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2015-12-15 12:11:47
Dec 10th 2015, 10:42 by Buttonwood
A LOW interest rate policy is designed, in part, to make people save less and
spend more. The problem is that this approach eventually hits a wall. That is
because the biggest reason people need to save is to cover their retirement,
when they need to convert their savings into an income. And then low rates have
a perverse effect.
Say you want a $20,000 private income (indexed to inflation) in retirement to
top up your state pension/social security. The size of the pot you need depends
very much on the income you can generate. So look at this simple table
Income rate Size of pot ($)
5% 400,000
4% 500,000
3% 666,666
2% 1,000,000
How many people have a million-dollar pension pot? If 2% seems a low income
rate, remember that US TIPS - the only way of guaranteeing an inflation-linked
income - yield just 0.7% (real yields on long-dated index-linked gilts in the
UK are actually negative). Even getting 2% depends on taking some risk.
So even a shift from an assumed payout rate from 5% to 4% requires one to save
25% more. No problem, you might say, that pension pot will be invested not in
cash, but in equities, which have rebounded strongly since 2009. True, but if
you take a longer-term view, the S&P 500 is only about 40% ahead of its 2000
level (or about 2.5% annualised capital gain. Add in dividends of 2% and take
out costs of 1% and you are talking about a 3.5% return). In the UK, the FTSE
100 is below its end-1999 peak (briefly surpassed this year).
Going forward, as we argued recently, investor returns are likely to be lower
than they were in the past, because starting valuations are higher. Indeed,
this year has illustrated the point. The S&P 500 is practically where it was 12
months ago, the MSCI world is slightly down, emerging markets have been
terrible, and commodities have slumped.
Keynes's paradox of thrift was that, if everyone tried to save more, demand
would fall, GDP would decline and, on average, everyone would be worse off. But
this paradox is that, rationally, low rates should cause people to save more in
the long run, not less. The personal savings rate in the US is 5.6%, double the
level of 10 years ago. But it is a long way below the 10-12.5% range from 1960
to 1980. Perhaps people simply haven't figured out the problem or perhaps given
the failure of real income to rise, they simply haven't been able to afford a
higher savings rate.