Wednesday, July 2, 2014

The High Cost and Painful Reality of Experimental Monetary Policy

Over the past five years since the Fed began its long-term experiment with near-zero interest rates in a desperate attempt to prod the economy back to life, the greatest impact has been on America's savers, most particularly, those who retire and live off the income from a lifetime of savings.  How much have savers sacrificed to QE?  For the purpose of this posting, I'm looking at non-compounding interest rates on jumbo deposits (i.e. more than $100,000), invested in a five year Certificate of Deposit.

Here is a graph from FRED showing interest rates on a five year CD since May 2009:

The first thing to note is that a five year CD is currently paying 0.77 percent.  This is down from 2.3 percent in October 2009.  Assuming an investment of $100,000, annual interest income has dropped from $2300 in 2009 to just $770 today.   Secondly, you should note that interest rates on five year CDs have been below 1 percent since mid-September 2012.  That's an interest income haircut of 66.5 percent!

Since FRED does not track interest rates on five year CDs before mid-2009, I'm switching gears a bit so that we can look back past the point where the Fed was really messing with the yield curve.  As such, I'm using the Federal Reserve's Selected Interest Rates Historical Data that you can find here.  I'm using the interest rates on five year Treasuries between 1953 and the present for the purposes of this posting:

The yield on five year Treasuries peaked at a heady 15.93 percent in September 1981.  Yes, those were the good ol' days for savers, weren't they?  The yield on Treasuries reached its nadir of 0.62 percent in July 2012 and has remained below two percent since July 2010 except for a  very brief three month period in early 2011.  The rate currently sits at 1.59 percent.  Over the full 61 year period from 1953 to the present, the yield on five year Treasuries averaged 5.79 percent.  If we look at the period prior to the Fed's Great Recession meddling (i.e. before November 2008 when QE 1 was announced) and exclude the time since the Grand Monetary Policy Experiment has been in place, the average yield on five year Treasuries rises to 6.21 percent.  Since Mr. Bernanke's Experiment began in December 2008, the average yield on five year Treasuries has fallen to 1.52 percent.

Now, let's go back to that imaginary $100,000 that you have lying around, waiting to be invested to provide funding for your retirement years.  Using the interest data (interest is paid annually) in the previous paragraph, here are some income scenarios:

$100,000 at 5.79 percent - interest income $5790 per year
$100,000 at 6.21 percent - interest income $6210 per year
$100,000 at 1.52 percent - interest income $1520 per year

Financial planners often banter about the $1 million number as what may be required as savings for retirement, particularly for those retirees that are not covered by a pension plan.  If interest rates had remained at or close to their six decade average of 5.79 percent, a million dollars invested would produce interest income of $57,900 annually.  Not too shabby and well within what many retirees could live on particularly when other sources of income (i.e. part-time work, government entitlements etcetera) are included.  Under the interest rate scenario that has become the new norm since 2008 - 2009, that same million dollars will only produce interest income of $15,200, putting the retirees in a financial bind unless they are willing to draw down the principal, a rather short-sighted approach to the long-term needs of retirement.

In case you should think that this is an issue facing just American savers, here is a chart from the Bank of Canada showing five year real (i.e. corrected for inflation) interest rates for several key OECD nations between 1971 and 2005:

Note that in several nations, by 2002, real interest rates were either negative or hovering around zero percent.  This alone makes it almost impossible for savers to get ahead.

With so much of growth in today's economy requiring spending by consumers, the aforementioned issue may explain part of the reason why the recovery has not been much of a recovery.  Quantitative easing and the resulting low interest rate environment has a strong anti-savings bias which, in large part, is its intention.  In the current low interest rate environment, there is little point to saving money if one's goal is to increase retirement income  Central bankers would much rather have us spend, spend, spend than save, save, save because they view savers as a drag on economic growth whereas, they can rely on spenders to prod the economy back to life.  As well, by keeping interest rates low, older savers have been forced to look to more risky investments to make a "living return", ignoring risk in that never-ending hunt for yield.  I believe that this is largely why the stock market no longer reflects economic reality rather, it is the unreasonably high demand by desperate and less than experienced investors for overpriced shares in what is currently a very weak economy.


  1. It might soon become apparent the economic efficiency of credit is beginning to collapse and the additional money poured into the system coupled with lower rates can no longer drive the economy forward. When this happens we are at the end game.

    At some point the return on loaning money is simply not worth the risk! Why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? When this happens the only safe place to store wealth will be in "tangible assets" and the only lenders will be those who print the money that nobody wants.

    The collapse of credit can pose major problems such as what we saw when many sellers were forced to demand payment up front before shipping goods in 2008. More on this subject below.

  2. What the Fed is pouring is banks reserves, not money in circulation. A big part of these reserves are excess reserves.

    As regards the interest rates, the income has to be inflation adjusted. Inflation was very low in the last couple of years. Moreover, you miss the point of how much poorer people would have been had the negative spiral that was triggered in 2008 been left to lead the US to a second Great Depression.

    And the housing market? Do you really think that US citizens would have been better off with hoeing prices still in the doldrums?

    1. I don't think that the Fed's intention was to add excess reserves held on deposit with the Fed when they started to crank up the presses. U.S. citizens would have been far better off had they not been fed what appeared to be cheap credit back in the mid-2000s.

  3. To Mihail Iliev, it should be noted this is a double edged sword and low interest rates come at a hidden cost. Those who have worked hard and saved are feeling this pain. More on this subject in the article below.

  4. I have yet to hear that the nations debt is declining! The rate at which we were borrowing is slowing as of late but we ARE STILL BORROWING! America at one time was the Golden country of safety thus people from other nations bought our debt and kept interest rates here low. Low rates helped us with growing our economy after WW2. But today America doesn't have the "Golden Country" title any longer. Other countries are actually safer than America. We will be forced to raise rate to attract money and if we raise them too high we wont be able to service that debt. The US will be forced in Bankruptcy as a nation.
    Yet we are still giving Israel money to buy arms to destroy Palestine and then giving Palestine money to rebuild and to care for refugees caused by the same destruction.

    We still have politicians that don't care about this country, don't require our courts to abide by the Constitution and laws of this nation. Politicians wont shake the boat and keep spending to buy votes. So like Rome, the US is failing while our politicians are still using our money to buy votes. Consequently we continue to get the likes of Reid and Pelosi both of whom would sell this country out in a moment to stay in office!