FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
May 13, 2014

IN THIS ISSUE:

1. How Super Low Interest Rates Punish Savers

2. Has the Low Interest Rate Policy Been Worth It?

3. Some Claim the Fed’s Policies are Corrupt

4. Conclusions – Ineptitude or Corruption?

How Super-Low Interest Rates Punish Savers

Get a group of adults together in a social setting and the conversation almost invariably gets around to a discussion about the paltry returns savers have been earning on their money in recent years. Three-month certificates of deposits are averaging only 0.23% nationally; one-year CDs are at only 1% if you can get it; and five-year CDs get you only about 2%. And rates have been at or near these depressed levels for the last four years.

Fig.1

When the Fed realized in early 2008 that we were in a financial crisis, it quickly ratcheted down the Federal Funds rate from 5.25% to near zero where it’s been since late 2009. The Fed Open Market Committee (FOMC) adopted a policy of keeping the key rate between zero and 0.25% indefinitely. This is commonly referred to as “ZIRP” – Zero Interest Rate Policy. As the Fed moved to ZIRP, banks, money markets and savings institutions quickly lowered their savings rates accordingly.

 Interest Rate

The current FOMC, now under the leadership of Janet Yellen, says it plans to keep the Fed Funds rate near zero at least until sometime in 2015. So savers have been punished for over five years now, with the likelihood of at least another year to go. The Fed says that when it does decide to raise rates, it will do so slowly.

I’ve often wondered when someone would calculate just how much savers have lost due to the plunge in short-term interest rates to near zero. Well in late April, MoneyRates.com did just that. In short, MoneyRates estimated that low interest rates have cost savers at least a whopping $758 billion in lost purchasing power over the five years ended in 2013. That number will almost certainly top $1 trillion by the time the Fed starts raising rates sometime next year.

For the past five years, MoneyRates.com has calculated the cost of the Fed’s low-interest-rate policies in terms of how much purchasing power savers have lost to inflation as a result of today’s artificially low bank rates. For each of the five years, those losses have exceeded $100 billion, and the running total at the end of last year was $757.9 billion.

MoneyRates suggests that it has not been the Fed’s intention to hurt savers, but I would argue that the Fed knew very well that its policy of keeping the key Fed Funds rate near zero would cause saving rates to plunge. While there is a lot of support for low interest rates – from stock market investors, home buyers, business borrowers, etc. – it has not been a cost-free policy.

While bank savings rates have traditionally been able to earn savers a little more than inflation, they have consistently lagged behind inflation during this era of extraordinarily low interest rates. That means that depositors in CDs, savings accounts and money market accounts have been losing purchasing power. This lost purchasing power is the hidden cost of the Fed’s policies.

In 2013, there was $9.427 trillion on deposit at U.S. banks. Over the past year, average money market rates have ranged from 0.08% to 0.10%. Inflation, meanwhile, was 1.5% over that same period. Because inflation grew much faster than the average bank savings rate, consumers lost purchasing power. Adjusting that $9.427 trillion upward for interest earnings but then downward to account for the inflation rate yields a net loss in purchasing power of $122.5 billion. When this loss is added to the purchasing power losses from the previous four years, the total comes to $757.9 billion – the effective price of the Fed’s low-rate policies.

Has the Low Interest Rate Policy Been Worth It?

The question is, what has this three-quarters of a trillion dollars in lost purchasing power bought us? The results of the Fed’s low interest rate policies are of questionable value:

  1. Slow economic performance. Late last year, the real GDP growth rate slipped from 4.1% in the 3Q to 2.6% in the 4Q. For the last four years, the economy has grown only 2.3% on average. Four and a half years into a recovery, the economy still cannot sustain any momentum. GDP was up only 0.1% in the 1Q of this year.
  2. Too much emphasis on borrowing. The housing crisis was caused by irresponsible borrowing, and yet the Fed’s response is to encourage more borrowing by lowering interest rates. While mortgage debt did decline immediately following the housing crisis (in large part because of foreclosures), total mortgage debt outstanding has begun to creep up again recently. Meanwhile, total non-mortgage consumer debt has risen by more than 20% since 2009.
  3. Over-dependency on low interest rates. Low interest rates have helped both the stock market and the housing sector recover, but there are signs that neither recovery would survive a return to more normal interest rates. In essence, those patients are still on life support.

Like any other economic decision, the Fed’s low interest rate policies should be looked at in cost-benefit terms. So far, the net benefits are highly suspect in light of the costs.

Things have been bad for depositors, to the tune of three-quarters of a trillion dollars in lost purchasing power over the past five years. But at the same time, at least some have been able to benefit from record-low mortgage rates, which were also a result of Fed policy.

Now, however, the Fed is cutting back on its bond buying program to keep long-term rates like mortgage rates down. At the same time though, it is continuing to keep short-term rates, such as deposit rates, near zero. The net result is the worst of both worlds for bank customers: It still does not pay to save money in these types of accounts, but it will increasingly cost more to borrow it.

Bailouts were largely seen as a necessary evil in the aftermath of the financial crisis. But at least with the bailouts of Wall Street firms and the auto companies, the price tag was disclosed on the front end.

Super low interest rates are effectively another form of bailout. They have helped to artificially support the banking system and the housing market. In this case though, it has been a stealth bailout, as no price tag has been disclosed until now. As noted above, MoneyRates.com estimates that that price tag now exceeds three-quarters of a trillion dollars. When measured against the shaky results low interest rate policies have produced, the bank depositors who have shouldered the burden of this bailout may well question if the loss has been worth it. And it’s certainly not hard to conclude that it wasn’t.

As noted above, the loss in purchasing power over the five years ended in 2013 comes to almost $758 billion. As also noted above, the loss in 2013 alone was a reported $122.5 billion. If the losses in 2014 and 2015 are also $122.5 billion, that will push the total loss to more than $1 trillion! You would think that would be making news everywhere. It isn’t. The media doesn’t care.

Some Claim the Fed’s Policies are Corrupt

Even with the huge volume of news I read each and every week, I have found only one story on this topic, which included a link to MoneyRates.com that did the

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