Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24
How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - 17th Feb 24
Why Rising Shipping Costs Won't Cause Inflation - 17th Feb 24
Intensive 6 Week Stock Market Elliott Wave Training Course - 17th Feb 24
INFLATION and the Stock Market Trend - 17th Feb 24
GameStop (GME): 88% Shellacking Yet No Lesson Learned - 17th Feb 24
Nick Millican Explains Real Estate Investment in a Changing World - 17th Feb 24
US Stock Market Addicted to Deficit Spending - 7th Feb 24
Stocks Bull Market Commands It All For Now - 7th Feb 24
Financial Markets Narrative Nonsense - 7th Feb 24
Gold Price Long-Term Outlook Could Not Look Better - 7th Feb 24
Stock Market QE4EVER - 7th Feb 24
Learn How to Accumulate and Distribute (Trim) Stock Positions to Maximise Profits - Investing 101 - 5th Feb 24
US Exponential Budget Deficit - 5th Feb 24
Gold Tipping Points That Investors Shouldn’t Miss - 5th Feb 24
Banking Crisis Quietly Brewing - 5th Feb 24
Stock Market Major Market lows by Calendar Month - 4th Feb 24
Gold Price’s Rally is Normal, but Is It Really Bullish? - 4th Feb 24
More Problems in US Regional Banking System: Where There's Fire There's Smoke - 4th Feb 24
New Hints of US Election Year Market Interventions & Turmoil - 4th Feb 24
Watch Consumer Spending to Know When the Fed Will Cut Interest Rates - 4th Feb 24
Blue Skies Ahead As Stock Market Is Expected To Continue Much Higher - 31st Jan 24
What the Stock Market "Fear Index" VIX May Be Signaling - 31st Jan 24
Stock Market Trend Forecast Review - 31st Jan 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Fed’s Monetary Monkeying Is Ruining Your Retirement and the Economy

Interest-Rates / Negative Interest Rates Sep 15, 2016 - 02:51 PM GMT

By: John_Mauldin


The Fed’s mission is to maintain a stable inflation rate while spurring employment. Its main tools are the money supply and interest rates.

What is an interest rate? You might describe it as the price of money. Or in investment terms, it’s the price of liquidity. You don’t have cash now, but you expect to have it in the future.

If a lender thinks this sounds plausible, you can borrow the cash now in exchange for promising to replace it later. But you don’t just replace what you borrowed. You pay an additional amount to compensate the lender for giving up liquidity on that money. That additional amount is called interest.

Is there any way that negative interest rates make sense? Maybe.

Central banks think NIRP will get people to take more risk

NIRP makes sense if liquidity is undesirable. And some central bankers want to make liquidity unfavorable to get people (and lenders) to take more risk.

But let’s look at the Fed’s grand assumption: Lower interest rates will create higher demand for goods and services. 

If that’s true, the Fed should have been able to stimulate economic activity by pushing rates lower and keeping them there over these past eight years.

Yet, as measured by GDP (or any other standard), economic growth has been mild at best. This dearth of desired results is a real problem.

The data is starting to show that consumers (and some businesses) are actually saving money in low or negative interest rate environments. So not only has the Fed failed to stimulate demand, it has arguably reduced demand as people save more and spend less.

Why does this happen?

People offset risk by spending less

Imagine you’re a retiree trying to live off the interest on your savings. In order to get any income, you’ve had to take on more risk by holding long-maturity bonds, junk bonds, preferred stocks, etc. You compensate for this risk by giving yourself a bigger savings cushion. That means you reduce spending somewhere else.

Plus, most Americans have excessive debt, low credit ratings, or both. Low or even negative interest rates will not make them spend more money as long as that is the case.

Do central bankers not see this?

Corporations are also hoarding cash. Apple, Microsoft, and other US tech giants have billions stashed outside the country for tax reasons. And they’d still keep cash even if the tax disadvantage went away. They have no need to spend it and very little to invest in. They see no reason to risk losing it or to bring it back into the US to pay high corporate taxes.

So there it sits… not stimulating anything.

The Fed’s monetary monkeying has ruined retirement

Retirees face another financial hurdle with NIRP. Pension funds generate profits from long-term loans to grow the money they need (along with your contributions) to pay for your retirement. They have built into their models a reasonable long-term return—at least from a historical perspective—on bonds and the stock market.

But, this model falls apart under a very low interest rate or NIRP regime. The returns pension plans make on their investments can no longer adequately fund the promises they have made. It gets even worse with NIRP.

This means real people who worked hard all their lives and made sensible decisions about retirement are getting the shaft. I recently wrote about this in my article “Killing Retirement As We Know It.” I don’t often quote myself, but this is important.

It was even simpler if you had an employer or union pension plan to do the work for you. Pension plans pooled people’s money, calculated how much cash they would need to pay benefits in future years, and built portfolios (mainly bonds) to match the liability projections. Government and corporate bonds yielded enough to make the process feasible.

Younger readers may think I just described a fantasy world. I assure you, it was very much a reality not so long ago. Ask your grandparents if you don’t believe me. However, you may find them in a state of shock today because they thought the fantasy would last forever. Indeed, their financial planner probably told them they could count on drawing down 5% of their portfolio per year to live on, because the income from the investments in their portfolio would more than make up for the drawdown.

None of this is possible today. Neither you nor a massive pension plan acting on your behalf can generate enough risk-free income to assure you a comfortable retirement.

Why not? Because our monetary overlords decreed that it should be so. Retirees and their pensions are being sacrificed for what now passes as “the greater good.” Because these very compassionate overlords understand that the most important prerequisite for successful future retirements is economic growth. And they think that an easy monetary environment is the necessary fertilizer for that growth. So, when they dropped rates to zero some years ago, they believed they would soon be able to raise them again—and get people’s retirements back on track—without risking future economic growth. The engine of growth would fire back up, and everything would return to normal.

So much for the brilliant plan. You and I, the expendable foot soldiers in the war to reignite growth, now gaze about, shell-shocked, as the economic battlefield morphs from the plains of ZIRP to the valley of NIRP.

And here’s the truth of it all. The Federal Reserve’s choice to keep interest rates near zero for years on end has exacted a direct and sometimes devastating human cost.

Join Hundreds of Thousands of Readers of John Mauldin’s Free Weekly Newsletter

Follow Mauldin as he uncovers the truth behind, and beyond, the financial headlines in his free publication, Thoughts from the Frontline. The publication explores developments overlooked by mainstream news and analyzes challenges and opportunities on the horizon.

John Mauldin Archive

© 2005-2022 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in