Central banks have kept their policy interest rates close to zero for nearly eight years and with the partial exception of the Fed are now intensifying this policy by pushing rates negative. Combined with large budget deficits and ultra-aggressive regulation in the service of several dubious causes, these policies have provided a destruction test of Keynesian economic theories, which those theories have by and large miserably failed. They have also formed a major offensive against savers, i.e. against nearly all of us during a substantial portion of our human life-cycles. Ethically as well as economically, this needs to stop now.
In the days of final salary pension schemes, those with such pensions (which included the salaried and most unionized blue-collar workers) did not need to save. The company deducted money from their paycheck automatically, it took all the reinvestment risk, and the individual could retire with his company pension, Social Security and nothing else (maybe a house with the mortgage paid off) and live a very comfortable retirement. He never had to care what the Fed did, because the company took all the investment risks of his retirement assets.
By and large at that time corporations were thus a useful lobby making sure interest rates did not go too low, otherwise their required pension contributions soared. Truly, whether or not the generation that served in World War II were the Greatest Generation, those that kept their jobs through their careers unquestionably had the Greatest Retirement.
This has now completely changed. The Baby Boomers now retiring are a transitional generation, but the Gen-X’ers and Millennials will both have to save hard. Very few of them will have guaranteed final-salary pension schemes from their jobs, so unless they build up a very substantial savings pot, they will have to rely on the modest payments available from the Social Security system. What’s more, since the Social Security system is scheduled to run out of money in 2033 or so, those payments are likely to become even more modest around that time. (Current projections are that Social Security will be able from its running cash flow to pay about 72% of the nominal benefits due, but whether the Trustees will do that, or bias the system towards politically favored beneficiaries and pay less to the disfavored must be an open question.)
Interest rates thus play a huge part in the lives of those without defined benefit pensions, whether we want them to or not. While we are young, low interest rates are a benefit; Millennials may have been ripped off by their colleges, but they are at least paying nice low subsidized rates on the huge loans they incurred to obtain their mostly useless degrees.
Low interest rates are also attractive to those taking out a mortgage to buy a house, although in this case higher rates would be compensated by lower house prices. When I first came to the United States in 1980, I looked at buying a house, the prices of which were eminently affordable. The problem was mortgage interest rates of around 12%. I was prepared to afford that, expecting inflation and salary raises to take care of the problem over a few years. However, the amount I could borrow was pathetically low, because banks based their calculations on the mortgage payment (bloated by the 12% rate) compared to my after-tax income, and not on the principal amount, as they did in Britain.
Still, mortgage rates somewhere between 1980’s 12% and today’s 4% would lower house prices sufficiently for Millennials with a steady job to afford them. While they might not like the higher interest payments in the early years, they would be very happy with the easier payoff of the smaller principal owed.
Thus today’s low rates are beneficial to heavily indebted ex-students in their 20s, but more equivocal for financially stretched home buyers in their 30s. After 40 they become hugely damaging, because of the need to save for retirement, and absorb longevity risk in old age.
If a person with an income of $60,000 wishes to retire at 67 with pension equal to two thirds of his salary, or $40,000, he needs to save enough to fund payments of $25,000 per annum, increasing with inflation, assuming his social security payment is around $15,000. At today’s annuity rates, he will need to save $370,000 to buy an annuity that will give him the income he needs, although without inflation protection and with a complete wipeout of principal at his death, thus impoverishing any surviving spouse. At today’s 10-year Treasury bond rate of around 2%, he will need to save $905 per month to get that, which is about 25% of his after-tax income – in addition to his payment on a $150,000 mortgage, which might be another $500 per month. The kids will certainly have to take out loans to pay for college.
The economics really don’t work, or at least they are colossally painful. In practice, the current generation of 60-year-olds has used three methods of getting round this problem. First, if they bought a house before 1990 or so, they have seen the value of that house increase even in real terms and the mortgage payments correspondingly diminish. If they have been sensible enough to avoid cash-out re-financings – and most haven’t – they now have an asset they can sell to finance part of their retirement. With house prices much higher and inflation lower, the next generation – today’s 40- and 50- year olds – won’t be able to do this.
Second, 60-year-olds have put all their money in stocks, hoping that the fantastic bull market of the last 34 years will carry on giving them returns of 8-10% per year for the rest of their days. Since the stock market is now above twice its 1995 level, adjusted for the rise in nominal GDP, that won’t happen. Already today’s 60-year-olds are conscious of being well short of the money needed to fund their retirement; the next big downturn will open a gap between retirement aspirations and available resources that is impossible to fill.
Retirees are therefore doing the only thing they can do; spending their capital. That works fine for the first few years of retirement, but gets very nasty indeed once the capital runs out and you are too old to work. However, given today’s low current interest rates they have no alternative; when as today the risk-free rate of return on long-term (25 year) inflation protected TIPS is only 0.84%, for each $1,000 per month you require in secure inflation-proof income, you need capital of $1,428,571. Needless to say, anyone with $1.4 million in capital is spending much more than $1,000 per month, so is either running down his capital inexorably or, more likely, investing in stocks that will someday blow out and leave him destitute.
Maynard Keynes notoriously called for the “euthanasia of the rentier” but there is nothing whatever merciful about this war on those trying unsuccessfully to save for retirement. Indeed, for many of them a literal euthanasia will be their only solution once the money runs out. The problem is not yet acute, because many of the “young old” are living on what remains of the savings they have. However, you can bet that the “rentiers” themselves are only too aware of the problem. Donald Trump consistently polls better among the over-60s than among younger voters, and this is almost certainly why. These are not people whose biggest problem is student loans or even, mostly, the job market. They are finding it impossible to support themselves in old age, and hence they are angry enough, without necessarily understanding the precise interest rate effect that impoverishes them, to support Trump.
In a sensible political system, the Republicans would be properly aware of this problem among the older saving voters that form their core constituency, and would have been raising hell about it, in Congress and on the stump. There was a little discussion of interest rates in the 2012 campaign, mostly from Ron Paul, but since Mitt Romney’s defeat, not a squeak. This is almost as severe a betrayal of their voters by Republicans as their 2013 attempt to open the floodgates to more immigration. It should thus have surprised nobody that the core of the Republican voter base was angered at the party hierarchy, and ready to vote for any candidate, however implausible, who reflected their anger, even though he offered no solution to their most pressing economic problem.
Far from reforming their damaging and one-sided interest rate policies, the world’s central banks appear determined to double down on them, venturing into the even more dangerous territory of negative interest rates. Truly in this case the Keynesian clerisy is betraying the populace as a whole, condemning them to an impoverished old age they have not deserved. Voters’ anger is entirely justified; what is needed now is some politicians who will act to rectify the problem.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)