Tuesday, September 24, 2013

Interest Rates, Savings Rates and Their Impact on the Economy

Low risk investors, particularly in the United States, are well aware of the ultra-low interest rate environment in which we are currently living.  These low interest rates have had a profound impact on investment income from CDs in the United States, GICs in Canada and government bonds in both countries.  In this posting, I'll look at a handful of charts from the St. Louis Federal Reserve FRED database that gives us a graphical look at how bad the situation has become for savers.

First, let's look at the yield on five year Treasuries for the past 50 years:

We certainly appear to be very close to at all-time lows, don't we?  The first data point on the graph is for January 2, 1962 and the interest rate on five year Treasuries on that date was 3.88 percent.  Interest rates reached a low of 3.51 percent in April of 1962.  The yield on five year Treasuries peaked at 16.23 percent on September 8, 1981 but that's ancient history, isn't it (even though I can quite clearly remember it!).  Since the beginning of the new millennium, 5 year interest rates peaked at 6.83 percent on May 8, 2000.  Right now, five year interest rates are off their 50 year low of 0.71 percent on January 31, 2012 (and again on February 2, 2012) and have risen to 1.5 percent.  This is well below the lows achieved in the 1960s, 1970s, 1980s and 1990s.

To put these numbers in perspective, the difference between the annual simple yield on $100,000 in savings invested in Treasuries at 6.83 percent (the high since the year 2000) versus 1.5 percent is quite marked, dropping from $6830 annually to only $1500 annually, a drop of 78.0 percent.  For savers, that is a massive drop in income and cannot help but impact their consumption habits.

Now, let's look at the yield on ten year Treasuries for the past 50 years:

Once again, let's look at a few points on the curve.  The first data point for January 2, 1962 shows a ten year Treasury rate of 4.06 percent.  Ten year rates peaked at a whopping 15.59 percent again on September 8, 1981 showing very little difference from the five year rate of 16.23 percent.  Since the beginning of the new millennium, ten year Treasury rates peaked at 6.57 percent on May 8, 2000.  Since that time, ten year Treasury rates fell as low as 1.83 percent on January 31, 2012 and have since risen to their current level of 2.75 percent.

Over a ten year period, a ten year $100,000 Treasury Bond yielding 6.57 percent (the peak rate since 2000) will pay an investor $65,700 since the interest is not compounded.  A ten year Treasury Bond yielding only 2.75 percent (roughly the current level) will pay an investor only $27,500, an income drop of $38,200 or 58.1 percent.  Again, that hurts!

Let's look at three last graphs starting with the personal savings rate:

Here's the personal savings rate (in blue) with an overlay of the five year Treasury yield (in red):

I selected the five year Treasury rather than the ten year since most savers purchase CDs with a maturity of no more than five years.  You'll notice right away that the two lines pretty much track each other; when rates are high, Americans tend to save more.  The lines diverged just prior to the new millennium as the housing market started to take off.  Even though interest rates rose, consumers were starting to get the feeling that their homes were a better store of wealth.  This is also quite noticeable around 2005 - 2006; interest rates rose but savings did not, falling to a low of 1.0 percent in April 2005.  Consumers were increasingly in debt and were unable to increase their savings to meet the rising yields on investments.  Savings rose as the economy started imploding in 2008 even though interest rates kept falling, reaching a peak of 8.3 percent in May 2008.  Unfortunately, in the past two years, the savings rate has fallen from 5.8 percent in June 2010 to only 4.4 percent in July 2013, tracking the ever-dropping yield on Treasuries.

Lastly, here’s the Personal Interest Income graph:

Notice how total personal interest income has dropped from its peak during the Great Recession?  Interest income fell from a peak of $1395 billion in September 2007 to $1194 billion in September 2011, a drop of 14.4 percent.  You will also note that this level has been more or less consistent since the end of the Great Recession, meaning that there is a persistent drop in income for millions of Americans.  Thank you indeed, Mr. Bernanke!

From this graphical presentation, I hope that you will see the close relationship between the savings rate and the interest yield on investments, two factors that may explain the very reluctant "recovery" since the "end" of the Great Recession.  While Mr. Bernanke and the Federal Reserve try desperate measures to plug holes in the economy by Quantitatively Easing and "Twisting", it is quite apparent that these fiscal mechanisms are probably having a negative effect on the economy simply because Americans who save money and live off of their interest income have seen their "wages" slashed, resulting in lower consumer spending, a factor that is responsible for 70 percent of GDP as shown here:

My suspicion is that the drop in interest rates has had a bigger negative impact than it normally would because it has been so prolonged, leading to a "poverty effect" (the opposite to the "wealth effect" of certain assets).  As well, consumers who rely on interest income have been forced to modestly increase their savings rate (as seen on the graph showing both interest rates and savings rates) to make up for the income losses, removing additional monies that might have been spent, from the economy.  Since consumer spending is such a key part of GDP, Mr. Bernanke's ultra-low interest rate policies have quite obviously had a substantial negative impact on GDP growth by cutting the incomes of mainly older Americans for a lengthy period of time, an outcome that the Fed obviously did not anticipate when their Grand Experiment started four years ago.  

Economics is not a science, a lesson that seems to be very difficult to learn, particularly by its practitioners.  It becomes more and more obvious that the negative impacts of the Fed's zero interest rate policies are far more widespread than would have been anticipated.


  1. Thanks for highlighting several of the hidden cost of low interest rates. Bernanke has done a great disservice to those who have worked and saved. When inflation is factored in savers can slowly watch their savings erode or enter the very high risk markets. More below to supplement your post,


  2. I was looking for the information like this.. good one