Low Interest Rates Distort the Value of Money: How Much for Your Coffee?

What do you pay for your daily dose of coffee?

$3, $4…more?

According to Statista, the average latte in Australia will set you back $4.18.

I usually pay a bit more than that, but not much more. Melbourne prices…

But the ‘good thing’ is that in the three years I have been going to my corner coffee shop, prices haven’t changed one cent.

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Now imagine this.

You go into your neighbourhood coffee shop, like every morning. As every day, your barista greets you by name and you don’t even need to place your order.

You take out your card to pay. As you tap, you notice that prices are slightly higher than the $4.18 you paid yesterday. It’s now $4.50 for a latte.

It’s quite a jump, but you don’t think much of it.

By the afternoon, you’re feeling a bit sluggish, so you decide to get another dose of caffeine. This time when you tap the price has climbed to $4.80.

The next day you pay $5.40. And the day after that the price has moved over $6.

What’s going on?

I had a similar experience in Argentina in 1989, when the country had a bout of hyperinflation. Inflation reached a whopping 1,000% a year.

If you have ever experienced it, it’s quite unsettling.

You have no idea what prices really are, how much your money is worth or how long it will last you.

Your salary has disappeared by the end of the month. That’s if you’re lucky. Most people don’t reach the end of the month.

People would rush to get US dollars as soon as they got their salaries to keep the value of their money and protect themselves from currency depreciation…which made the problem worse.

Buying the simplest of things is difficult. Stores don’t want to sell their stock, because they don’t know what price to charge. But also, because they have no idea how much it will cost them to replace it.

And this came hand in hand with a total collapse of the system. Unemployment increased, consumer spending and purchasing power collapsed.

Those few months of hyperinflation were one of the craziest economic experiences I’ve ever had.

True, Argentina’s economic history isn’t like many other countries. Argentina has a long history of crises.

But my point is that hyperinflation distorts the value of money. And when a distortion of money happens, people start moving to assets that will preserve value.

I heard two stories recently.

According to the 2019 UBS Global Family Office Report, 55% of family offices are expecting a recession by next year and they’re getting ready for it by decreasing risk. Almost half of rich families are increasing the cash they hold.

The other story is that central banks are loading up on gold, which is paying off as gold prices rise.

According to the World Gold Council, central banks bought 374.1 tonnes in the first six months of the year. Central banks have been accumulating gold, mainly to diversify, but also as global growth slows and trade war tensions increase. This higher gold demand has been pushing up gold prices.

Russia, for example, has been one of the countries that has been increasing their gold reserves.

From The Moscow Times:

Russia’s long-running bet on gold is looking better every month.

The country quadrupled gold reserves in the past decade as it diversified away from U.S. assets, a move that has paid off recently as haven demand sent prices to a six-year high. In the past year, the value of the nation’s gold jumped 42% to $109.5 billion and the metal now makes up the biggest share of Russia’s total reserves since 2000. […]

If Russia did need to tap its gold holding, it would fetch a hefty price — the metal is heading for the best year since 2010 as the U.S.-China trade war hurts global growth and central banks ease monetary policy.

And, according to a recent survey by the World Gold Council once again, that trend is not going anywhere. Central banks said they intend to keep increasing their gold reserves over the next 12 months.

Pushing gold prices higher, are the recent trade war and a global slow down. But also lower interest rate expectations.

Remember, it was only last year that we were seeing increases in interest rates. Now monetary policy and central banks around the world have done a complete U-turn.

The US Federal Reserve, the European Central Bank and the Bank of Japan are all looking at lower rates and more stimulus.

The RBA is also following suit. It is looking at lowering the cash rate below 1% as things slow. It also hasn’t ruled out unconventional policies like negative interest rates and quantitative easing.

This is all with unemployment at record lows, mind you!

Long term, low interest rates distort the value of money.

They distort asset prices. We have seen housing prices increasing much faster than salaries. They allow for more borrowing and more debt. They allow for zombie companies. They bring in lower growth.

It’s not normal that we haven’t seen coffee prices move in three years.

Low interest rates are meant to spur growth and recovery. To create enough growth to avoid another recession.

But we have been using them for over 10 years now, without much to show for it.

And they are distorting the value of money.


Selva Freigedo Signature

Selva Freigedo,
Editor, The Rum Rebellion

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Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

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