3.30.2010

Charles Schwab: No incentive for saving

Low Interest Rates Are Squeezing Seniors

Excerpt:

In February 2006, when Ben Bernanke was first sworn in as chairman of the Federal Reserve, the federal-funds target rate stood at 4.5%. That same year, the average yield on a one-year certificate of deposit was 5.4%. A retiree who diligently saved for a lifetime and had amassed a nest egg of $100,000 could count on an added $5,400 in retirement income per year. That may not sound like much to the average Wall Street Journal subscriber, but for a senior on fixed incomes that extra money improved the quality of his life.

Today's average rate for an identical one-year CD is roughly 1.3%. On the same nest egg, that retiree will now get annual payout of just $1,300—a 76% decline in four years.

Some would argue that today's low inflation rate offsets the decline. But even at an inflation rate of zero, a 76% decline in spending power is painful. And we're already seeing signs of inflation this year. The first two months of 2010 showed an annualized inflation rate of 2%, further exacerbating the spending power problem for retirees by eroding the value of their principal.

To be sure, the country's recent financial crisis required unprecedented action by the Fed, including lowering rates to levels not seen in more than 50 years. In particular, the infusion of capital into the banking system through historically low fed-funds target rates pulled many banks from the precipice of collapse. By that measure it has been a resounding success.

Yet these unprecedented low rates have now been in place for almost 18 months. As a result, banks have enjoyed virtually free access to money while retirees have been deprived of any meaningful yield on their fixed-income portfolios. For a large segment of our population—people who worked long and hard, who followed the rules by spending less than they earned and putting the remainder away to keep themselves independent in retirement—the ultra-low interest rate is more than a hardship. It's a potential disaster striking at core American principles of self–reliance, individual responsibility and fairness.

To put the scale of this problem in context, consider the fact that more than $7.5 trillion in American household wealth is held today in short-term, interest-bearing products such as checking and savings accounts, retail money funds and CDs. At today's low interest rates, the return on those savings is hundreds of billions less than it would have been at 2006 interest rates. Retirees feel the consequences disproportionately, but because much of that income would have made its way into the economy, spending and job creation also suffer.

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It's not just retirees on fixed income we should be concerned about. Let's not forget that savers of all ages—even the young person opening his first savings account—need some incentive of future reward for saving. Today, there is none.


Comment: The problem is that if interest rates rise (and they will and they should!), the cost of money for the debt laden Federal government will also rise! But back to personal finances: there is little incentive to save. But save you must!

2 comments:

  1. JP, can you save me some great confusion? A person made an article over at SI about how the memorials in Washington DC were purposely shaped like a cross to reflect Christian history. I was shocked that this fine man actually believed this! Maybe you should tell him that Washington symbolism has much, much more to do with Masonry rather than Christianity! http://www.freemasonrywatch.org/washington.html

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  2. We've been, via the Fed, promoting spending and borrowing over saving for the past 97 years, and now we're wondering why the savings rate is effectively zero.

    "Professing to be wise....."

    Anon, it's true that Masonry contributed a lot to our country, but somehow at the Founding era, people did not necessarily see that as contrary to Biblical faith in the way we do today. So it's not necessarily either/or in this case.

    Regarding cross shaped edifices....one could make all kinds of arguments about it, and absent a "fess up" from the architects or Congress, I'm reluctant to insist on any one. A cross shaped building could simply be an efficient design (it is), an assertion of Christ ruling over government (He does), or (more scary here) an assertion that government becomes a god (it tries).

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