Merryn's Blog

Low interest rates are doing more harm than good – quadruple them and see what happens

Low interest rates are damaging the economy, says Merryn Somerset Webb. They aren’t making people borrow and spend, they’re making them worry about their retirement – and save.

160414-cash

I've been boring you all for a few years now on the pernicious effects of very low interest rates. I've said more on the subject in my editor's letter in the magazine this week. But I'm pleased to see that the group of people who think that low rates are now doing more harm than good is expanding fast. Here's a quote from Blackrock's Larry Fink that pretty much exactly reflects our thoughts on the matter.

"There has been plenty of discussion about how the extended period of low interest rates has contributed to inflation in asset prices. Investors are being forced to trade liquidity for yield by taking on more risk and investing in less liquid asset classes a potentially dangerous combination for retirement savers.

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"Not nearly enough attention has been paid to the toll these low rates and now negative rates are taking on the ability of investors to save and plan for the future. People need to invest more today to achieve their desired annual retirement income in the future. For example, a 35-year-old looking to generate $48,000 per year in retirement income beginning at age 65 would need to invest $178,000 today in a 5% interest rate environment. In a 2% interest rate environment, however, that individual would need to invest $563,000 (or 3.2 times as much) to achieve the same outcomein retirement.

"This reality has profound implications for economic growth: consumers saving for retirement need to reduce spending if they are going to reach their retirement income goals and retirees with lower incomes will need to cut consumption as well. A monetary policy intended to spark growth, then, in fact, risks reducing consumer spending."

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I know he is right on this one for the very simple reason that I am doing exactly what he says people are doing. I spend much less than my income suggests I could because I am really worried about my retirement.

A decade ago when I made mental calculations about my income in my 70s I figured out how much I might save and assumed a 6% return on it. Now, with most global assets already overvalued and rates on the floor, I assume 2-3% tops. That at least doubles the amount I know has to be in my Sipp the day I put my pen down for good. I've got a long way to go.

Low interest rates aren't making me borrow and spend. They are making me worry and save.

A central bank employee said to me recently that raising rates is too dangerous a thing to do. We don't really know what happens if we cut rates below zero, he said, but we do know what will happen if we raise them from their current levels, given our previous experience in raising interest rates (he was assuming that a rise in rates would mean a fall in economic activity as has been the case in the past). I reckon he is wrong.

We do know what will happen if we cut them more (an exaggeration of the effects above and the others I have mentioned here nad in the mag). But we really don't know what will happen if we raise them. Rates have never been this low before so we have no experience in raising them from these levels.

There is every chance that a quadrupling of interest rates from here would do no harm at all instead it might do an awful lot of good. At this point it might be worth a go!

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