September 17, 2012
If I were about to retire and hoped to depend on my pension for an income, I would be very worried about the implication of the US Federal Reserve’s move last Thursday.
Before we look at the pension implication of the world’s new zero-interest rates policy, lets examine what the Fed did last Thursday, why it did it, what is says about politics in the US and what it says about what might be around the corner for the US. After that, we will bring it all back home and see what it means for pensions.
Here’s what Ben Bernanke said: “We’re looking for something that involves unemployment coming down in a sustained way, not necessarily a rapid way, because I don’t know if our tools are that strong, but we’d like to see an economy which is strong enough that it will support improving labour market conditions.”
With this statement, Bernanke set the record for American – and to a large extent – global monetary policy for the foreseeable future. This is the most radical monetary move by a central banker that I have witnessed since the Bundesbank converted worthless East German marks to real Deutschmarks at a rate of one for one. But back then, the German central bank’s reason was a once in a two-generation moment – German reunification.
Even Draghi’s moves last week were set against the backdrop of a collapsing monetary union.
In contrast, the Fed acted because it was fed up or mildly annoyed with the jobs market not reacting to previous stimulus quickly enough. It was impatient, so it decided to fire the big bazooka.
But the true scale of the radicalism is not yet appreciated.
The Federal Reserve has said that it will print money in unlimited quantities, with no upper limit, and it will lower its own standards about what sort of collateral it will accept in exchange for these new crisp dollars.
From now on, Bernanke has eliminated any doubt about what he is going to do. If economic data is weak in the US, the Fed will buy up all sorts of securities, creating money and making sure that, whatever else might be lacking in the US economy, it won’t be liquidity.
This is in contrast to the ECB’s move of last week, which now seems prudent and coy. The ECB is targeting Spanish and Italian bonds to save the euro – which is a big deal. The US central bank is reacting because it’s a bit irritated.
Both central banks have signalled that monetary policy will be used extensively to achieve different aims. In Europe, it is to bring down bond yields so that countries don’t default. In America, rates are to be kept low primarily to coax people to invest and spend, generating the demand necessary to bring down unemployment.
While I can see why Draghi acted, Bernanke perplexes me. It scares me to think what horrors he sees down the road for the US economy to justify such an aggressive response.
We know that monetary policy takes a while to work, so does he see a massive recession next year or a major bond sell-off? Is that why he wants the dollar weaker and is prepared to use everything in his power now?
The move has prompted rallies in all sorts of assets from stocks and gold to property prices in Singapore. Obviously, the timing of the move in the US has also given political commentators much to chew on.
Those in the Republican camp see this a blatant economic engineering to protect Bernanke’s boss, Obama, ahead of the election. Those in the Democratic camp see it as responsible central banking in the face of a weakened jobs market.
Indeed, in the great culture war that defines American economics, the different sides are interpreting Bernanke’s move completely differently.
On the Democratic side, left-of-centre economists are urging Bernanke not to stop here, but to keep printing money until the economy turns around. They depict the Fed boss as a well-intentioned man who hasn’t got the courage of his convictions, which are urging him to be more aggressive. They argue that the absence of inflation means that he can do more and more. They say let’s worry about jobs now and worry about inflation later when it emerges.
On the other side, the type of economics that were on display at the Republican convention the other week, believe that, the more the Fed prints now, the more hyper-inflation in the US will become a reality in the years ahead.
They also point to the fact that there have been two previous bouts of quantitative easing and nothing has happened. They offer this as evidence that monetary financing doesn’t work.
The Democratic side says it hasn’t worked because it wasn’t big enough and therefore, the US needs more of it.
Whatever side you are on, there is no denying that the moves from both central banks – but now led by the US Federal Reserve – will drive interest rates down to extremely low levels.
The angle I would like to finish on is all this means for your pension and for the outlook for investment in general.
There are many thousands of Irish baby boomers, who are now looking to live off their private pension, and there are more who depend on the state pension.
There are people who are managing their savings and need to get a low-risk return over the coming years to live off. What does the zero-interest rates policy mean for them?
In short, it means they are up the creek. The simple truth of the matter is that keeping interest rates near record lows tramples all over investment income and retirement prospects.
There is no return now in the safe bond market with yields down at 1 per cent. This is less than the rate of inflation in Ireland so you would be paying a government to hold your money.
In the past, when bond yields were at 5 per cent, a risk-averse investor could invest in bonds and not worry. These days are over.
Investors now have to go looking for yield ,and this is dangerous and risky. Also, the many fund managers in Dublin who simply took people’s money and put it in a bond fund, took a fee and headed to Guilbaud’s for lunch, now have to think a bit harder.
The implication of the zero-interest rate policy for Ireland’s retiring baby boomer generation, traditionally dependent on bond yields for their pension’s income, is disastrous.
A cynic looking at the ways that different generations in Ireland have fared over the past two decades might say that it is only fair. Since the late middle-aged and recent retirees made all the money on the property boom, we shouldn’t worry too much about them.
In terms of the generations in Ireland, it is now clear that the zero-interest rate policy is the debtors’ revenge. Maybe it’s about time.