The Great Experiment Part 1—Falling Interest Rates and the Fleeced Retiree

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Economics is a funny thing—you can fill a room with economists and ask a seemingly elementary question like, “Define inflation for me,” and you’ll find there is no clear answer. One may talk in terms of rising prices, while another may argue that rising prices are simply a symptom of inflation, much like a fever is a symptom of an illness. The inflation, the second one may argue, is an increase in the supply of money, which causes the rising prices. Money supply alone won’t cause rising prices, interjects a third, it is the velocity that money changes hands that matters. “What if the money supply doubled, but all the extra money simply went into savings accounts instead of competing for goods and services?” the third might ask. This fun crowd of economists could debate all night, but for retirees surviving off of their savings, falling interest rates equal inflation. It is falling interest rates that causes inflation so severe that retirees are forced to eat their plants, rather than live off of the vegetables.

We’ve all been taught to save for retirement. It makes perfect sense that we aren’t always going to be able to work like we could when our bodies were young and strong. As time slowly does its thing, we eventually hand in our uniforms and transition from putting money into our savings to living off of them.  With our savings, we might buy some rental properties, and live off the rental income. Or, we could purchase farmland, and rent it to a farmer. Other’s may lend their savings to a business that can make productive use of it, and live off the interest payments. Whether we are earning rent or interest, the concept is the same. We work, we save, and then we lend out our savings in exchange for an income. We bring this up because, with our current monetary system of unbacked currency and Central Bank experiments, the poor saver has been completely gutted of their retirement. Let’s take a trip back in time to see how this works.

September 1981 was a date that savers remember with tears in their eyes. What a month it was to be a financial landlord! Imagine having saved $500,000 and then read in the paper that the US government is looking to borrow your money for ten years. Hmm, you ask yourself, I’m sure their credit is good, but what will they pay me? How about 15.84%? That’s right, you lend your life savings to the US government, and in exchange, they will make annual interest payments of $79,200 every year, for ten years, and then return your $500,000 in full.

Over the life of the bond, you would have received $792,000 in interest, plus your original $500,000 returned to you in perfect condition. If it crossed your mind that you better hurry, a deal like that isn’t likely to last, you would be more correct than you could have imagined.

That month marked the beginning of a bear market in interest rates that brought rates on the ten-year bond all the way down to a low of 1.46% in July of 2016. For perspective, that same $500,000 loan that offered $79,200 per year in interest in 1981, only paid $7,300 per year in 2016.  But for the retiree trying to survive off of their savings, it gets worse. $79,200 in 1981 was no chump change.The average home cost $85,000 then. Today? try $286,251. The average new car would set you back $8,900 in 1981. Try finding one for that price today! If you are so lucky, it won’t be average, we are sure.

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For the savers looking to live off of their interest, there is no question that falling interest rates was highly inflationary. In 1981, it cost $500,000 to purchase a $79,200 annual income. By 2016, that same income rose to $5,424,657. But it gets worse! That’s before we adjust for changes in our currency’s purchasing power. According to the Bureau of Labor Statistics handy CPI inflation calculator, $79,200 in 1981 was equivalent to $204,482 in 2016 dollars. Adjusted for consumer price inflation, the true cost of retirement skyrockets 2700% to $14,005,627! With inflation that rampant, its no wonder pension funds are in crisis! Any real estate landlord would balk at having to buy over 14 million dollars worth of rental properties to achieve the same lifestyle that they enjoyed with $500,000 worth of property in 1981, but that’s what happened to the poor saver who dreamed of living off of interest.

Falling interest rates had other perverse effects that we will explore further in future writings. A look at the chart above shows that since rates bottomed in 2016, they have been working their way higher. At this point, it is impossible to tell if it is just another counter-trend rally before rates resume their decline, or if the long-term trend is actually changing. If it is true that rates are going to begin a sustained uptrend, there are going to be some major consequences. We’ll explore those in future letters.

Wanderer Financial