Tuesday, 3 May 2011

Five Economic Myths I Would Love to Shatter-#5 (The Time Machine/Interest in a Bank Scheme)

 I'm feeling real good about things lately, so let's get into some more humor-provoking stuff.

You've all seen it before. Guy goes into some kind of slumber, wakes up, and then he's like "OH GEE WOW, I'M RICH NOW, CAUSE THE BANK BE GIVIN ME INTEREST WHILE I BE DEAD".

The alternative "clever" version of this is someone from the future coming back into the past and actually setting up a bank account for themselves and therefore making mad amounts of profits in the future. This, fittingly enough, was proposed in Luke Wilson's Idiocracy, which we'll deal with later.

Yes, hi, I'd like to open up a savings account. I plan to deposit my money for three thousand years.    

The reason why this doesn't work

Actually, it's quite simple if you realize the first rule of economics/finance---namely that the banks are always out to screw you.

Three thousand years, you say?

Any interest rate the bank offers you is nominal, and does not account for inflation, or the loss of purchasing power that comes with it. One of the first things anyone learns in finance classes is how to calculate the real interest rate. For simplicity's sake, that can be aggregated, for discussion purposes, into this simple expression: real interest rate=nominal interest rate-inflation, which fully reflects the fact that any money you get is balenced out by the decline in purchasing power of this money.

The rate of inflation varies from country to country. In the United States, it typically hovers around 2-5%, although in the past (especially in the 1980s), it has shot up to around 14%.

So what did Bank of America offer its' regular savings customers?

0.05% Annual Percentage Yield. Seriously. You minus inflation from that (averaged out to about 1.5% for the whole of 2010), and you're actually losing 1.45% a year in purchasing power (but gaining 0.05% in green, official-looking paper!). I was so shocked that I actually had to ask a Bank of America Live Chat representative whether this annual percentage yield was in nominal or real terms, which he had no idea about. Finally, I asked him whether it accounted for inflation (how is it that I know more about banking than a bank representative? o_o)---and he quite simply said no.

This doesn't take into account the fact that you are sacrificing opportunity cost by not investing your money into stocks or hell, risk-free bonds, that would offer much higher average returns (and in the case of risk-free bonds, essentially, well the same risk). It doesn't take into account the fact that if America continues her current policies, the American dollar will be further devalued and lose purchasing power relative to other currencies. Finally, it doesn't account for a world where the bank you deposit in will have collapsed, or one where alien overlords have enslaved mankind.

basically, you're getting screwed

Your face, after realizing you can only afford 20% of the Big Macs you would've been able to afford before you thought up this terrible plan. Also your face after realizing Future Earth's alien overlords don't make Big Macs.

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