Dear Savers and Retirees: here’s how you’re being Screwed

On today’s Capital Account, we were lucky to have both economist Dean Baker, as well as deputy editor of Business Insider, Joe Weisenthal on our program to discuss a few things. The interview with Joe is what I would like to focus briefly on though [comes in at 16:50], because it was relevant to a post he published today titled “DEAR SAVERS AND RETIREES: Stop Whining About Those Lousy Rates You’re Getting From The Bank.”

In the post, Joe contested the notion that savers should be earning a return on their money. We thought it would be fun to have him on, because it was clear that his post was going to inflame the opinions of various people. Joe is of the opinion that negative real savings rates (although I do not believe the hedonically adjusted, geometrically weighted and substitution laden CPI, even this phony number is higher than the interest you would earn on a 3-month CD) are where they are not because of the Federal Reserve and central bank instituted financial repression (as PIMCO’s Bill Gross calls it), but because of the realities of a bad economy.

This couldn’t be further from the truth. Absent a Federal Reserve, we would be in a deflationary period. Prices would be falling, which means that your savings would be earning a real return irrespective of what the nominal interest rate on your CD is. You could be earning zero nominal interest at the bank, but when you took that money out 1 or 3 or 5 years later, you would be able to buy more stuff with it. In particular, you would be able to purchase assets at a much cheaper price. Although we have had asset price deflation since 2008, the extent to which prices are being propped up by the Federal Reserve and other government actions is simply unknowable due to the historically unprecedented balance sheet expansion of almost 4x in the past 3 years, along with a policy of zero-percent interest rates.

Credit driven booms always end as a result of credit contractions. The “boom” we had during the middle of the 2000′s was driven by a mortgage refinancing bubble. That bubble burst in 2007-2008, and it burst because people slowly, and then quickly, went from being buyers to being sellers, and from extending credit to contracting credit. The contraction of credit in an economy means that savings become more scarce a) because the saver begins to demand higher and higher interest payments as he/she reappraises risk upwards in the marketplace and b) because savings are destroyed through bankruptcies, default and liquidations of malinvestment as banks go under. Savings are what drive investment. If you don’t have savings, then you can’t have capital formation, which occurs when savings are put to work for the purposes of creating profitable enterprise and economic growth. When the supply of savings becomes more scarce, the price of those savings rises, which is reflected in the interest rate. The interest rate is actually the price of money. It is the cost of capital. It is the price that a borrower is willing to pay for someone else’s money. Therefore, it behaves exactly as one would expect any price to behave. It reacts every second of every minute of every hour of every day to the normal fluctuations in supply of and demand for money in the market place. The marketplace is the credit and capital markets. When they froze in late 2008, it was because the savers (i.e. those with money) were no longer willing to lend their money out at any price (i.e. interest rates shot up through the roof) irrespective of the intense demand for that money by firms like Lehman and Citigroup. Everyone wanted money, and no one was willing to lend it. In addition, everyone was selling, and no one was buying. A cascade of prices had a feed-back effect on credit, because credit is extended off the back of asset price inflation. Things are good during the boom, as money goes for cheap, but during the bust, credit can quickly evaporate into thin air.

It seems to be Joe’s contention, and that of others, that in a period where uncertainty abounds, and investors are more concerned with the “return of their money,” as opposed to the “return on their money,” interest rates should be low. This is because, in his view, people are willing to pay any price to keep their money safe. I agree with him, and this would explain why treasury yields have fallen during a period where LSAPs have been tapered off, but this is hardly the entire story. Interest bearing savings accounts have been negative, in real terms for most if not all of this crisis, even while the stock market was rebounding from its March 2009 lows. In fact, savers have been punished irrespective of what the market and investors have been doing with their money, and this is because the central banks are dictating what savers should and should not earn by virtue of their interest rate policies. The market is not determining the rate of interest for savers, as should be the case, but rather, it is the central banks that are doing it. And they have decided that savers should be punished for not taking the risk of investing or speculating with their money. They are trying to force savers, at gunpoint, to put their money into the stock market, or into their home, or anywhere – just not at the bank. This seems counterintuitive, since you would think that banks want your money, but the reality of our current money system is that so much credit has been extended by the banking system, that if banks were actually forced to compete for savings, there wouldn’t be many left standing by the end of the process. The healthiest banks would quickly suck up all the savings, and the rest would collapse. Therefore, banks want zero interest rates and special loan facilities. This is the only way to fund the banking system now. If banks actually had to fund their operations through savings, we wouldn’t have a banking system today, because it would collapse instantaneously.

When Joe says that savers should basically shut up and deal with a negative return on their hard-earned money, what he is really saying is that central banks have a right to decide how much of your own money you get to keep. This philosophy is what has created this depression (and I believe we are in one, not so technical, depression) to begin with, because each time we had a rescission, it was met with “accommodative” monetary policy. This is another way of saying that the Fed intervened in the interbank lending or fed funds market to push down the price of money (interest rate) when savers were demanding higher interest on their money. Why were they demanding higher interest rates? Because, money was becoming more scarce as debts were being liquidated and the investment landscape was being seen as riskier than before, therefore warranting higher returns for that extra risk. These are periods where it “pays to be in cash,” but the Fed, and other central banks, don’t like this. They no longer seem to think that it should ever pay to be in cash. The philosophy that was adopted by the Greenspan Fed in particular was one of keeping the pedal to the monetary metal all the way through the smokey, crash ridden turn, and pray to god that they don’t hit anything. Right now is one of those periods, where it should pay to be in cash, but the central banks are hell bent on preventing this. Their obsession with preventing price declines and credit contractions is why people like Mohamed El-Erian are coming out with words like “Paranormal” and “Bi-Modal Fat Tail Distribution” to describe the investment environment. The saver is no longer able to decide whether it is better for he or she to remain in cash or to jump out of cash and into assets, because the central banks are leaning against the wind and no one knows yet whether the wind or the crew will win out.

I may have digressed here a bit, so let me just get back to one other point that Joe made in his article, and that many other people make. In response to those who suggest that we raise rates, Joe says:

We’d be incentivizing people to save more at a time when the biggest problem is a lack of investment and hiring. And we’re not even convinced that rates would rise. Think about it: An interest rate hike would discourage people from taking risk, meaning they’d dump their stocks … and buy Treasuries, driving the curve even lower!

Sorry, but it simply isn’t true that the biggest problem is a lack of investment and hiring. That is a symptom of a private sector that doesn’t see sufficient opportunities on the horizon to warrant borrowing other people’s money (or even using their own capital) to make investments in the future. Business would rather sit on that cash, wait for the economy to contract and for more bankruptcies to occur, and then begin to deploy that capital. It’s this type of thinking that supports the logic behind ZRIP and deficit spending. If the only problem is investment and hiring, then just get the government to do it, right?

The Fed has been able to overcome periods like this in the past by pushing the rate of interest earned on savings lower and lower, until now, where it is at zero and will remain there for the indefinite future. The government, in turn, has engaged in deficit spending, trying desperately to offset the drop in aggregate demand seen in the private sector, so as to hopefully incentivize more investment and more hiring. It isn’t working this time though, and the smooth tongued wizards can’t seem to figure out why. The reasons is simple: the private sector is burned out. It doesn’t want to borrow anymore. And this obsession by mainline economists and other pundits with growth, and the need to expand economic growth at all costs, is part of the problem. You need sustainable growth (actually, you don’t need growth at all, as Chris Martenson has pointed out, but that is another story for another time), and the private sector is in a far better position to create sustainable growth, absent certain depleting resource constrains and environmental degradation, than the government. The private sector isn’t in the business of creating jobs. The jobs are a consequence; they are not the objective. When the objective is jobs and growth, irrespective of what kind of growth and what types of jobs, then you get massive capital misallocation, which shows up in the form of housing bubbles, or excessive car building, or whatever. The soviet union was expert at this. They actually managed to create products with NEGATIVE value. In other words, they dug up and put together goods whose component parts were worth more than the final product. This is UNSUSTAINABLE growth, otherwise known as WASTE, and it doesn’t matter how low you make rates, or how much you divert spending from the private sector to the public sector, you can’t get around the economic reality that you can’t get something for nothing. You can’t go around creating profit-losing enterprises and negative-value products and expect to not drive your economy into the ground. You also can’t function with the subconscious idea that resources are infinite, and that therefore, growth is infinite. You can only fuck up so many times before reality puts on the breaks, and that’s where we are today.

So, I guess my response to the argument that savers should be happy with a negative real return is that is should be left up to the saver, not the central bank, to make this determination. Of course, if the market were left to decide, real interest rates would sky-rocket, because the economy would contract, and the only service that a depositor would pay for would be the fees associated with storing his/her money. This is essentially what people have been doing with gold. This is why some very smart people have been in precious metals since well before the crash of 2008, and have been storing those metals in their own homes or at bullion vaults and gladly paying a fee for the service. The metals have been appreciating in value, despite the fact that they do not yield a return, but rather cost the owner for holding them. This is exactly what you would expect during a deflation, and I think this is where people like Joe miss the point. It is exactly because you demand a return of your money over a returnon your money, that people expect a positive return on their savings. It isn’t that we need a positive nominal yield, but rather that we expect to at least sustain if not grow our purchasing power during bad economic times. In this sense, gold and other precious metals have been a safe store of value for investors who do not trust the banking system (FDIC insurance included), but who also want to hedge against central bank monetary debasement. But I’m digressing again.

Hope that wasn’t a ramble.