Monday, November 12, 2012

Baby boomers blunt Fed easing while saving for retirement

Bloomberg reports that savers are cutting back on current consumption to make up for the shortfall in the earnings on their retirement savings.  As a result, they are blunting the impact of the Fed's zero interest rate and quantitative easing policies.

Regular readers know this is precisely what your humble blogger predicted would happen based on a) Walter Bagehot's observation in the 1870s that savers cannot stand interest rate below 2% and b) Mark Twain's observation that he was more concern about the return of his capital than the return on his capital.

I went further than predict this, I coined the expression "Retirement Plan Death Spiral".

Under the retirement plan death spiral, both individuals and companies reduce their current demand to offset the lack of return on retirement assets.  Companies do this by making up the earnings shortfall by contributing funds that would otherwise be used for reinvestment and growth.

Cutting back on current consumption feeds into a self-reinforcing negative cycle.  The more they cut back on current demand, the bigger the earnings shortfall....

What triggers the retirement plan death spiral is the sub-2% interest rate policies pursued by the Fed and other central banks.

John Rodwick cuts corners so he has money to spend on his seven grandchildren and cruise around the Rocky Mountains with his wife, Jean, in their blue-trimmed Roadtrek motor home. 
“My wife and I love to travel, so that is our one big expense, but we are very, very conservative,” cooking and sleeping in their 19-foot vehicle, said the 72-year-old former business professor. With the value of their three-bedroom home plunging 30 percent in the past six years, the Rodwicks have become “very cost conscious,” he said. 
Federal Reserve officials say they’re concerned that retirees like the Rodwicks are blunting the impact of record easing aimed at creating jobs. 
The reason: Older people are more likely to forgo purchases of houses, cars and other big-ticket items that the Fed is trying to encourage with near-zero interest rates. And their numbers are growing, making the Fed’s task ever harder. ....
People usually save more as they near retirement. Now, the effect is magnified because Americans’ wealth has been depleted by the financial crisis, which decimated home values and retirement accounts invested in stocks, according to Britt Beemer, chairman of America’s Research Group Ltd., a Summerville, South Carolina-based consumer-behavior research company.... 
Retirees and older workers probably will reduce spending as they anticipate tax increases and cuts in Medicare and Social Security, said Dudley, who is vice chairman of the policy-making Federal Open Market Committee.
Talk about a one-two punch.

The cut in interest rates reduces earnings on savings and results in a reduction in current demand.

The anticipated austerity measures like tax increases and cuts in social programs also result in a reduction in demand.

Regular readers know that this one-two punch is the direct result of continuing to pursue the Japanese Model for handling a bank solvency led financial crisis and protecting bank book capital levels and banker bonuses at all costs.

This one-two punch would immediately go away if the Swedish Model were adopted and banks were required to recognize upfront the losses the will ultimately incur if the excess debt goes through the long process of default and foreclosure.
Meanwhile, retirement incomes are being hit by the very Fed policies that are intended to spur the three-year economic expansion ....
“All this money-printing hurts savers,” Republican Representative Paul Ryan of Wisconsin, his party’s vice presidential nominee, said during remarks at an AARP event in New Orleans on Sept. 21. “It threatens the future value of our money -- and seniors are bearing most of the risk.” 
Bernanke says the scant return for savers is preferable to the losses they may suffer if the central bank were to begin raising interest rates too early....
It is only too early if the Swedish Model is not adopted and the banks have not yet recognized all the losses hiding on and off their balance sheets.
The postwar generation is shifting spending toward education, mortgage debt and their adult children and away from entertainment, dining, furniture and clothes, according to a report last month from the National Center for Policy Analysis, a Dallas-based research group that advocates free markets. 
Retirees are consistently more frugal than younger age groups, said Pamela Goodfellow, consumer insights director at BIGinsight, a research company based in Worthington, Ohio. 
“If you’ve got to put your kid in college, you’ve got to spend,” she said. “Retirees have almost a luxury of not having quite so many spending demands put upon them.”
To ensure sufficient income later in life, Americans will need to increase savings, delay retirement and prepare for changes to entitlements such as Social Security and Medicare, according to a report by the National Academy of Sciences.
 This fact is not lost on anyone.  Hence, the lack of a rebound in current demand.

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