Over the last eight years, the Fed’s imprudent policies have hurt one major demographic: savers. Especially those saving for retirement.
Low interest rates only make it more difficult to build assets and, more importantly, they require a larger pile of assets, because they don’t yield much interest income.
Every retirement plan must allow for roughly a year or two of low interest rates. But extended over an eight-year earning period, as they have been, low rates have crippled many people – with only about 25 years to plan for retirement, at most.
Even more extraordinary: In this presidential election year, nobody is vouching for savers’ interests.
Between a Rock and a Hard Place
The Greatest Generation – those who grew up during the Great Depression and lived through World War II – had defined benefit pension schemes, and, therefore, took no investment risk. Instead, their employers took the risk for them.
This forced employers to function as a useful lobby for higher interest rates. If rates got too low, their pension funds were squeezed and required additional contributions.
Thus, the Greatest Generation got the Greatest Retirements!
But since around 2000, pensions have switched to a money-purchase basis through 401(k)s and the like. These require investors to take massive investment risks.
Allow me to elaborate…
A person earning $60,000, who wishes to retire at 67, will need about $25,000 per annum after retirement, increasing with inflation, on top of social security.
To get that sum risk-free and with preservation of capital, by investing in 25-year Treasury inflation-protected securities (TIPS) yielding 0.84%, this person will need an astounding $2.98 million – obviously an impossible amount to save on such a salary.
Alternatively, this person can buy an annuity, which spends capital and will, thus, dwindle any inheritance that would otherwise remain after death.
The cost of this alternative looks more hopeful. At today’s annuity rates, he’ll need to save $370,000 to buy an annuity that will give him the income he needs. However, it’s just as precarious.
At today’s 10-year Treasury bond rate of around 2% and inflation of 2%, this person will need to save $1,140 per month to save enough during their employable years. This amounts to about 30% of his after-tax income – in addition to housing and other costs of living.
The economics really don’t work. And when they manage to amount to any livable savings, they are colossally painful in the interim.
The annuity costs far more than it would at higher interest rates, and saving is less productive.
Politicians Ignoring a Growing Problem
In practice, most 60 year olds have put all their money in stocks, hoping that the fantastic bull market of the last 34 years will continue to yield returns of 8% to 10% per year for the rest of their days.
But because the stock market is now more than twice its 1995 level, adjusted for the rise in nominal gross domestic product (GDP), these kinds of returns simply won’t happen.
Already, today’s 60 year olds are conscious of being short of the funds needed for retirement.
Retirees are spending the money they have and hoping for the best. And while this may cover the first few years of retirement, financing becomes far more complicated once the capital runs out and a person is years out of the workforce.
Yet the problem is practically invisible to policymakers. In five to 10 years’ time, however, pensioners will be forced to face the music when a high proportion of seniors are impoverished.
Not Just an American Problem
If you think this problem is uniquely American, think again. The pattern is repeated in Britain, the EU, and Japan – except worse. Interest rates are even lower than in the United States and savers are in greater danger.
In Japan, for example, interest rates have remained marooned near zero for 18 years. Its market boom ended 26 years ago – a huge fraction of any individual’s active lifetime – meaning that those headed into retirement aren’t walking away with a fortune in stocks.
Yet despite this global problem, there’s no country in the world where there’s a “savers’ lobby” committed to addressing this problem.
But it’s not clear how such a lobby could even be effective.
In most countries, there are provisions for the central bank to be “independent of political interference.”
Sounds great, right? These provisions were designed to prevent politicians from pushing for low and inflationary interest rates in recessions.
But it doesn’t account for the possibility that the world’s central bankers would universally go on a binge of irresponsible ultra-Keynesian policymaking, disregarding the needs of the citizens for whose economic welfare they were theoretically working.
Central bank independence is unworkable without some statutory provision – a revised “Humphrey-Hawkins” objective, in order to prevent inflation, as well as the destruction of the time value of money.
The Responsibility to Savers
The problem is crystal clear to seniors themselves.
This may partly explain why Donald Trump sees more support from seniors than from any other age group.
It may also explain the resurgence of populism in much of Europe, as well as the surge in “Brexit” opinion in Britain, whose biggest support comes from older voters.
Only time will tell whether or not Japan produces an analogous movement, once the failure of Abenomics has become fully apparent.
In most of the first world, a monetary policy reversal is urgent.
And while the urgency for such a revision has yet to manifest, as savers and their chosen Trojan horses have been ineffectual in demanding one, that may be changing.
Once we see an evolution in pension planning, the global economy will be much healthier and better for it. Savings aren’t just essential for retirement, they also provide the seed funding for most small businesses that ensure the financial stability of the future.