The Fed Put a 50% Tax on Your Retirement Plan

By: John_Mauldin

If a politician said he thought he should tax the income from your retirement plan, right now, at 50% (no matter where you are in the retirement process, that would certainly hurt the ability of your portfolio to compound), what would you think (other than that he was completely Looney Tunes)?

But that's exactly what the Federal Reserve has done by keeping interest rates low.

It has reduced the fixed-income returns in retirement plans and the broad pension plans upon which so many people are dependent to practically nothing. And the Fed has done this to prop up asset prices.

Here’s why the Fed can’t raise rates

The Fed should have allowed rates to normalize years ago. Now, the Fed has unbalanced the financial system so badly that the markets will likely have another tantrum—no, make that a grand mal seizure—when rates start to rise.

And that means your bond funds will get killed. So will your equity funds. It’s going to be a huge disaster for retirement and pension plans. Any right-thinking person knows that.

That’s why the Yellen Fed can’t get to the point of actually normalizing interest rates. They know the reaction from the stock market is going to be truly ugly. And because they’ve pushed the heroin of ultra-low rates, they are going to be blamed for the withdrawal.

Larry Summers just went on a rant in the Washington Post. It’s instructive reading. His title is “The Fed thinks it can fight the next recession. It shouldn’t be so sure.”

He points out that despite all the happy talk from Janet Yellen at Jackson Hole, the Fed doesn’t have any ammo left. Larry and others argue that the Fed typically cuts interest rates by about 550 basis points in a recession.

If a recession kicked in tomorrow, that would plunge us to the breathtaking interest rate of -5%. As I wrote last week, Janet Yellen cited a footnote in her paper. She suggested that rates should go to -6% or -9% during the next recession to be effective.

Now here’s Larry, teeing off:

My second reason for disappointment in Jackson Hole was that Federal Reserve Board Chair Janet L. Yellen, while very thoughtful and analytic, was too complacent to conclude that “even if average interest rates remain lower than in the past, I believe that monetary policy will, under most conditions, be able to respond effectively.” This statement may rank with former Fed chairman Ben Bernanke’s unfortunate observation that subprime problems would be easily contained.

Rather I believe that countering the next recession is the major monetary policy challenge before the Fed. I have argued repeatedly that (1) it is more than 50 percent likely that we will have a recession in the next three years (2) countering recessions requires four to five percentage points of monetary easing (3) we are very unlikely to have anything like that much room for easing when the next recession comes.

And here is where one of the highest of High Priests and I agree. Models have serious limits. We should be very wary of policies based on models that rely on past performance:

There is an important methodological point here: Distrust conclusions reached primarily on the basis of model results. Models are estimated or parameterized on the basis of historical data. They can be expected to go wrong whenever the world changes in important ways. Alan Greenspan was importantly right when he ignored models and maintained easy policy in the mid-1990s because of other more anecdotal evidence that convinced him that productivity growth had accelerated. I believe a similar skeptical attitude toward model results is appropriate today in the face of the clear evidence that the neutral real rate has fallen. I pay attention to model results only when the essential conclusion can be justified with some calculation where I can see and follow each step….

I suspect that prevailing views at the Fed about the efficacy of quantitative and forward guidance substantially exaggerate their likely impact. I don’t think the Fed has taken on board the lesson of the three-year period since QE ended. If longer-term rates had risen after QE and forward guidance ended, this would surely have been taken as further evidence of their potency. It follows that the fact that term spreads have fallen substantially since the end of unconventional policy, as shown in Figure 3, should lead to more skepticism about their efficacy.

Now, would the markets have screamed bloody murder if the Fed had raised rates back to 3% in 2010 or 2011?

For sure, but the members of the FOMC must make these weighty decisions. They are not there to be popular. And, they are not there to worry about the level of asset prices.

Or are they?

Fed Vice Chair admits to sacrificing savers

Federal Reserve Vice Chair Stanley Fischer shared a moment of perfect candor with Bloomberg’s Tom Keene. I guess he didn’t realize that some of us might take offense.

Keene asked him about the impact of negative interest rates on savers (emphasis mine).

1. FISCHER: Well, clearly there are different responses to negative rates. If you’re a saver, they’re very difficult to deal with and to accept, although typically they go along with quite decent equity prices. But we consider all that, and we have to make trade-offs in economics all the time, and the idea is, the lower the interest rate the better it is for investors.

That’s about as clear as it gets. The Fed has no interest in helping savers earn a decent return on their bank deposits or money market funds. Dr. Fischer thinks “decent equity prices” are great and lower interest rates are good for investors.

In any case, the result has been nearly a decade of return-free risk for millions of savers and investors. Those living off of fixed-income portfolios—never mind simple savings accounts or CDs—have grown more desperate as each holding matured and couldn’t be reinvested at a decent rate.

The bottom line? They are willing to trade off your returns on fixed-income for a rising stock market.

Subscribe to John Mauldin’s Free Weekly Publication

Each week in Outside the Box, John Mauldin highlights a thoughtful, provocative essay from a fellow analyst or economic expert. Some will inspire you. Some will make you uncomfortable. All will challenge you to think outside the box. Subscribe now!

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.