Monday, February 13, 2012

Higgs: Immiseration of Personal Interest Income

Last week I had a CD post on how the Fed's zero interest rate policy has significantly reduced personal interest income and it generated a lively discussion. Robert Higgs had a related post last Friday titled "The Fed's Immiseration of People Who Live On Interest Earnings," here are some of his comments:

"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."

MP: Bob refers to a graph showing personal interest income in nominal terms, displays a graph of the PCE price index, and discusses how the effects of reduced personal interest income would be even more dramatic if adjusted for inflation.  The chart above combines those two charts into one, and displays real personal interest income adjusted for inflation, which supports Bob's conclusions that: a) real personal interest income has dropped by more than a third since 2008, from $1.4 trillion to $973 billion, and b) the flow of personal interest income today at $973 billion has only about 77% of the purchasing power of personal interest income in 2000 ($1.26 trillion).

Bob concludes:

"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.

The link between the Fed’s policies and this undeniable effect is too direct and too obvious for anyone, including the Fed’s managers, to overlook or misunderstand. We may only conclude, then, that the Fed’s managers either: 1) want to wipe out the retirees and others who rely heavily on interest earnings, or 2) consider these people’s immiseration an acceptable price to pay in order to achieve other objectives. Can any decent person approve such policy making?"

HT: Warren Smith


At 2/13/2012 10:57 AM, Blogger morganovich said...

it's also worth considering that this will keep trending down.

right now, many living on interest still have longer term bonds etc as i'm sure most of them "laddered".

if you have a 10 year from 2003 though, this is a real quandary for you. it's going to mature next year and the fed has said ZIRP will still be in effect.

so what do you do?

lock in 10 years at 1.96% and let inflation eat you alive? look for something riskier and higher yielding?

it's not a situation i'd want to be in.

At 2/13/2012 11:06 AM, Blogger EGLA said...

I was wondering is it possible that part of these decrease in interest income is because people are moving out of these investments into riskier ones, so the amount invested is also down?

At 2/13/2012 11:40 AM, Anonymous Anonymous said...

"it's not a situation i'd want to be in."

Maybe ZIRP will show the weakness of an unbalanced 100% fixed-income portfolio. To beat inflation over a long period of time takes an asset allocation that contains at least a small percentage of equities.

I've used the Boglehead approach the last 20 years while those around me invested in their houses or played the stock market by trying to time it. I am semi-retiring while they can't afford to. My advice for what it is worth: buy half the house you can afford, invest the other half long-term through payroll deduction in an asset allocation that allows you to sleep at night. Don't worry about the yearly ups and downs because you will do fine in the long run.

I probably would have been a millionaire now if I had followed this advice for another ten years. Compounding interest is cool.

At 2/13/2012 12:05 PM, Blogger Benjamin Cole said...

Yes but Higgs makes a simple mistake. If interest are higher, that reflects higher inflation, and thus capital erosion for people who own bonds.

Moreover, bondholders have enjoyed fabulous capital appreciation in last several years, as interest rates came down.

Higgs left his thinking cap in the toilet on his way to work.

Meanwhile, ponder this quote from Karl Smith, well worth reading:

"I used to believe that the disagreements in the economics/policy/elite journalism world were founded on attempts to seize the zeitgeist through intellectual intimidation. That is people pretended to be arguing over policy issues but instead were try to push the political culture towards their preferred answers to meta-questions of policy.

For example, is providing lots of assistance to the poor something society should embrace? Is letting people keep what they earn something society should embrace?"

At 2/13/2012 12:08 PM, Blogger morganovich said...


"Maybe ZIRP will show the weakness of an unbalanced 100% fixed-income portfolio. To beat inflation over a long period of time takes an asset allocation that contains at least a small percentage of equities."

such a portfolio has massively outperformed equities which are flat since 1999 and down over 40% in inflation adjusted terms since then. if you had a 100% equities allocation for the last 20 years, you made 5.8% a year if you mirrored the S+P. if you had bought a 30 year bond in 1992 instead, it would have yielded 7.75% and whupped this return (and you'd have a decade left on it).

you seem to be under some misconceptions about how strategies have performed.

just what is it you are expecting people to hide in? commodities are much too volatile to be a big component of an income portfolio that you intend to live off of.

the classic strategy is to overweight equities and commodities when you are young and transition to fixed income as you age and need more reliability and actual income generation.

i also think your whole formulation of the issue is flawed. ZIRP is not "revealing" anything. it's an outrageous policy that is doing damage, not revealing weakness. ZIRP reveals the weakness of bonds the way a flamethrower reveals the weakness of a wooden house.

but also keep in mind that if you owned that 30 year bond it would now be worth a ton due to ZIRP. it's only buying them now that sucks. if you had one from 20 years ago, ZIRP would be your best friend. yield and price move inversely. the problem is that if you sell it, what are you going to buy?

not everyone was lucky enough to buy 30 years in 1992.

if you are rolling things over now and/or trying to set up long term savings, you have few good options if you want to generate income. those getting into their 50's face a terrible set of options in terms of saving. they are going to have to take on far more risk that they would likely prefer or face negative real returns from fixed income.

At 2/13/2012 12:16 PM, Blogger morganovich said...

"If interest are higher, that reflects higher inflation, and thus capital erosion for people who own bonds."


real rates are generally positive. the only reason they are not is fed intervention. there is no deflation.

thus, the one year would be (using cpi) 3% + some real rate and therefore likely 4% or so, not the less than 20bp currently prevailing thanks to QE's, twists, and ZIRP.

the problem is that rates now do not reflect inflation and are deeply negative in real terms.

higgs has it right and you, bunny, just have no idea what you are talking about.

those looking to de risk a portfolio as they near retirement face deeply negative real interest rates. that's not saving, it's damage limitation.

At 2/13/2012 12:16 PM, Blogger Buddy R Pacifico said...

The loss of interest income and savings compounding, has led many to seek dividend income and reinvestment.

One of the best places to find ideas on dividend investing is at SeeakingAlpha's Investing for Income section. There you will find a variety of equity and strategy ideas on dividend investing. The comments on the articles are often very good and challenging to the author's viewpoint.

At 2/13/2012 12:27 PM, Anonymous Anonymous said...

"you seem to be under some misconceptions about how strategies have performed."

My misconception was that everyone has a strategy or that they can keep it when so much noise is made about the market.

Try this: Pick any historical 20-year span of a 50-50 bond/stock allocation with a low expense ratio (less tahn 1% yearly)and see how it does compared to inflation (or owner-occupied housing). Also assume a savings rate of 10-20% of yearly gross income over the same time period.

The allocation can be adjusted for those who feel they must to sleep at night, but not to within 90-100%either way and not because of what the market is doing at the time (people tend to emotionally buy high and sell low).

You don't need to de risk your portfolio unless you started too late in life that you have to take on too much risk to meet your target too quickly. Time is both your friend and your enemy.

At 2/13/2012 1:19 PM, Anonymous Anonymous said...


I had the information I asked you to supply from the latest 20-year period. A 50-50 mix would have yielded 7.82%. It looks about like the 20-year periods before this one that I have (Source: Callan). This is not inflation or compound adjusted (if I remember correctly the CPI is about 3% over this same time period)

Year BC Agg SP 500 AVG
1992 7.4 7.62 7.51
1993 9.75 10.08 9.915
1994 -2.92 1.32 -0.8
1995 18.46 37.58 28.02
1996 3.64 22.96 13.3
1997 9.64 22.58 16.11
1998 8.7 28.58 18.64
1999 -0.82 21.04 10.11
2000 11.63 -9.11 1.26
2001 8.43 -11.89 -1.73
2002 10.26 -22.1 -5.92
2003 4.1 28.68 16.39
2004 4.34 10.88 7.61
2005 2.43 4.91 3.67
2006 4.33 15.79 10.06
2007 6.97 5.49 6.23
2008 5.24 -37 -15.88
2009 5.93 26.47 16.2
2010 6.54 15.06 10.8
2011 7.84 2.11 4.975
% AVG 6.5945 9.0525 7.8235

At 2/13/2012 1:20 PM, Blogger morganovich said...


your hypothetical 50/50 portfolio needs to be re upped all the time though.

bonds mature and need to be replaced.

new savings has to go into bonds.

the current interest rate environment means that buying government bonds yields negative real return and has for 3 years.

that's a lot of negative return to suck up.

it also means that to get to a positive real return on equities, you have to go back to about 1997.

sure, if you roll in you got some great buys in 2009, but you also made some terrible ones in 2007-8.

the point is that right now, as you put some savings into bonds, you are getting negative real return. that's the direct result of fed policy.

this makes it all but impossible to save effectively in bonds.

it also ups the risk of equity investing significantly as these policies and ones like them are what has been driving recurrent bubbles, upping the risk of equities considerably, especially if it's money you might need.

needing cash in early 2009 was a disaster if you had it in equities.

toss in a 1% fee, and the last 20 years of 50/50 have barely kept up with inflation. you would be lucky to pull out 1.5% real return. (and that's using the new CPI. use old CPI and returns were significantly negative)

this is massively below pretty much any 20 year period in us history.

the reason is the fed policy of wildly low rates from the "greenspan put" to the overreaction to 2000 to this last round of insanity.

far from protecting us from the business cycle, the fed has been driving us into the ground.

that's the point of this discussion on ZIRP. it's doing dramatic harm to savings and causing huge debt accumulation.

why save as opposed to consume when the real returns are negative anyhow? better to buy a car and at least use and enjoy it than buy a bond certain to be worth less than you paid in real terms.

the big winner since the easy money really got rolling in 2000 has been commodities.

the CI is up 193% from 2000. that trounced bonds and stocks by multiples.

over 20 years, it looks like the S+P in terms of return, but since the fed got "active" it's been a big winner.

the problem with commodity markets for savings is that 1. they are quite small relative to bonds etc and 2. they are very volatile.

thus, relatively few can hide there, and those that do can face massive drawdowns in any given year, so it's a tough place to put money you might need in the near term.

At 2/13/2012 1:29 PM, Blogger morganovich said...


your math is bad.

compounding does not work like that.

you cannot just average the returns.

the numbers you are claiming are MUCH too high.

if you have $100 and it goes up 20%, you have $120. if it then drops 20%, you have $96, a 4% loss.

the arithmetic average says you should have $100 and 0% return.

but that's not how compounding works.

in 1992 the S+P was 435. today it is 1351. that's 210% return. that's 5.8% compounded (20th root of 3.1).

that's about the best vase over that period.

in many of the years since 2000, the return is negative as the S+P was higher in 1999, 2000, 2001, 2006, 2007, and 2008 than it is now.

the actual return to equities from rolling investment over this period is more like 4%.

add in fees, and you barely beat inflation.

At 2/13/2012 1:33 PM, Blogger morganovich said...

here's another way to look at it:

the S+P was 435 in 1992.

9% return on the S+P for 20 years is 560% return. (1.09^20)

thus, the S+P would be 2872 today, more than twice it's current value.

At 2/13/2012 1:37 PM, Blogger juandos said...

"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"...

Well this is sad...

Obviously having a money market type of investment will not work with this sort of Fed policy in place...

To bad folks can't reinvest their money in something that isn't depreciating like money is...

I've been to two different gun shows the past two weekends and I can say for sure that firearms prices are NOT suffering from this fed policy...

At 2/13/2012 2:25 PM, Anonymous Anonymous said...


I see what you are saying, but your numbers don't match my year-to-year portfolio performance. My yearly averages are close to the yearly averages I quoted after subtracting the money I put in that year. I keep the same mix in good and bad years, and the same amount of savings out of every paycheck and raise, so I have some cheap and expensive stock shares. I also added more percentwise to my portfolio after the bad years because the base was smaller.

I'll have to work on this calculation a bit. A lot of my perception of success is simply from working a lot and saving a lot instead of spending :)

At 2/13/2012 2:40 PM, Blogger Rich B said...


I read your comment and I know you think it's a devastating rejoinder, but it makes no sense.

At 2/13/2012 2:47 PM, Blogger Benjamin Cole said...


Are you now contending that when interest rates go down, bond values (all other things being equal) do not go up?

Have not bondholders done well in the last five years?

Perhaps you left your thinking cap in the toilet too.

Interest rates are low now as there is a global glut of capital, and no inflation. The lower inflation, the lower interest rates will be. Are you contending that is not true?

Is anyone forced to buy US Treasuries? That is the market rate.

At 2/13/2012 3:28 PM, Blogger Rich B said...


To get the S&P total return you must include reinvested dividends. A quick search and some quick calculations indicated that the compounded annual return with dividends 1992-2011 is about 7.7%. Of course that's based on a single investment in 1992 and the rates would be different if you had cash flows in/out during the period.

At 2/13/2012 3:55 PM, Blogger morganovich said...


it looks like you left your reading comprehension hat in the toilet (if ever you had one).

that's not what i said at all.

what i said was that income has dropped. most people roll and ladder bonds. those saving now have no good options because real rates are negative.

sure, if you bought a 30 year govvie in 1992, you cleaned up and zirp has given you some good capital appreciation, but few have much of their portfolio in anything so long term. any bond you bought in the last 4-5 years has had negative real return.

given how laddering works, that's going to be a fair chunk of most portfolios.

being forced to buy them is not the point. it's having the option of risk free return deliberately taken away that's the point.

more risk, less return, ooh, yeah, great plan.

At 2/13/2012 4:01 PM, Blogger morganovich said...


1. you also have to take out management fees and taxes. that will offset dividends (if you do well, and exceed them significantly if you trade a lot)

keep in mind that low fee products are fairly new. in 1992, you were going to pay up. and taxes take a HUGE bite out of compounding and you will pay them unless you never trade. note that even many index funds generate tax bills as they rebalance and buy/sell stock based on AUM driven by inflows outflows.

2. taking 1992 forward is not really a valid way to go in looking at the return to savings over time.

you need to take contributions each year (or month or whatever), find their profit to date, sum them all, etc.

the stock you bought in 2000 or 2007 is going to have negative nominal returns to now.

At 2/13/2012 4:09 PM, Blogger morganovich said...


you may just be beating the market.

but the average guy winds up under-performing the market (due to fees, taxes etc).

if so, either you or your adviser are picking good investments.

(or you are pulling a beardstown ladies and not accounting contributions correctly. god that was funny. all those books and it turns out they were massive underperformers.)

At 2/13/2012 4:37 PM, Anonymous Anonymous said...


I am dividing the loss/gain at the end of the year by the beginning year balance using Excel (I am not counting any contributions). About 80% of my portfolio is in 401ks and IRAs, so taxes have not come into play on them yet (except Roths), and I believe the fees would be counted using my methodolgy. My Pimco Real Return and Pimco Core Plus Bond Funds were up an average of 10.55% last year with stock funds at 0%, and bond funds are 57% of my portfolio. This year my bond funds are flat but positive and my 43% stock funds are up 5.3% already this year.

I only buy individual stocks and ETFs for amusement and keep that to less than 5% of my portfolio. My GM stock is disappointing me. I don't own any individual bonds.

I am my own financial advisor, but I do not do anything fancy at all (no options and no margin accounts). You are much more knowledgeable about finances than I am. I just save a lot using mostly low-cost, low-expense mutual funds, and I buy-and-hold for long time periods. I don't try to beat the market because it will always revert to the mean over time.

At 2/13/2012 4:53 PM, Blogger Rich B said...


I only use index funds with low expenses and most of my money is in tax deferred accounts. My (valid) point is that if you ignore dividend reinvestment, you seriously understate total return.

I picked 1992 because that was the period you used.

At 2/13/2012 5:16 PM, Anonymous Anonymous said...

Rich B

I initially used 1992 that morganovich replied to because it was the beginning of the latest 20-year historical period.


Is "risk free return" the same thing as too big to fail?

At 2/13/2012 6:34 PM, Blogger morganovich said...


1992 was just the first year in the 20 year period walt and i were discussing.

you cannot assume that return for the other years.

that's how i'm getting to 4%ish. i suspect that is optimistic.

for the last 12 years returns have been far less on a compounded basis. you're likely down on buys from 6 of those 12 years.

also note: dividends are taxed (unless you have and IRA, but contribution limits to them are so low it's hard to get much money in one) and if you have significant dividend income, it can effect the taxes on your other income as well by pushing up your marginal rate.

and not even index funds are not taxed. they still buy and sell around asset flows and re-balancing etc and also on dividends.

At 2/13/2012 8:00 PM, Blogger bix1951 said...

buy high yield blue chip stocks
(be careful)
write calls deep in the money
pocket the dividends and the premium and your can get a rather safe return of 5% to 10%
(be sure there is a decent premium on the calls)

At 2/13/2012 8:04 PM, Anonymous Anonymous said...

Think long on the S & P 500:

Last 12 years compound annual growth rate (CAGR) adjusted for inflation -1.93%

Last 20 years compound annual growth rate (CAGR) adjusted for inflation 5.20%

Last 25 years compound annual growth rate (CAGR) adjusted for inflation 6.24%

Last 30 years compound annual growth rate (CAGR) adjusted for inflation 7.84%

(Source: S & P 500 calculator from money chimp)

At 2/13/2012 8:11 PM, Anonymous Anonymous said...

Clarification: That is -1.93% for 12 years. The Preview puts the negative sign on the same line as the percentage.

At 2/13/2012 11:04 PM, Anonymous Anonymous said...

While I have been making the same point about the Fed merely redistributing income from lenders to borrowers for some time now, I think this chart probably overstates the point. There are a couple reasons for interest rates to be low at the moment: lower inflation, Fed policy, and lower expectations for future growth. While the Fed may play a small role in making life tougher for retirees, their moves so far are likely not the culprit for that massive dropoff. It's likely that the general economic malaise is the main reason, with the Fed maybe accounting for 20-30% of the charted dropoff in interest income at most. So yes, let's get the Fed out of the banking market, but let's not overstate their importance either, because getting them out of this market likely won't help these retirees much. The real problem is the lack of easy investment opportunities during this recession and there's not much that can be done about that.

At 2/14/2012 8:53 AM, Anonymous Anonymous said...

"The real problem is the lack of easy investment opportunities during this recession and there's not much that can be done about that."

Sprewell, you and morganovich are seeing something much different than I am seeing. I see lemonade where you guys are seeing lemons:

2008: was a buying opportunity
2009: was great
2010: was great
2011: was flat, but up a bit
2012: has been through-the-roof great (up 5.9% in 44 days)

It's not easy, it was hard to go against the noise to buy in 2008 instead of sell, but this is a very, very simple investment method. Buy low, sell high to hold a once-a-year adjustment in a bond/stock fund ratio constant using low-cost mutual funds.

At 2/14/2012 10:02 AM, Blogger morganovich said...


those numbers do not mean what you think they do.

they would only matter if you saves all you money in that year.

for most, who save a bit every year, the last 15 years have led to zero increase in real wealth from the S+P.

now bonds offer negative real return as well and have for years.

hey, don't get me wrong, as a professional investor, this has been great to me.

but for a buy and hold guy, your "lemonade" theory is just nonsense. you are cherry picking.

you are down on half the years from 1999-now in NOMINAL terms. in real terms that mean you've been crushed.

if you take the actual time weighted return over 20 years (a much more complex calculation) and adjust it for inflation, you get somehting like 2%, tops.

the last 15 years has been the worst real market performance in US history and that's with the huge tailwind of CPI being changed in the early 90's ti read much lower.

apples to apples, this looks much, much worse. either returns then were much higher or they were deeply negative since about 1997.

At 2/14/2012 10:43 AM, Blogger Buddy R Pacifico said...

Walt G, morganovich and Rich B,

If Walt only invested in the S&P 500 equities, according to this chart from Crestmont Research(click on the + sign about four times), Walt's return is:

after adjusting for inflation, re-investing dividends and in a no-tax or tax deferred account...

1992 to Present 4%...

& assuming a saving start in 1980 is 6%.

At 2/14/2012 10:55 AM, Anonymous Anonymous said...

I used 20 years instead of your 15, which would include the phenomenal performance of the S & P for the four years from 1995 to 1998 (and the booming emerging markets of the six-year period of 2003 to 2007 and 2009). Maybe knocking those earlier years off would be cherry picking :)

My point is that opportunities exist even now, and government interference is a given whether it is the UAW/GM deal or the fed’s actions. My bond funds are already up 1.26% this year, which is only flat compared to my stock funds. I don’t now, and I have not in the past, seen negative real return in my bond funds using the current CPI. Maybe my being a less sophisticated investor makes me a happier investor.

Beating inflation by 2% would be a huge improvement for those that can forgo immediate consumption and that now live paycheck-to-paycheck. As some fixed-rate investors have found, there is no such thing as a risk-free investment.

At 2/14/2012 12:46 PM, Blogger Rich B said...

In the end, Higgs is right. Take a look at CD yields and they are abysmal. My inlaws used to get 8% return on CDs in the early 90's. That was down to the 4-5% range in the early 00's. This is typical of what has happened to savers.

At 2/14/2012 1:03 PM, Blogger morganovich said...

"My point is that opportunities exist even now, and government interference is a given whether it is the UAW/GM deal or the fed’s actions. My bond funds are already up 1.26% this year, which is only flat compared to my stock funds"

walt, 1. then your stock funds are horribly under-performing.

2. that's capital appreciation for the bonds, not income generation. when you push rates down, bond prices rise, but most bond investors are not looking for cap appreciation, but rather income generation. and with yields this low, it becomes mathematically impossible for bonds to appreciate much. where do you go from a 20bp yield?

there are always opportunities, but the group right now are very unattractive relative to the past. bonds are a sure loser in real terms.

that makes the game much trickier.

At 2/14/2012 1:07 PM, Blogger morganovich said...


you are making the same mistake with the math that walt did.

that's just return from 1992 to now if you put all your money in then.

that's not how people save.

the tend to put money away each year.

when you take that into account, the real return drops under 2%.

At 2/14/2012 2:48 PM, Anonymous Anonymous said...


None of my investments are underperforming by any measurement that I personally use on my spreadsheets or that is supplied to me by Fidelity or Vanguard (again, ignore my GM IPO stock purchase affair). I’ve only had a few downs in the past few years and I bought into them to keep my target asset mix. I am very, very pleased with what I see. I would not be happy at all with a 2% inflation adjusted yearly return.

I do hope those who are financially struggling for whatever reason or have poor investment returns much better luck in the future. I know this is what you do for a living, so thanks for your input and your patience with me.

At 2/14/2012 2:59 PM, Blogger morganovich said...


the S+P is up 7% year to date.

the russell is up double digits.

if your equity fund is up 1.26% like your bond fund, it's under-performing the market pretty significantly.

At 2/14/2012 3:35 PM, Blogger Buddy R Pacifico said...


"that's just return from 1992 to now if you put all your money in then.

that's not how people save.

the tend to put money away each year."

morgan, thank you; understood now.

At 2/14/2012 4:39 PM, Anonymous Anonymous said...

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