Interest Rates and Inflation (and Wealth Transference)
April 8, 2022
Banks are generally important buyers of government debt. They buy bonds with depositors’ money, which can create very different incentives from those of a long-only bond investor. And the bank is typically a very leveraged bond investor; leverage of 10x equity capital is considered prudent.
Negative real yields place banks in Argentina and Turkey in a very interesting position. For an Argentine bank, there is a negative real rate of return when buying a 10-year government bond: -1.90%. However, the depositor gets -12.44%. Since the bond is purchased with the funds of the depositor, the bank earns the difference between -1.90% and -12.44%. That is a substantial profit, and can be amplified as much as 10x due to the bank’s leverage.
The Turkish bank pays a depositor 12.50% and earns 24.19% on the Turkish government bond. This 11.69% spread is below the Turkish inflation rate of 61.1%, but the bank can be 10x leveraged – that enables it to earn 10x its spread, or 116.9%, well above the inflation rate.
In the case of Brazil, a bank earns a positive real rate of return on its government bond investments of 0.71%. The depositor earns a negative real rate of return of -3.10%. Therefore, a bank using the funds of the depositors to purchase 10-year government debt will earn a real return of 3.81%: the bank captures the negative real rate of return of the depositors as a positive real rate of return for itself.
This is a form of wealth transference. The purchasing power debasement endured by the depositor in Brazil is an augmentation of the bank’s purchasing power, which is then multiplied by the bank’s leverage.
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Horizon Kinetics LLC
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