPI for August 2010 showed a year-on-year increase of 3.0%. This means that the weighted basket of items that make up the index increase 3% over the preceding 12 months. If your cost of living went up at the same rate as the CPI, then it costs 3% more to live in Hong Kong today than it did a year ago. (Of course, very few people's personal cost of living will fluctuate at the same rate as CPI.)

This compares with:

1. very close to zero for call and short term bank deposits (HSBC is offering 0.015% for a one month deposit)

2. less than one percent pa to borrow money on a residential mortgage (all my mortgages are currently costing my less than 1% pa)

3. a little bit more than 3% pa for a good quality HKD corporate bond with about 10 years to maturity

Given these factors, I am amazed that the level of deposits held by banks in Hong Kong is so high (especially when non-HKD deposits are taken into account). Why on earth would people would so many people leave so much money sitting in bank accounts losing real value for so long? If the answer is risk aversion, then this behaviour amounts to embracing a small certain loss and sacrificing any possibility of avoiding loss altogether in order to avoid the possibility of a greater loss. While I can understand the wish to avoid a loss, the possibilities that ready cash offers to take advantage of opportunities and the need to have enough cash on hand to meet short term needs, I just do not understand why people would be prepared to adopt loss making behaviour when there are so many other alternatives available.

That said, at one level I am grateful - all that cash sitting in the banks and not being more productively invested is available for people like me to borrow at negative real interest rates.

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