[mattecheverria]

I am currently living in Argentina where inflation is running at about 25% PA and interest rates for personal borrowing are running at between 20% and 35% (fixed).

In the UK, inflation is running at about 2.7% and interest rates for personal borrowing are about 4%.

I have heard people say that although the interest rates are very high in Argentina, the inflation has an effect on the interest which makes them almost as good as the 4% rates in the uk.

Can someone please explain to me which of the two scenarios explained above is the best, and why?

[paraclete]

It is highly desirable you keep inflation as low as possible. Your position in Argentina leads to instability as it is difficult for personal incomes to keep pace with inflation. In my country, Australia we have experienced periods of inflation which means that what once might have cost $1,000 in 1970 today would cost from $30,000 to $100,000. Shifts in currency value have held down inflation in some prices, but never have we experienced 25% inflation in a short time.

High interest rates also lead to instability and stunt economic growth and the position is highly undesirable leading to short term currency flows into the country fueling inflation and disrupting currency values

[mattecheverria]

Paraclete

Thank you for your answer. I may not have really asked the question correctly. I can't do anything about the inflation rate, or interest, unfortunately! What I really want to know is if I'm any worse off than someone in the UK, for example. Here's my reasoning's - I can't give you all the working on this over this forum, but I'm sure you could probably work them out to check it. Lets take a property worth 1 million Argentine pesos.

In Argentina with inflation at 24%, the "value" of this property in 10 years would be 8.6 million pesos, if inflation continues at 24%. If I was to borrow 1 million pesos on a 30% fixed interest rate, payable over 10 years, the total repayments (capital + interest) would be 3.1 million pesos.

In the UK, lets keep using pesos as a currency, at 2.7% inflation, the 1 million property will be worth 1.3 million pesos, and the cost of the loan, as per above, would be 1.2 million pesos.

Is the Argentine scenario then not a better one (all things considering!) where I end up with a property worth 8.6 million, at a total cost off 3.1 million, compared to the UK, where I would end up with a property worth 1.3 million, compared to my 1.2 million investment?

Leaving fluctuations in land value aside, which is often not only an economical consideration, what pit falls could I come across? Or is my perspective of this totally warped?

Many thanks.

[paraclete]

The raw data suggests that you have made a profit but because of the erosion in the purchasing power of your money you are no better off. The difference between the rate of inflation and the interest rate is called the true interest rate, in this case 6%, which is relatively high, indicating risk. The real interest rate in your scenario in the UK is 1.3%.The other question is whether you can sustain the income necessary to meet the interest bill in a situation of high inflation, what if the interest rates fall and you are locked in to the higher interest rate. You may not be able to renegotiate the loan

You really can't compare situations in two different economies because they have different drivers. What I can say is that your situation in Argentina might produce a bubble where values collapse. I would say you certainly should not borrow money in Argentina to buy property in another country because you expose yourself to soveriegn risk and currency fluctuation risk. We have many stories in this country of people who borrowed where the loans were in foreign currency and those people are bankrupt today unable to meet repayments because of shifting currency values. Those people acted on scenarios similar to what you are proposing. Now if you could borrow in the UK and buy property in the UK it is likely this is a more stable investment than what you propose in Argentina even though the prima face yield is lower, but don't engage in cross border transactions

[ArcSine]

@Mattecheverria, your basic premise is correct that inflation makes the real cost of borrowing less than the nominal cost. Generally, for some inflation rate i and a nominal borrowing cost r, your real cost of repaying a loan dollar or peso at some point in the future is given (in the form of an annual 'real' rate) by



The inflation factor in the denominator clearly makes your real borrowing rate something less than r itself (your nominal borrowing rate).

Hence, using your numbers, the real annualized borrowing rates in Argentina and UK would be in the vicinity of 4.8% and 1.3%, respectively.

Your UK - Argentina comparison is missing the mark by not taking into account the timing differences between your loan repayment outflows and your asset terminal value. In your illustration you're allowing the asset to bake in the oven at the inflation rate for 10 years, whereas you're repaying the loan steadily over the 10-year period. Since the asset isn't being monetized until at least 10 years out, then the interim loan repayments must be funded either from new debt or from liquidation out of other productive assets. The cost of doing so isn't captured in your numbers.

For a better apples-to-apples, change the borrowing to be a 10-year zero-coupon type. The Argentinian loan would have an accrued payoff at maturity of 13.786M (against an asset value of 8.59M) whereas the UK numbers would be 1.480M and 1.305M, respectively.

The fact that these are losing propositions is due to just what Paraclete mentioned: If your assets are just appreciating at the inflation rate, then they are generating a 0% real return. In real terms, you're borrowing in the UK (Argentina) at 1.3% (4.8%) to invest in a 0%-return asset; in nominal terms you're borrowing at 4% (30%) to fund an asset which returns just 2.7% (24%).