Why low interest rates encourage saving, not spending

[HF63]

I found this article in Martketwatch very interesting.

A 30-something’s open letter to Janet Yellen

Why low interest rates encourage saving, not spending - MarketWatch

[Gone4Good]

Alternative titles: "Why Intuition Fails In Macroeconomics"

Low rates are an effect, not a cause.

1) The way to raise rates is to restore healthy economic growth.

2) If the Fed raises short-term rates, growth will slow

3) If growth slows, interest rates will fall

4) See 1 above

(see Inverted Yield Curve to reconcile points 2 and 3 above)

[Gone4Good]

Also, stock returns have averaged 17% annually since the end of the recession. The idea that savers are being starved of returns by low rates simply isn't true.

What may be true is that some savers have miss-allocated their portfolio and are earning low returns as a result. That's the risk you take when you overweight an asset class, though. The Fed can't be blamed because some folks make bad financial decisions.

[Totoro]

It depends, so many second order effects, not to mention third order.

People with a long horizon save more. I'm one of those.
People with a short term view try to borrow more. My sister is one of those.

The above applies also to mortgage financing. Prudent people save the lower mortgage costs, not so prudent people take out a HELOC or try and buy a bigger house. Right up to the limit that regulations allow.

Businesses make more profits (cheaper lending), so increase their payouts. That increases income for richer people, who typically save the extra. Businesses don't typically invest more when interest rates drop. So no change there.

Retirees with defined pensions and a paid off house typically don't care.

[jim584672]

Stocks have gone up directly because of the low interest rate policy, it is not rocket science. People now must take a lot more risk to get any return so they go to stocks. Its creating bubbles in lots of markets: stocks, real estate, bonds. They can never normalize back to 5% short rates, the whole show would collapse if they did.

They are playing a dangerous game and ultimately it all doesn't end well. Hopefully they kick the can down the road enough so that I am not alive when the piper gets paid.

[Senator]

Quote:

Originally Posted by Gone4Good Alternative titles: "Why Intuition Fails In Macroeconomics" Low rates are an effect, not a cause. 1) The way to raise rates is to restore healthy economic growth. 2) If the Fed raises short-term rates, growth will slow 3) If growth slows, interest rates will fall 4) See 1 above (see Inverted Yield Curve to reconcile points 2 and 3 above)

Exactly. Rates would be the same, give or take a few basis points, even if the Fed did not exist. Mortgage rates are based on the 10-year yield, sort of. They would likely not change regardless of what the Fed was charging.

Bond investors buy and sell bonds based on their assessment of future value. There really is no growth or inflation in the USA. Wages are a function of inflation. Wages are static.

We are in the beginning stages of a global wage equalization cycle, that will last many (20+) years.

[HF63]

We are in the beginning stages of a global wage equalization cycle, that will last many (20+) years.

I really hope this is not true because in Mexico if you work at a well paying factory job, your are making only ~ 1,000 pesos per week. This equates to about 60 dollars, I do not see where you can afford the property taxes in the US with salaries like this.

[ziggy29]

Quote:

Originally Posted by Gone4Good Also, stock returns have averaged 17% annually since the end of the recession. The idea that savers are being starved of returns by low rates simply isn't true.

Or maybe that the market is up 17% a year since the end of the recession because yield-starved savers are willing to a little too much risk in order to have any hope of decent return with persistent pathetic yields.

I think at this point the Fed, and many others, are pretty sure that if interest rates (especially on the short end) started reverting to long term historical norms, the equity market would crash as investors would start abandoning inflated stocks if they could actually keep up with inflation (or better) in cash. This is probably why any significant unwinding of QE will be *very* gradual.

[LARS]

Quote:

Originally Posted by ziggy29 Or maybe that the market is up 17% a year since the end of the recession because yield-starved savers are willing to a little too much risk in order to have any hope of decent return with persistent pathetic yields. I think at this point the Fed, and many others, are pretty sure that if interest rates (especially on the short end) started reverting to long term historical norms, the equity market would crash as investors would start abandoning inflated stocks if they could actually keep up with inflation (or better) in cash. This is probably why any significant unwinding of QE will be *very* gradual.

How dare you bring commonsense into a discussion of Monetary Policy. Shame on you...

[Totoro]

Quote:

Originally Posted by HF63 We are in the beginning stages of a global wage equalization cycle, that will last many (20+) years.

We are actually at the late stage of global wage equalization.

Hans Rosling: Let my dataset change your mindset | TED Talk | TED.com

From 8:02 onwards.

[Sunset]

I think we have been in the global wage equalization phase for the past 16 yrs, at least that is when I noticed it.
Philosophically I don't understand why 1 hr of my life is worth so much more than 1 hour of someone's life in China/India/Africa/etc..
I do think it is perhaps that prior to globalization this was fine as every country was basically an economic island, but the glaring difference in values becomes absurd once international exchange of goods and services became common.
Since we are on the high side of wages globally, we will stagnate (or fall) for decades until the low side equalizes (roughly).

Somehow returning to work for $3.00/hr does not excite me

[Gone4Good]

Quote:

Originally Posted by ziggy29 Or maybe that the market is up 17% a year since the end of the recession because yield-starved savers are willing to a little too much risk in order to have any hope of decent return with persistent pathetic yields.

Does it matter in the context of the linked article?

The complaint is "savers have to save more because the Fed Fund's rate has been ~0-50bp for so long."

The answer is "Um, no. If they had a diversifed portfolio they have far, far more than when rates were higher."

And aren't we confusing causes and effects again?

Are rates low because the economy has sucked or are rates low because of Fed policy?

[LARS]

Quote:

Originally Posted by Gone4Good Does it matter in the context of the linked article? The complaint is "savers have to save more because the Fed Fund's rate has been ~0-50bp for so long." The answer is "Um, no. If they had a diversifed portfolio they have far, far more than when rates were higher." And aren't we confusing causes and effects again? Are rates low because the economy has sucked or are rates low because of Fed policy?

Rates have not been market driven for years; instead, they've been driven (many might say manipulated) by Central Bank monetary policy, which includes but is not limited to QE.


Sent from my iPad using Early Retirement Forum

[Gone4Good]

Quote:

Originally Posted by Senator Exactly. Rates would be the same, give or take a few basis points, even if the Fed did not exist.

This is a hugely misunderstood aspect of the economy. Everyone assumes the Fed is all powerful, when to a large extent the Fed is a price taker.

So if we take the 30-something's argument from the attached link seriously the Fed should simply hike rates to 15%. Everyone will make tons of money. We'll all be stupid rich and live happily ever after on our yachts.

Obviously that isn't going to work.

The Fed can't set any rate they want. They're significantly constrained by the economic environment. If the Fed lifts short rates too high, we have a deflationary recession. If the Fed cuts rates too low, we have inflation. Only if the Fed's policy is in keeping with the economy's natural speed limit do we get non-inflationary growth.

With that in mind, how's the Fed been doing since 2009?

Rates have been "low" but are they too low given the economic fundamentals? If they were, we'd expect accelerating inflation and most likely a tight labor market.

What we've actually gotten over the past 7 years is a Fed that has consistently missed it's 2% inflation target and also it's "full employment" statutory mandate.

Given that history, there's strong evidence monetary policy has been too tight rather than too loose.

[ziggy29]

Quote:

Originally Posted by Gone4Good Does it matter in the context of the linked article? The complaint is "savers have to save more because the Fed Fund's rate has been ~0-50bp for so long." The answer is "Um, no. If they had a diversifed portfolio they have far, far more than when rates were higher." And aren't we confusing causes and effects again? Are rates low because the economy has sucked or are rates low because of Fed policy?

I think rates have been kept artificially low at least in part because the Fed wanted to prop up the stock market and encourage money to flow back into it after the crash of 2008-09. And I think that same consideration is keeping rates as low as they are.

That said, yeah, if "savers" are also "investors" the investment part should be making up for their lack of growth in savings. But having said that, my point is that many savers have become reluctant investors in the last several years, even when they would rather not.

[Senator]

Quote:

Originally Posted by Totoro We are actually at the late stage of global wage equalization. Hans Rosling: Let my dataset change your mindset | TED Talk | TED.com

If we were at the late stages, companies would be just as likely to build a manufacturing facility in the USA as anywhere else.

There are still a LOT more countries that have cheaper labor. The entire central and south America regions. All of Africa. Still most of China has a lower lifestyle for the same effort as the USA. India has a bunch of tech workers, but for the most part is cheaper labor.

We have a LONG way to go...

[GrayHare]

People spend now if they believe the price will be higher in the near future. If the Fed wants to nudge spending they can do it by posturing, "We've changed our inflation target from 2% to 10%. Yes, mortgage rates will go up, so you'd better buy that house and lock in today's low rate. Car prices will be going up too. Just about everything will cost more during 2017."

[Gone4Good]

Quote:

Originally Posted by ziggy29 I think rates have been kept artificially low .. .

How do we objectively judge whether the Fed fund's rate is artificially high or low?

My position is that rates kept artificially low will result in accelerating inflation. Too high of rates result in slowing economic growth and disinflation.

If there's another way to evaluate monetary policy I'm open to learning. But objectively measured by inflationary pressures, the Fed hasn't kept rates artificially low.

[Totoro]

Quote:

Originally Posted by Senator If we were at the late stages, companies would be just as likely to build a manufacturing facility in the USA as anywhere else.

Maybe my definition of late stage is a bit weaker than yours. We're not at parity yet ("just as likely") but closing in fast. Within 10 - 20 years at the current pace we're there. Given that the equalisation via globalisation started in the 1970s (45 years ago), I'd call it late stage where we are now.

American businesses are already reshoring and insourcing at a significant rate.

China's Rising Wages and the 'Made in USA' Revival - Bloomberg

From that article:

Quote:

A new survey by Boston Consulting Group found that 16 percent of American manufacturing executives say they’re already bringing production back home from China. That’s up from 13 percent a year ago. Twenty percent said they would consider doing so in the near future.

Quote:

Within five years, U.S. executives also expect that nearly half their global manufacturing capacity will be located in the U.S., a big change from just a few years ago. While it’s a small sample size—252 senior execs at companies with at least $1 billion of sales—it’s telling of the change that’s under way.

Quote:

Originally Posted by Senator There are still a LOT more countries that have cheaper labor. The entire central and south America regions. All of Africa. Still most of China has a lower lifestyle for the same effort as the USA. India has a bunch of tech workers, but for the most part is cheaper labor. We have a LONG way to go...

Your view is outdated. Correcting for productivity and overhead it's not a no-brainer anymore today, and hasn't been for some years in several sectors, including hi-tech.

It used to be you could hire 10 or 20 indians or chinese for one american. Not its only a factor 4. Before correcting for productivity. The move you are describing towards south america and rest of asia is already done. Only Africa remains as a reservoir, but they lack infrastructure. Hopefully that changes, and we can lift the last billion from poverty too.

Quote:

What’s not so well known is just how competitive cheap oil and gas has made American manufacturing. BCG, the Boston consultancy, estimates the average cost to manufacture goods in the U.S. is now only 5% higher than in China and is actually 10% to 20% lower than in major European economies. Even more striking: BCG projects that by 2018 it will be 2% to 3% cheaper to make stuff here than in China.

U.S. Manufacturing costs are almost as low as China’s - Fortune

Report: China Labor Costs Only 4 Percent Below US