Swooning stock markets are not the only threat to baby boomers’ retirements. Having just finished a periodic update of retirement income projections, it is clear my wife and I won’t be as flush in retirement as we had expected just a few years ago.
The problem is not the drop in asset values. We put our money where my mouth was by mid-2007, after having opined for years on the unsustainable trends underpinning the U.S. economy, and moved the last of our funds out of equities. So we have not lost anything in the stock market.
It is rather low interest rates that are eroding the retirement income projections we started to make when I got into my 50s. And we are not alone. Fellow boomers who are fretting about how far their 401(k) balances have fallen should pay more attention to how real investment returns barely above zero will affect them. For many, ongoing depressed interest rates will have a bigger long-term impact than whatever has happened to stock prices since mid-2007.
This all illustrates an old but harsh fact: Interest rates are a two-edged sword that can cut brutally when falling as well as when rising. What benefits one group in society savages another.
Interest is simply a price for the use of money over time. As such, it is no different from the price of milk or pork chops. Low prices benefit buyers, as the ongoing two-gallons-for-$6 milk sale at a neighborhood gas station benefits a milk-loving farm kid like me. But low milk prices hammer our relatives and friends who are still involved in the dairy business, just as cheap pork chops punish those who raise hogs. But when farmers enjoy high prices, as dairy and pork producers did just 18 months ago, consumers must pay more.
There is no “right” interest rate any more than there is a specific price for milk, onions, blue jeans or toilet paper that is optimal for society as a whole.
Low interest rates favor borrowers, including people buying houses and those who build or sell them. They also favor many near-insolvent financial institutions, providing access to money on the cheap.
But low rates harm savers, including more than 75 million baby boomers who will retire in the next 20 years. Low returns on capital, whether directly as interest or through lower dividends and stock appreciation, cut the levels of household spending that any given retirement nest egg can support. We won’t be able to do all that we hoped or dreamed of doing.
Money does differ from milk or onions or jeans in one crucial respect, however. No one can create these goods out of nothing with the stroke of a computer cursor. But a central bank can create money that easily, and the Fed has created money with a vengeance over the past two years.
Interest rates are not low through some natural cause. They are low because central banks around the world have boosted their nations’ money supplies in desperate efforts to stave off another Great Depression. But while the world economy did not fall into an abyss 12 months ago, it is mired in a swamp of sick financial institutions, cash-strapped consumers and increasingly indebted governments. And it is likely that we will remain in this swamp for several years to come.
The Fed giveth and the Fed taketh away. Only time will tell whether the Fed’s name and decisions will be blessed by history. In the meantime, those for whom interest earned is more important than interest paid face tough sledding for a long time.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.