Saving for Retirement? Mission: Impossible

Too often we forget that inflation has a human cost. When I think of inflation, I am typically thinking about business cycles and Cantillon effects. But as a recent Wall Street Journal article remarks, inflation can spell doom for retirees.

As of January, the average interest rate paid on relatively safe vehicles such as short-term savings accounts, time deposits and money-market funds stood at only 0.24%. That’s one-tenth the level of late 2007 and the lowest on records dating back to 1959. Such depressed rates don’t come close to compensating for inflation, which was running at an annualized rate of 5.6% in the three months ended February.

“Americans who have done everything right, have worked hard, saved their money and stayed out of debt are the ones being punished by low interest rates,” says Richard Fisher, president of the Federal Reserve Bank of Dallas and a voting member of the Fed’s Open Market Committee. “That state of affairs is not sustainable for a long period of time.”

There is a large moral hazard here. If we want people to save for their retirement, that needs to be a realistic possibility. Thanks in part to the Bernanke and Greenspan Feds, it increasingly isn’t. People get squeezed at both ends. High inflation eats away at the buying power of retirees’ savings, and low interest rates mean those savings earn little interest. The picture looks even grimmer when you realize that only looking at “core” inflation is an obfuscation. EuroPacific’s Michael Pento remarks:

If you talk about the grand sweep of Fed policy, it’s fairly easy to fix the onset of our current monetary period with the onset of the recession of 2000. To prevent the economy from going further into recession at that time, the Fed began cutting interest rates farther and faster than at any other time in our history. During the ensuing 11 years, interest rates have been held consistently below the rate of inflation. Even when the economy was seemingly robust in the mid years of the last decade, monetary policy was widely considered accommodative.

Over that time annual headline Consumer Price Index (CPI) data has been higher than the Core CPI 9 out of 11 years, or 81% of the time. Looking at the data another way, over that time frame, the U.S. dollar has lost 20% of its purchasing power if depreciated year by year using core inflation, and 24% if depreciated annually with headline inflation. The same pattern held during the inflationary period between 1977 thru 1980, when the Fed’s massive money printing sent the headline inflation rate well above the core reading. The empirical evidence is abundantly clear. When the Fed is debasing the dollar, headline inflation rises faster than core. The reason for this is clear. Food and energy prices are closely exposed to commodity prices which have a strong negative correlation to the falling dollar that is created by expansionary policies.

The situation will only get worse when you consider the fact that in the future, pensions, and Social Security payments are likely to be smaller than people had been told to plan on, simply out of necessity. The state of the economy means that private pension funds are hurting, and the structural problems with our entitlement programs are well documented.

I always chuckle a bit when people mention the Fed’s dual mandate to fight inflation and achieve high employment. The Fed is the ultimate source of inflation! It could achieve an end to long-run inflation tomorrow if it wanted to. I for one believe it ought to do so.

Furthermore, if you believe, like I do, that Social Security ought to be phased out, it becomes even more important to reign in the Fed’s constant money-printing. Per Pento’s analysis above, the dollar has lost about a fifth of its purchasing power in the last decade. Suppose that continues. A dollar I saved today would be worth 80 cents in 2021, 64 cents in 2031, and 51 cents in 2041. By then I’d be in my early 50s — still 15 to 25 years from retirement and the dollar I put away has lost half its value. All of a sudden getting a check from the government every month seems more attractive.

The prudent advice used to be, start saving early and let compounding interest work in your favor — but thanks to Fed policy, savers are seeing their gains wiped out and their principal eroded. The incentive is to spend, spend, spend, now, now, now, retirement be damned.

The Fed is creating dependence on the government retirement programs its money-printing helps finance. We can’t address one problem without looking at the other.