Thursday, June 2, 2011

Interest Rate Math and the Gathering Collapse of GDP

Taking a break from the usual, tired explanations of why the economy is imploding or why stocks went up or down on a particular day, today we will endeavor to discovre how much money is being lost to the US economy via the Federal Reserve's Zero Interest Rate Policy, that drives all other rates towards ZERO.

The idea for this enterprise came from an article n the September, 2010, edition of Reader's Digest, titled "Bonus Question" by Michael Crowley, abot how Wall Street profits at the expense of the middle class, especially through low interest rates. There's a podcast of the article available here.

The premise is simple. A long time ago, somebody, probably one or both of our parents, told us that saving was a good idea. And it was, especially when you could get 5% interest in a savings account.

Well, times have changed. One per cent is now the norm for CDs, savings accounts, money markets and other similar investments. So, the question emerges: how much has the Fed's Zero Interest Rate Policy (ZIRP) cost the middle class and the overall GDP?

Let's take an example of a person or couple having put away $300,000 for retirement, their plan, to retire on that money (they'll probably need more) and use the interest to pay for much of their daily living expenses. At 5% interest, they'd be looking at $15,000 a year, which is a very good start and would cover at least food, fuel and probably most of the rent.

But, let's suppose they've still retired, but they are only earning 1% today. That's only $3000, or, in other words, $12,000 that now has to come out of the principal, so every year that the Fed keeps ZIRP in place, they'll have to spend more and their net worth declines, impoverishing themselves and their heirs, someday in the future.

Editor's Note: I would like to point out that I'm using $300,000 in savings as an example here, figuring it is probably around the median savings of the already retired. Surely, many have saved less, but quite a few have saved even more. Actually, prior to 2000, the number was probably quite a bit higher.

OK, so now we can clearly see that the ZIRP has benefitted banks and Wall Street, as they borrow at nearly zero and lend at higher rates while investing in riskier assets like stocks and commodities. Retired individuals have no doubt tried to do the same with their savings, but the results have been poor over the past decade.

Getting back to our original premise, we have an average of $12,000 being lost to ZIRP, the money coming from the principal rather than interest. But suppose we say that this money is not being spent - and in some very real ways it isn't - because these retired folks are spending less on discretionary items since they have poor prospects for the future. Any way you look at it, ZIRP is causing a reduction in spending by seniors.

How much? Good question. We took a look and found that in April, 2011, there were 36,378,000 people collecting Social Security aged 65 or over.

So, simple math tells us that because of the Fed's ZIRP, there's roughly (36,378,000 X $12,000) $436,536,000,000 being lost in general spending to the economy. That's close to half a trillion dollars, and since we're two-and-a-half years into the Fed's ZIRP experiment, we lost that much in 2009, again in 2010 and are well on our way to doing it again this year.

Also, it's worth pointing out that Fed Chairman Greenspan, Ben Bernanke's predecessor, cut the federal funds rate to one per cent in the aftermath of the dot-com bust in 2001. Through the decade of the 2000s, the federal funds rate never got higher than 5 1/2%, and for much of the time it was well below that level, so the savings destruction has been going on for some time. We have been slowly eroding the wealth of seniors and future generations for over a decade and the effects are beginning to become quite a strain on the US economy.

So, how much damage is being done. If we can trust that number of $436,536,000,000 as the difference between 5% interest on savings versus 1%, it comes to about 3% of annual GDP, about the same amount the government would like the economy to grow annually. With the Fed's ZIRP in place, though, GDP will actually have to grow 6% just to make up the slack. And it isn't. It's not even close.

Charles Hugh Smith penned a very poignant essay on the topic of GDP on his Of Two Minds blog, in which he suggests that the economy isn't growing at all, thus reinforcing our point.

Since economics is mostly guesswork, extrapolation and statistics, please take this back-of-the-envelope with appropriate grains of salt, but the upshot is still the same: the Fed is actively destroying the savings and spending potential of seniors and anyone else who might be prudent enough to want to put something away for "a rainy day." Add in the implications of inflation, and it becomes clear why we're stuck in a no-growth economy and why deflation is not only desirable, but the best path out of our current morass.

Now, for our usual market recap:

Stocks went almost nowhere today, bothered by Wednesday's wicked sell-off and cognizant of Friday morning's May Non-farm Payroll release. Nobody seemed willing to put much "risk on", as they say, in advance of what could be a game-changing number. Most of the residual pain from Wednesday was felt in the Dow and in commodities, with the notable exception of crude oil (go figure).

Two pieces of economic data should have moved markets further to the downside, but the stubborn "recovery" crowd still refuses to buckle.

Initial jobless claims came in again above expectations (400,000) at 424,000, and factory orders fell 1.2% in April. This news, though bad, is about as good as anything seen in the past month. The Dow Jones Industrials were down nearly 100 points close to midday, but, as usual, recovered during the afternoon.

Dow 12,248.55, -41.59 (0.34%)
NASDAQ 2,773.31, +4.12 (0.15%)
S&P 500 1,312.94, -1.61 (0.12%)
NYSE Composite 8,277.76, -3.83 (0.05%)

Declining issues topped advancers, 3411-3119. On the NASDAQ, there were 30 new highs and uh, oh, 68 new lows. The NYSE saw 48 new highs and 47 new lows. Taken together, we have the expected flip, with 78 new highs being exceeded by 115 new lows. Unless the BLS pulls a rabbit out of its hat tomorrow morning and announces 150,000 or more new jobs created in May, it could mark a very important market turn that has taken many months to set up.

Volume on the day was back to pedestrian, depressed levels.

NASDAQ Volume 1,886,108,625
NYSE Volume 4,256,270,500

Crude oil was lower for much of the session, but finished the day up 11 cents, at $100.40, even though the government reported an inventory build of 2,878,000 barrels for the week ending 5/28.

Gold was punished again for being an alternative to paper money, losing $4.80, to $1534.30, though still very near all-time highs. Silver took more lumps, down 64 cents, to $36.18.

Just for fun, here's a chart which helps explain where the US economy is really heading via the Debt-to-GDP ratio:

And if that doesn't whet your technical appetite, try this long term chart of the S&P 500 measured in gold.

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