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February 15, 2012

Unintended Consequences 101

At least one would like to think they're unintended:

As I have noted previously, the Fed’s policy of acting to hold interest rates well below free-market rates in recent years has had the effect of greatly diminishing the earnings of people who rely on interest income. Such people include especially many retirees who do not wish to hold risky assets with substantial variability of earnings. In the past, many retired people have held the bulk of their wealth in the form of bank certificates of deposit, bonds, and bond-heavy mutual funds, hoping that their incomes would be secure and predictable when they were no longer working. The Fed’s actions in recent years have taken a heavy toll on such people’s earnings.

...Defenders of the Fed historically have argued, among other things, that central-bank monetary policies have a sort of neutrality: they affect aggregate demand, the overall price level, and other macroeconomic variables, but they do not attempt to carry out the kind of micromanagement of the economy that Soviet-style central planning attempts. This argument has always been bogus because monetary policy was never—indeed, could not be—neutral. It always had differential effects on different classes of people and different sorts of economic activity, depending in part on who received new infusions of central-bank money first, second, and later in the process and on how these persons’ actions affected ongoing real economic processes. Nonetheless, defenders of the central bank might have argued that at least the Fed did not attempt in any direct way to determine definite changes in the distribution of income, either personal or functional.

Such defenses now ring unmistakably hollow. Even apart from the Fed’s entry into clear credit-allocation activities (e.g., buying mortgage-backed securities rather than Treasury bonds alone), it is plain that the Fed is acting in a way that impoverishes a definite class of persons—those heavily dependent on interest earnings for their income—and, moreover, that a policy of keeping interest rates on low-risk assets near zero must eventually wipe out such persons’ incomes completely. In that event, people who worked and saved over a working lifetime, taking personal responsibility for guaranteeing their self-sufficiency during their elderly, nonworking years, will be able to survive only at the mercy of the providers of private and public charity.

Posted by Cassandra at February 15, 2012 08:49 AM

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I'm afraid that what is going to happen is that many of the savers, who have been avoiding the stock and corporate bond markets because of perceived risk and also because they don't understand them very well, are going to finally get so desperate that they WILL enter the markets, with very bad timing and without benefit of knowledge or good advice.

And some of them will fall for outright scams.

Posted by: david foster at February 15, 2012 04:20 PM

I'm reminded of some remarks by Sebastian Haffner, who grew up in Germany between the wars and wrote a very valuable memoir. In the following, he was talking about the social/psychological effects of hyperinflation, but this also has applicability to ANY financial environment which is hostile to the average saver:

The old and unworldy had the worst of it. Many were driven to begging, many to suicide. The young and quick-witted did well. Overnight they became free, rich, and independent. It was a situation in which mental inertia and reliance on past experience was punished by starvation and death, but rapid appraisal of new situations and speed of reaction was rewarded with sudden, vast riches. The twenty-one-year-old bank director appeared on the scene, and also the sixth-former who earned his living from the stock-market tips of his slighty older friends. He wore Oscar Wilde ties, organized champagne parties, and supported his embarrassed father.

Haffner believes that the great inflation–particularly by the way it destroyed the balance between generations and empowered the inexperienced young–helped pave the way for Naziism.

In August 1923 the dollar-to-mark ratio reached a million, and soon thereafter the number was much higher. Trade was shutting down, and complete social chaos threatened. Various self-appointed saviors appeared: Hausser, in Berlin…Hitler, in Munich, who at the time was just one among many rabble-rousers…Lamberty, in Thuringia, who emphasized folk-dancing, singing, and frolicking.

I don't think we dare assume that if we reach the point of needing a "savior" we will get one as harmless as Lamberty.

Posted by: david foster at February 15, 2012 04:30 PM

I cannot believe that the Fed has been keeping the interest rates low simply as a means of sucking the life-support out of old rich people. For one thing, it's too danged slow! That's why President Obama's new budget calls for taxing dividends as "earned income." Hey Grandma! Been holding on to that 3M stock for the steady annual dividend? WHOOSH!!!! All gone! Now just try and dump it! You'll be lucky to get half of what you paid for it! And we'll take half of that!!!! Ha ha ha!

Posted by: spd rdr - not as smart as david foster at February 15, 2012 05:29 PM

That's why President Obama's new budget calls for taxing dividends as "earned income."

Bingo. I ran out of time this morning but that's what hit me right between the eyes. Somewhere I saw a great article about this but it got lost in my pre-caffeinated brain fog.

Posted by: Cassandra at February 15, 2012 05:36 PM

Pretty smart observation, though, Spd Rdr...the combination of low interest rates with increased dividend and capital gains rates is a killer, both in the direct impact and the obvious effect on stock prices.

Do you think Obama could learn "folk-dancing, singing, and frolicking?" It might be a good way to keep him usefully and harmlessly employed.

Posted by: david foster at February 15, 2012 05:39 PM


On and off, I've been reading "This Time is Different" by Rogoff & Reinhart or listening to the audio CD on the way to work.

I highly recommend it. It's about how governments handle the problem of sovereign debt defaults. From what I can tell so far, there are only two options for a nation that's over its head in debt:

1. Debase the currency (in a fiat currency economy, inflation does this quite effectively but the old fashioned method was to reduce the amount of gold in coins).

2. Default on foreign debt.

Contrary to what most people assume, such defaults are quite common. Some nations (Greece is one) are serial defaulters.

The US is unusual in that we haven't yet defaulted. I wouldn't rule that out, though. I found it interesting (or maybe just predictable) that there's no hard and fast threshold (debt to GDP ratio) where default becomes inevitable.

In the end, like most everything else in life, the way debt crises are handled is a matter of political will.

Posted by: Cassandra at February 15, 2012 05:41 PM

Sounds like an interesting, if depressing, book, Cass.

I don't think Bernanke is *trying* to harm elderly savers; his argument is that saving doesn't consist only of bank deposits and short treasuries, but also of stocks, etc. Which is true. Where I think he goes very wrong, and Obama even more so, is misdiagnosing the causes of the economic slowdown. There is only so much that the availability of low interest rates can accomplish in an environment of policy weirdness and general hostility to business. And to the extent that low rates are jacking up stock prices, they are merely "borrowing" returns from future periods.

Posted by: david foster at February 15, 2012 05:55 PM

Pretty smart observation, though, Spd Rdr

That's why we had to swipe his vowels, David. It slows him down just long enough that I can swat him with that ruler :)

Posted by: Sstr Mr Bg 'Mtphrs at February 15, 2012 06:12 PM

Where I think he goes very wrong, and Obama even more so, is misdiagnosing the causes of the economic slowdown. There is only so much that the availability of low interest rates can accomplish in an environment of policy weirdness and general hostility to business. And to the extent that low rates are jacking up stock prices, they are merely "borrowing" returns from future periods.

Oh I think that's exactly what is going on here.

Despite Obama's frequent admonitions that We the Little People should grow up and eat our veggies, he shows very little inclination to take his own advice.

Sooner or later the other shoe is going to drop, but in the meanwhile we're supposed to all pretend that the prosperity we've been enjoying for decades wasn't made possible by artificially cheap credit and unhealthy savings rates (and the two aren't exactly unconnected).

I recall when we kept hearing that American households were holding too much consumer debt and not saving anything for a rainy day.... the point being that this was not only wrong/bad but ultimately unsustainable.

Remember that the next time one of these jackwagons starts yammering on about how we need to "get back where we used to be..." :p

Posted by: Cassandra at February 15, 2012 06:19 PM


How come you're the only one who gets a bingo card? And who's calling the game....one of your itinerate eskimos what owes their economic existence to the paltry pittance paid by the Princess?

Posted by: Snarkammando at February 15, 2012 07:20 PM

Unintended? I think not unless they really are demonic imbeciles. But then they may be

Posted by: Kbob in Katy at February 16, 2012 08:07 AM

...and why with these policies should anyone save?

Posted by: Bill Brandt at February 16, 2012 08:39 AM

I saw this pearl in the Washington Examiner today. I think the last paragraph says it all. This is why we need a new bus driver. And I don't think Mitt be da man. Not sure who will suvive the republican free for all, but I am afraid that whoever it is, I would vote for that person. They can't do any worse.

From The Washington Examiner, on the subject of the debt ceiling:

"Treasury Secretary Timothy Geithner will undoubtedly make every effort to bend the law so that Obama will not need to ask Congress to raise the debt limit before election day. But it will be close. More importantly, however, the speed with which Obama blew through this current debt limit should cause his administration to pause and think about our long-term debt crisis. Unfortunately, the opposite appears to be the case.

Testifying before the House Budget Committee yesterday, Geithner admitted that the Obama administration has no plan to control the debt. “We’re not coming before you to say we have a definitive solution to that long-term problem,” Geithner told Budget Chairman Paul Ryan, R-Wis. “What we do know is we don’t like yours.”

That is Obama’s entire governing record in just one statement: we have no plan, we just don’t like yours. This kind of lazy and vindictive thinking is turning our country into Greece faster than anyone previously imagined possible."

Posted by: Kbob in Katy at February 17, 2012 10:09 AM

This is, of course, intentional. As that demographic are usually composed of people who stand against certain Democrat policies.

Posted by: Ymarsakar at February 18, 2012 03:27 PM