Posted on November 2, 2012 by David Laidlaw
One concern in the here and now is about the effect of low interest rates on savers and investors. My colleagues and I know that people who rely on investments that pay a fixed interest rate, such as certificates of deposit, are receiving very low returns, a situation that has involved significant hardship for some.
Excerpt from Ben Bernanke’s speech on October 1, 2012 at the Economic Club of Indiana
The Federal Reserve’s Quantitative Easing policies involve the central bank’s purchase of bonds. This purchasing creates demand which supports the price of those bonds and reduces interest rates throughout the market. Ben Bernanke has proactively defended potential criticisms of this policy in a number of public forums since QE 3 was unveiled.
Bernanke’s basic argument is that savers are not just savers, but participants in the overall economy. He drove home this point by concluding this section of his speech as follows:
If, in contrast, the Fed were to raise rates now, before the economic recovery is fully entrenched, house prices might resume declines, the values of businesses large and small would drop, and, critically, unemployment would likely start to rise again. Such outcomes would ultimately not be good for savers or anyone else, to maturitydditionally argues that some savers are also borrowers who benefit from lower mortgage or other debt servicing costs. These arguments do not make any sense. The Federal Reserve is actively keeping interest rates significantly lower than they would be absent the artificial demand provided by sustained buying of Treasuries and Mortgage-backed Securities.
Most savers have accumulated wealth to provide for themselves in the future. Many are retirees who no longer receive a paycheck and therefore must rely on interest, dividends and asset sales to meet their daily needs. The biggest financial issue facing these retirees is how to get a sustainable level of income from their savings.
Given the Fed’s policies, it is now impossible to obtain sufficient income through buying quality bonds. Here are yields-to maturity for a few quality bonds:
- 10-year Treasury: 1.62%
- 10-year Municipal Bond – S&P Index (AA rated; Duration = 6):1.69%
- US Intermediate Grade Credit (Corporate Bond Index): 1.9%
These levels compare unfavorably with the level of inflationwhich shows that the CPI has increased by 1.7% over the last 12-months. Stripping out food and energy shows that “core” inflation has increased by 1.9%. Therefore, holders of the bonds listed above are losing money against inflation.
It is disingenuous for the Bernanke to argue that savers are better off as of a result of the Fed’s programs. The well-being of savers is being sacrificed for the benefit of borrowers.
* “P&G Directors Face Own Challenges While Keeping Tabs on McDonald”, Jeff Green, September 4, 2012, Bloomberg News.