Low Interest Rates are a Double-Edged Sword
In the United States, the Fed has a long-standing policy of adjusting interest rates as a means to propel the American economy. When they lower interest rates, companies can borrow affordable capital and invest in growing their business operations. Likewise, consumers can borrow money to purchase homes, cars and other necessaries.
However, this comes at a steep cost to those who are not borrowing capital. One consequence to low interest rates is that much of the population has no means to earn significant return on their savings. When I was a boy, my father took me to our local bank and offered to match whatever I put away in a savings account. He did this to teach me the importance making my money work for me rather than me working for my money. It’s a lesson that I have taken to heart for most of my life.
With that said, I struggle to understand how the lesson my father taught me can be conveyed to today’s generation. Putting aside money no longer leads to building wealth. When my father took me to the bank for the first time, rates were around 7% for a savings account. Today, interest rates for savings account are below .5%, which hardly encourages people to put away money. As investments go, a savings account will not even keep pace with inflation.
Ultimately, there is an inverse relationship between low interest rates and economic return for the majority of the country. For people with wealth, providing low-cost capital means that they can grow their businesses and ultimately make more money. But for those whose jobs do not provide a high level of income, the money they save will not allow them to accumulate wealth.
Furthermore, when those low-income-earners ultimately retire (if they can), they will have to consume their principal rather than live off the income generated from it. Not only does this make retirement difficult for many, but it means that retirees are less likely to have a financial legacy to pass down to their children. This leads to a cycle for families where each generation must effectively start over.
Over the years, I have shared this point with several business leaders. They often argued that even a wealthy person must save money and they will also experience the pain of low interest rates. However, this is simply not true. When you have large amounts of capital, you also have greater access to investments. You can work with investment banks to receive preferred investments that offer a much higher rate of return and protect principal. You also have the option of investing in real estate within urban areas which is far less risky than cheaper real estate options outside of major cities. In short, you can make less risky investments with higher returns.
For example, I work with an investment bank that offered me an opportunity to purchase BRIDGE WORKFORCE AND AFFORDABLE HOUSING FUND. This fund invests in affordable housing in major metropolitan areas. The terms of the investment are a tax-efficient 7% preferred yield with some additional benefits and the group that manages the property has no upside unless you receive your interest and have complete repayment of principal. The properties they invest in are supported by debt from a preferred loan from Freddy Mac and carry a far lower interest rate than any that you or I could get on our own. This type of investment has a very high minimum cash commitment which keeps it out of reach for most.
What it boils down to is that without wealth, there is no access to investments like this. This leaves most investors with options such as savings accounts, bonds and other common securities that are publicly traded. Bonds and savings accounts being susceptible to low interest rates and common securities such as publicly traded stocks.
This brings me to the second most common argument people make about low interest rates; everyone can simply invest in the stock market to get a higher return. The problem with using stocks as a substitute for savings accounts is that to do so, you are putting your principal at risk. The stock market can be a good way to invest your money, but it is not the same risk incurred by a wealthy business owner when they take out a low interest loan.
Low-cost loans are a low-risk venture for a wealthy business owner, but those same low-cost loans push lower income investors into riskier investments. In other words, the Fed is indirectly subsidizing businesses through low-cost capital but at the expense of average citizens.
We Should Care About the Impact of Low Interest Rates
When retired people use their principle to live, they have to anticipate their expenses over the remainder of their lives. The problem is that most people are one catastrophe (e.g. major healthcare incident) away from losing the income they rely upon. Once they encounter such a hiccup, they lack the ability to get themselves back on track economically.
Furthermore, having no investment vehicle to accumulate wealth ensures that many Americans do not have the means to save money and get ahead. They remain consumers rather than savers and as with retired folks, they do not accumulate a financial buffer to cover rainy days or retirement.
Both of these problems allow people to fall off the economic spectrum which in turn leaves them reliant on expensive social services. Having no vehicle for savings leads to poverty, food insecurity and hardship for many.
There is an additional point to consider. Society as a whole is always better off when we establish a limit on far, we are willing to let people fall. I am not advocating a world of social services, but I do think that if we want a happier, healthier society, we should consider how we elevate those less fortunate in our population. Promoting savings is a great way to do just that.
Making Our Economic System More Balanced
One simple approach is to establish a subsidized savings rate that operates separately from current interest rates. The rate can be pinned to the current rate and potentially be set up with a minimum rate (e.g. 5%).
This type of savings program coupled with setting the maximum amount to the IRA contribution limit would reduce the opportunity for abuse while still incentivizing people to put away some portion of their earnings and plan for their future.
Another approach would be for the government to provide some level of savings matching to low-income earners. For example, contributing $3000 to savings could lead to a government contribution of $1500 a few years later.
You have heard some of my thoughts on the topic. I would like to hear yours. Please respond with your ideas.
-Mark
Comments