I am not going to get into any sort of argument over Phillips Curves or the sociology of the Fed or whatever. We know that many at the Fed have gone out on a limb wanting to raise rates to "return to normal," which has not been here since sometime in 2007 or at the latest 2008. Yeah, getting to be a long time, a possible new normal. Understandable they would like to get out of the rut, but then we have China blowing up and all the markets going blooey. I am not remotely going to try to forecast what they will do in a couple of weeks, although I note that Janet Yellen did not go to Jackson Hole, and I suspect she is not sleeping as well as usually...
So, I think there is a deeper hidden issue here that some at the Fed are in fact aware of, although I do not think that it is a major factor in the immediate considerations. It has to do with the funding of the retirement of the baby boomers, many of whom are planning to cash in this or that accumulated asset account into an annuity. How nice. The problem is that the sources of funding by the companies providing for them are heavily dependent on bonds. Many of them have been holding long term bonds from way back, with the interest on those bonds far above what is out there right now for when they must eventually refinance. There has been little publicity about this and how without interest rates moving up noticeably sometime in the near future, these companies are going to come under serious pressure within the next few years as their longer term high yield bonds mature. There are serious people aware of this, but, if in fact the Fed cannot get those interest rates back up somewhere near where they were some decades ago, the retired baby boomer rentiers-to-be may find themselves fulfilling Keynes's old wish that they be euthanized, or at least have to struggle to make up for a much lower income out of their long-accumulated savings than they thought they would get.
Barkley Rosser
PS Added 9/6: Obviously this is a longer term issue and is highly unlikely to be playing much role in what is coming up at this next FOMC meeting. There are obviously reasons why they may put off the rate increase, with the rising value of the dollar against nearly all other currencies perhaps being the issue that really puts it off. Stock market volatility is one thing, but the forex rate of the dollar is much more serious.
11 comments:
Raising rates will most likely slow the economy, which in turn stands a good chance of lowering longer term rates, which would not help at all with annuities.
Social Security is the major source of income for the vast majority of retirees, and slowing the economy would be counterproductive for Social Security funding.
Those not reliant on Social Security would likely own at least some stocks. "Diversify" is about as common financial advice as there is. Raising rates will hurt stocks.
Hard to see how raising rates is going to have a good effect on retirees, let alone enough of a good effect to make a meaningful difference for a meaningful number of retirees.
Financial companies mark bonds to market, so bonds with a high stated yield are essentially held as higher principal, market yield bonds.
I am not necessarily in favor of raising rates now given all the turmoil in the world economy and the markets. However, it may be that a small increase will not slow the economy all that much. We really do not know, not having had rates above zero for the fed funds rate for well over half a decade.
If they raise rates and the economy slows, then they should lower them again)
BTW, I am not the first to point this issue out, with old people occasionally complaining about the low income they are getting from bonds. Wolfgang Munchau has been writing about it in the FT for some time. It is an issue that is slowly creeping up on us. We have forgotten how totally weird the current situation is, with persistent negative real rates (although having negative nominal rates for awhile was even more dramatic).
But, hey, Keynes said to "euthanize the rentier class," so maybe that is what we should do...
Barkley you have put your finger on the decades long anxiety that has fed the Fed.
What about the poor widow of the rich guy whose income comes from clipping coupons on her inherited portfolio of utility bonds?
Granted those bonds no longer come with physical coupons and the widows of the 1% are no longer actually wielding their scissors every quarter but this has always underlayed the right obsession with inflation - it cuts away at the value of fixed interest securities and investments. Yes it would be nice if working people got a raise, but God forbid it cut Gramma Rich's retirement income.
But this concern is more one from your and my childhood, even wealthy widows aren't living from clipping their Con Ed Bonds, and the idea that we have to protect middle class retirement by punishing the working class wage is out of date by decades. Even that small fraction of the middle class that actually has investment income is mostly not relying on fixed rate investments, it has been a long time since the upper middle class religiously purchased physical pieces of paper with neat little coupons to clip. Or God Help them stuck their money into a CD hoping for a real return.
Realistially we don't need to euthanize the rentiers. Just clip their wings the way those rich widows of yesteday clipped their coupons. There is little to nothing that needs to be done to advance the economic (if not entirely the social justice) agenda of the working class than a little thing I call MJ.ABW. More Jobs. At Better Wages. And if those jobs and wages come with some nominal inflation then so be it. As long as we keep the balance between Real Wage and Real Return in proportion to actual income growth Workers and Rentiers can live together. If not in total peace.
Although the idea tat we are getting close to full employment is beyond absurd, I have wondered about potential depressed demand effects of very low interest rates. Forget matters of fairness -- spare the whining taunts -- because this is purely a question of how these rates affect the economy. If there is $80 trillion in total wealth, if about 70% of that wealth is owned by people in or nearing retirement ($56 trillion), and 50% of that wealth held by seniors in fixed income investments (roughly per standard advice), that is $28 trillion in wealth expected to generate interest or returns to individuals who spend all of their income (and then some). They are currently receiving a whole lot less income than they would "normally" have been receiving from such investments within the memory of anyone still alive. If current rates are about 2.5% lower than they "used to be," that is a $720 billion income (and spending) gap. Why is that not a huge hole in demand? Even a 0.5 percentage point difference amounts to $144 billion, which does not seem like peanuts.
As we approached zero per cent real rates in the recession, it was often said that because there was depressed demand it was like pushing on a string: a further reduction was not going to pump up investment to generate economic growth because there would be insufficient demand for the product or service to be generated by the investment. If the converse is true, that means raises at these very low rates would have relatively small negative effects on investment. Does that not raise the possibility that the increase in demand from higher rates, especially among older Americans because in effect they spend 100% of it, would outweigh the normally expected negative effects of an increase?
What is wrong with my math or analysis here?
Forget math what about your premises? Who all is included in those "in or nearing retirement" who hold 70% of all wealth? Because Peter G Peterson and the Koch Brothers are firmly in that category plus a certain Warren Buffett. And are we really to understand that fully half of the wealth of those 60 and overs is really held in fixed rate investments? Are the bond and money markets actually THAT big in comparison to equities and real estate? Or are you defining wealth in some way that waves those investment sectors away?
Waht you are telling us is that a full 35% of all American wealth is held by retirees who "spend all their income (and then some)". That may be true but before I accept a whole pile of "math and analysis" built on it it would be nice to see some evidentiary citations supporting those numbers.
So they'll raise the rate to let a guy like me retire on some bonds I buy? And they raise this to 2%, right? (Assuming the raise in rates is far higher than anyone is saying - or am I wrong; are people expecting the Fed to raise rates that much?). So I need a million bucks to make 20 grand a year?
Does someone figure that works somehow?
I do have a little money in the market (not likely it will ever approach a million dollars) and I have a pension (which is not being funded by a group invested only in bonds) and raising rates enough for people with very large amounts of capital (that million) to live in near poverty (that 2%) will likely kill my investments.
I sure don't know a lot about finance and investing, but unless I'm even more clueless than I think I am, well, if that's the thinking of those Krugman termed VSP they sure are stupid about their job.
"the retired baby boomer rentiers-to-be may find themselves fulfilling Keynes's old wish that they be euthanized, or at least have to struggle to make up for a much lower income out of their long-accumulated savings than they thought they would get"
I don't think grandma trying to live on her retirement savings is what Keynes had in mind when he was talking about the rentier class
foosion is correct. Raising rates would hurt retirees almost as much as any one else.
On top of lowering longer term rates and future short term rates and lowering GDP which puts upward pressures on tax rates and downward pressure on government benefits, it will immediately lower the price of stocks and short term bonds the very things near retirees want to convert into annuities. In fact, just the expectation of a rate increase may be responsible for lowering stock prices by over 10% in the past month.
An overly tight central bank reduces the total amount of wealth created. Some groups may think they can get a larger slice of the pie through rate being manipulated above natural full employment rates, but there are all kinds of ways for the markets to sidestep these manipulations. Shrinking the pie in order to secure a larger slice of it is a risky proposition at best.
A good reason for preferring present conditions that might justify increasing rates.
Not a good reason for ignoring the absence of such conditions.
Bruce and others,
I am not for raising rates if this clearly slows economic growth, job growth, and wage growth, which it is not obvious to me is necessarily the case, although at the moment the prospect of a possibly more rapidly soaring US dollar forex value does threaten that, which is why I said that I think right now is probably not the time to do it.
Let me note what has not happened. When the latest QE was ended, lots of people were worried that both economic growth and the stock market would decline. They did not. The problem right now is all the turmoil and uncertainty coming out of China, which may mean that this is not a good time to "normalize" the financial sector. But if that turmoil can get under control, this "hidden case" is sitting there as what will become an increasing issue.
I do not know what the breakdown is precisely of exactly what the share of income for oldsters is coming from bonds or annuities. I suspect that Bruce W. is right that the recipients tend to be among the better off, but it is not just the super wealthy, so throwing around their names is really not very useful here. I do know that for lower income/less wealthy old people, they more heavily rely on Social Security, which is why I think, along with Bruce, that not only should we be making sure that benefits are not cut, but that if anything they should be expanded. This is how we help out the poorer of the old.
That said, this problem is one that is building up. I do not know if those who have been talking about, mostly Wolfgang Munchau in the Financial Times (a German writing in a British newspaper about an American problem, somewhat hilarious actually) are seriously exaggerating, but Munchau looks pretty convincing when he writes about it.
So, the low income from bonds is an issue right now, which one occasionally hears older people (at least those with some bonds) complaining about. But the issue I raised is more subtle and less obvious, the gradually declining financial situation of those firms, many of them insurance companies, who pay for annuities. They are in this long term rollover that is providing them with less and less income from the sources from which they have paid annuities.
For the record, I do not believe in the "natural rate of unemployment" and never had. This is one of the biggest frauds in all of macroeconomics. So, I am not calling for an increase in interest rates to prevent a possible inflation any of the rest of that claptrap. I am talking a carefully timed and gradual and relatively small (from zero to maybe 2% on the fed funds rate) increase that would move financial markets into something a bit more like they were prior to 2007, which would be consistent with some better financiing for the future for important parts of the funding for retired and older people.
I think it was obvious from the outset that the way the mega-banks were bailed out via ZIRP and QE, would end up requiring a secondary bailout of insurance and retirement entities. I don't have any sense of the quantitative proportion of this effect, but one of the ways that these policies are actually counterproductive is that insurance and retirement entities need to save up on assets to provide future income to meet future contingent liabilities, and by lowering the yield and thus raising the price of "safe" assets, ZIRP and QU forced such entities to increase their savings in higher priced assets to assure adequate future income to meet their required future income obligations. Thus increased savings would lead to decreased current consumption demand (and correspondingly decreased investment demand, even in the face of excess savings and low rates, due to lower consumption demand), producing via that channel the very opposite of the stimulus effect intended, via the reduced financing costs for consumption and investment, the "wealth effect" of higher asset prices, the implied future tax cut due to lowered gov. interest costs, or whatever other channel might be imagined.
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