By Agvisors LLC
We previously wrote an article about how the current Federal Reserve's policies affect overall interest rates. Keeping rates artificially low does allow for low interest rates on home loans and commercial loans. More importantly, it keeps the federal government's borrowing costs at record lows and gives a false sense of security regarding the national debt. But at the end of the day, those who are savers, wanting to living on a safe and secure income in U.S. Treasury bond income, are the ones who are being punished.
Treasury rates have been beaten down by the monetary policies of the Fed. TARP, QE1, QE2 and the most recently announced QE3 (also known as QE-infinity or QEternity) have increased the money supply and kept rates at historical lows. Hardly ever mentioned, or if it is addressed it is only done so in passing or as a simple acknowledgement, is the punishment put on savers. Here is a clear example:
On Oct. 1, 2007, John Q. Smith retires along with his wife of 40 years, both at the age of 60. The Smiths receive Social Security and a modest pension from John's years of service at his past employer. To supplement their Social Security and pension income the Smiths invest in U.S. Treasuries, backed by the full faith and credit of the U.S. Treasury. The only decision was what length of guaranteed interest rate they would choose. Seeing the stock market start to falter and the news of a housing bubble and financial crisis the Smiths choose the 5-year Treasury, which they were able to purchase at a 4.2 percent interest rate (source U.S. Treasury). Over the years the Smiths had accumulated $500,000 of money to aid in the retirement years, which at a 4.2 percent interest rate would garner them $21,000 of income each year.
On Oct. 1, 2012, the Smiths are called by their stock broker letting them know their bond has matured and the $500,000 is sitting in their cash account and would like to know how they want to invest the money to earn interest income for their retirement. The Smiths ask the most logical question, "Can we invest it back into a 5-year Treasury?" Of course the answer is yes, but the shock and surprise is the current rate and expected income of a 5-year Treasury.
The silence on the phone is deafening as the Smiths cannot believe what they are hearing. The current rate on a 5-year Treasury is .62 percent annually. The hard truth sets in that the annual income stream of $21,000 will now be set at $3,100 per year. That is right, a full $17,900 less per year. To replace the income the Smiths will have to chase riskier investments, get a job, spend less or find additional resources to invest to earn additional interest income. Just so you know the additional amount they need to "find" is $2,887,096 at the current 5-year Treasury rate.
The only real option for the Smiths is to chase higher yields in different areas. Maybe corporate bonds, but they may default or decline in value. Perhaps dividend paying stocks, but they may decline in value given the current economic forecasts. There is no real good solution for the Smiths right now. Most likely they will have to sit back and take their punishment and hope the housing markets, employment markets and the global economy improve.
We don't often present a problem without a solution, but there is no good solution for the Smiths right now. We wanted to illustrate how the effects of the current monetary policy effect people negatively versus what we read or hear every day in the media.
Editor's note: Agvisors provides commentary about agricultural markets, including grain, dairy, livestock, equities, financials, and energy, highlighted by a live weekly webinar discussing conditions and responding to questions. For more information, visit http://agvisors.com.