James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter: @JamesGRickards.
This week the Economic Policy Subcommittee of the Senate Banking Committee will hold a hearing on the shortfall in retirement savings in America. This shortfall has many causes including inadequate savings, financial mismanagement, unrealistically high projected returns by pension plans, and public policy that is hostile to investment.
One of the most important causes of the shortfall is the Federal Reserve's zero interest rate policy which offers retirees and near-retirees almost no interest on savings held in the form of bank accounts, Treasury bills, or money market funds.
In response to a financial crisis resulting from a collapse in housing values, the Federal Reserve began to cut interest rates in 2007. The federal funds rate was lowered from 5.25 percent in August of 2007 to effectively zero by December of 2008, and it has remained at or near that level ever since. The Fed has declared an intention to keep short-term interest rates at this near-zero level through late 2014. If this intention is fulfilled, the entire course of the zero rate policy will have lasted six years, an unprecedented and extraordinary policy move on the part of the Fed.
The rationale for this policy as expressed by the Fed has gone largely unexamined and unchallenged. Seasoned economists and everyday Americans have deferred to the Fed's expertise and have trusted the Fed to do the right thing to fix the U.S. economy in the aftermath of the Panic of 2008. The view is that Chairman Ben Bernanke knows best and debate is unnecessary. Yet, the costs of this policy are more apparent by the day.
It should come as no surprise that an unprecedented policy should have unprecedented, unforeseen, and unexpected results. By many measures, the Fed's policy has failed to achieve its goals and is leaving the U.S. economy worse off when compared to a more normal interest rate environment. The principal victims of these failed policies are those at or near retirement who face a Hobson's Choice of gambling in the stock market or getting nothing at all. A look at the negative effects on retirement savings shows:
- Increasing income inequality. Zero rate policy represents a wealth transfer from prudent retirees and savers to banks and leveraged investors. It penalizes everyday Americans and rewards bankers, hedge funds, and high-net worth investors.
- Lost purchasing power. Zero rate policy deprives retirees and those nearing retirement of income and depletes their net worth through inflation. This lost purchasing power exceeds $400 billion per year and cumulatively exceeds $1 trillion since 2007.
- Sending the wrong signal. Zero rate policy is designed to inject inflation into the U.S. economy. However, it signals the opposite—Fed fear of deflation. Americans understand the signal and hoard savings even at painfully low rates.
- A hidden tax. The Fed's zero rate policy is designed to create a situation in which nominal interest rates are lower than inflation resulting in negative real interest rates. This is designed to encourage lending and spending because the real cost of borrowing after inflation is negative. For savers the opposite is true. Real returns are negative which erodes the value of savings—a non-legislated tax on savers.
- Creating new bubbles. The Fed's policy says to savers, in effect, "If you want a positive return, invest in stocks." This gun to the heads of savers ignores the relative riskiness of stocks versus bank accounts. Stocks are volatile, subject to crashes, and not right for many retirees. To the extent many are forced to invest in stocks, a new stock bubble is being created which, as with all bubbles, will burst leaving many retirees not just short on income but possibly destitute.
- Eroding trust and credibility. Economic science has been heavily influenced in recent decades with the findings of behavioralists and social scientists. While the social science research is valid, the uses to which it is put are often manipulative in ways deemed suitable by Fed policymakers. This approach ignores feedback loops. Once retirees realize the degree of interest rate manipulation they will lose trust in government more generally.
The United States, indeed the world, is mired in a swamp of seemingly unpayable debt. In these circumstances, there are only three ways out—default, inflation, and growth. The first is unthinkable. The second is the current path of the Fed although it can only be pursued in stealth. The third is the traditional path of the American people. Growth does not begin with consumption, it begins with investment. Only when private productive investment is encouraged and pursued does consumption follow as the fruit of that investment.
America's retirees and near retirees are ready, willing, and able to provide the prudent savings needed to fuel investment and growth. All they ask in return is stable money, positive returns, and a friendly investment climate. The Fed's policy of money printing and negative returns is anathema to investment and growth. Until the Fed's war on savers is ended, income security for retirees will be an illusion.
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