But the killer situation is to borrow for holding.
Compared to not doing anything, here is what happens: At T=0, you borrow $100. You don't change your spending patterns in any way. Then, at T=1, you repay your loan with a mere $95. Yes, those $95 are worth more than the $100 you borrowed at T=0. But simply holding the cash made those $100 of yore turn into $100 of today -more valuable. So you are still left with $5 more than in the situation where you did not borrow, at zero risk (in fact, at negative risk, since the institution might collapse and never require those $95), for not doing anything.
OK, it's not quite true: somebody may steal those banknotes in the meantime. So you need someplace safe to hold them. But any rate negative by more than the risk of theft won't work. Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
Case 1: Inflation rate is 5%, interest rate is 10%. I loan somebody $100; at the end of a year he or she pays back $110. I have gained $10 of cash due to interest, and lost $5 of value due to inflation. Net gain of $5.
Case 2: Inflation rate is 0%, interest rate is 5%. I loan $100; get back $105. I have gained $5 in cash, not lost or gained any value. Net gain of $5.
Case 3: Inflation rate is -5%, interest rate is 0%. I loan $100, get back $100. I have not lost or gained any cash, but have gained $5 of value due to deflation. Net gain of $5.
Case 4: inflation rate is -10%, interest rate is -5%. I loan $100, get back $95. I have lost $5 of cash, but have gained $10 in value due to inflation. Net gain of $5.
What is wrong with this argument?
Case 5: Inflation rate is -10%, interest rate is now adjusted by the government to -10%. I loan $100, get back $90. I have lost $10 of cash, but have gained $10 in value due to inflation. Net gain of $0 and there is risk. So I don't make loans in this case, either...
Hmmm.
