Doubling Down Against Retirees

Sharia law prohibits charging interest for loans of money. Capitalism has a rather different view. It says that if we manage to accumulate money through our efforts, we should earn something if we give someone else the use of that money.

Ben Bernanke and his Federal Reserve seem to prefer Sharia law. The Fed has forced down interest to the vanishing point — driven to virtually zero since late 2008 when the Fed moved to counter the crash.

Americans are notorious for saving next to nothing, but those seniors had had listened to advice about saving and had carefully tucked away money for their retirement in the expectation that those funds would earn them interest income to live on have been harshly disappointed. Bernanke decided to reward the banks instead — those financial institutions whose risky behavior had played an instrumental role in igniting the 2008 financial panic.

The Federal Reserve has kept interest at 0% or thereabouts so that the banks can borrow money from the government at next to no cost. The idea is that they will then have cheap money to loan to businesses and homeowners who in turn will use it to re-start the U.S. economic engine.

Funny thing happened, though. The banks had already used bailout money to swallow other banks or buy back their own stock rather than make loans. Now they simply use the 0% money to buy Treasury notes that pay higher interest than the interest cost of the money they borrowed from the government. Or they bet the money in the worldwide casino of the derivatives market. Trading is what banking has become. That has proved much more rewarding than the mundane business of loaning to businesses, financing car loans or writing mortgages.

Zero interest isn’t working all that well to regenerate the economy, but the Fed won’t give it up. So retired people who place their money in the safety of Treasuries are, as we've said before, loaning money to the government for free. They get nothing back, nothing to pay their bills. Fed policy effectively asks them to to risk their money elsewhere — exactly what older people are told not to do.

If a lack of consumer demand is one cause for stalled hiring by businesses, the irony is that the Fed program has been somewhat self-defeating, especially among seniors. With less money to spend, they’re spending less money, scrimping on everything. Of the 78 million baby boomers, each new batch of 10,000 who retire every day are hanging onto what money they have in a feedback loop that helps keep demand from rising.

Because zero interest isn’t working, the Federal Reserve has tried a second approach — pumping huge sums of money into the economy in the hopes that might turn over the sputtering economic engine. The program is shrouded behind the bewildering name of “quantitative easing” (QE) but a valid enough translation is “printing money”.

There have been two such surges — $600 billion injected into the economy beginning in November 2008 after the September crisis, and another $600 billion starting in August 2010.

The third QE began a few months ago when the Fed declared that, rather than huge dollops of occasional money, it would buy $45 billion in Treasuries every month from the banks that routinely invest in them. As payment, the Fed issues credits to the selling banks — effectively printing new money because the credits are money that doesn’t exist. But these IOU’s from the Fed are treated as increases to bank reserves, which frees up money for them to lend.

Or so goes that theory which doesn’t seem to be working. And because it hasn't, the Federal Reserve has now doubled its outlays, adding $40 billion a month of mortgage purchases to the $45 billion a month in Treasuries.

The idea is to reduce the supply of Treasuries and mortgages so that sellers of those instruments can dictate still lower interest payments to buyers, who still need to place America’s vast sums of money somewhere, anywhere that at least pays something. That’s how the Fed puts its foot on the throat of interest rates to pin them to the floor.

The Federal Reserve has by long tradition held a monthly meeting followed by announcements of deliberations limited only to the moment. This time, though, Bernanke and Company have made public their long term plan. Their mandate to stem inflation has succeeded; their mandate to spur employment has not. The new emphasis is therefore on jobs. The central bank has announced that it will continue the program of interest rate suppression however long it takes for the jobless rate to drop to 6.5% (it is now 7.7%) or until inflation rises to 2.5% (it now runs at less than 2%).

Setting goals for the first time is called “lead targeting”. It comes from the Fed board finally listening to other than their own counsel. A little known University of Chicago-trained economist named Scott Sumner, living in Newton, Mass., has been blogging about this approach for nearly three decades, according to this Bloomberg account. His thesis is that a central bank should increase the money supply until a specified target is reached. As a by-product, that gives a clear signal to industry what to expect and watch for, the better to be able to plan.

Sumner’s work was gradually noticed by better known economists such as Tyler Cowen and Christina Romer. Central banks in Sweden and the British government made contact. The Fed seemed the last to hear about it, whereupon Ben Bernanke found himself having to answer questions at a press conference about the theories of someone named Scott Sumner.

So why do we say that the Federal Reserve has now doubled down against retirees? The U.S. has enjoyed an extremely long period of low inflation. Heavy injections of new money is the recipe for disrupting that stability. With hundreds of billions more dollars floating through the system, producers can finally get away with raising prices. With rising prices, those fixed savings of seniors will buy less. But a 2.5% limit on inflation doesn't sound all that bad. Except that, if inflation does start rising to the 2.5% point, it will not obediently stop. Once set in motion, it will keep rising until tightening of interest rates brings it again under control, by which time those retirees may find that their nest egg — for years having suffered the blow of no earned interest — could be dealt a second blow by inflation reducing the value of their savings by appreciably more than 2.5%.

And now a possible third blow, with President Obama making a fiscal cliff offer to trim Social Security’s annual cost of living increases. The message from New Normal seems to be: forget about retiring.

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