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| The Basics | For today's savers, its the 1970s all over again
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Money is cheap and the living is easy -- for borrowers. But conscientious savers are finding that dollars saved yesterday are worth less today.
By Scott Burns
Federal Reserve Chairman Alan Greenspan raised the fed funds rate one-fourth of 1%. Wall Street shrugged. Borrowers cheered. Mortgage rates actually declined.
But what, you might ask, about savers? You know, that weird little group who actually spends less than it earns, prepares for rainy days and puts money aside for the future.
Well, we're still in the back room, hopelessly outnumbered and being beaten. No one seems to care. Like agents for "Mission: Impossible," our actions are disavowed by the government.
Return to the 70s
While many people still fear the return of 1970s inflation rates, the brute fact is that today's savers are in much the same situation, particularly retirees. I could go on about pathetically low rates on CDs. But you already know that.
Let's take another direction.
Let's ask a simple question: What interest rates would make it reasonable for people to save?
The quick answer: higher.
We'll start with traditional money -- gold. It's rare, it doesn't corrode, and it has a winsome glow. That has made it a store of value for centuries. The same qualities made it a refuge from corruptible paper and metal money issued by governments.
Buy an ounce of gold on Jan. 1, and you'll still have an ounce of gold a year later.
Paper money is different. Buy a dollar on Jan. 1, and it won't have the same utility a year later. Unlike gold, paper money has no use other than exchanging it for goods and services. For paper money to function like gold, it has to pay interest to compensate for inflation. Nearly as important, the interest rate also has to compensate for the taxes we have to pay on the interest.
Preserving purchasing power
In the 12-month period ending June 30, the Department of Labor tells us that the unadjusted consumer price index (CPI-U, the consumer price index for urban consumers) increased 3.3%. This is the one that includes silly items like food and energy. As a consequence, you need $1.033 today to buy what cost $1 a year ago. (The trailing three-month rate is higher, a scary 4.8%.)
To maintain your purchasing power, a dollar saved last year needed to earn interest at a 4.4% annual rate. I say this assuming a 25% tax rate. Savers in lower tax brackets would need somewhat less; savers in higher tax brackets would need somewhat more. But for most people, if you earned less than 4.4% on your savings in the last year, you were losing purchasing power. You would have been better off to buy canned goods and put them in your kitchen closet.
More important, 4.4% is what short-term, risk-free savings yields have to be if we want to (1) give savers a fair shake and (2) stop subsidizing asset speculation.
Savers left in the lurch
That figure isn't far from the historical averages, according to Ibbotson Associates data.
In the 1926-2003 period, Treasury bills returned an average of 3.7%, while inflation averaged 3%.
But think about last year: Treasury bills returned 1%, about 2% less than the rate of inflation. The comparison gets worse if you consider taxes.
Over longer periods of time, risk-free intermediate- and long-term government bonds have provided an average return of 5.4%, well over the 3% average inflation rate. As a result, borrowers compensated savers for both taxes and liquidity risk.
Not today.
Money is free. While a saver has to commit to five years to get a 3.63% return on the average bank CD, home equity lines of credit are advertised as low as 3%, tax-deductible. So while savers earn a net 2.72% and lose purchasing power, borrowers pay a net 2.25% and gain through inflation.
The following table compares actual current interest rate offers today with what savers should be earning to maintain their purchasing power.
| Yields: comparing what is and what should be* | | Investment | Real World (today) | Reasonable World | | Short-term/no risk | 2.01% (or less) | 4.4% | | Intermediate-term/no risk | 3.63% | 5.4% |
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Sources: Ibbotson Associates, Bankrate.com, Bloomberg.com
The last time the markets were this kind to borrowers -- and this cruel to savers -- was the 1970s. The period was followed by the annihilation of the thrift industry and a real estate bust that took more than a decade to clean up.
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