GLENN STEVENS: Low interest rates will ruin your retirement

Uh oh. Photo: Peter Macdiarmid/ Getty Images.

RBA governor Glenn Stevens this week joined the CEO of the world’s biggest investment firm, Blackrock, in saying that ultra-low global interest rates are causing problems for people’s retirement planning.

That in turn, Larry Fink said, was part of the reason why global growth was not responding to low interest rates but rather is stuck in the mire of low growth and low inflation.

That’s important, because since Alan Greenspan first dropped interest rates in the US to support the US economy after the 1987 stock market crash, modern central bank policy has been all about lowering, and raising, interest rates to smooth out economic activity.

For the most part it worked. But as each recovery has proved weaker than the last, the path of interest rates globally has continued downward.

So, as effective as dropping rates was in stimulating the US and global economies in the 20 years leading up to the GFC, it’s clear that in the post-GFC world monetary policy is failing to reignite growth. It’s lost its efficacy, as governor Stevens noted in his speech in New York earlier this week.

Negative rates are being pursued in a number of jurisdictions including Europe and Japan, and elsewhere rates in many countries are at modern day lows.

But the global economy is failing to relaunch.

Part of the reason for this, according to Fink, is that low interest rates are having the opposite of their intended impact on people in the economy – consumers. Fink said that rather than encouraging consumers to increase debt and spend now, low rates were actually causing savers to fret about their future income, lifestyle and retirement.

“Consumers saving for retirement need to reduce spending if they are going to reach their retirement income goals and retirees with lower incomes will need to cut consumption as well,” Fink wrote recently in a note to investors..

“A monetary policy intended to spark growth, then, in fact, risks reducing consumer spending.”

That’s something Stevens himself highlighted.

“This world of ultra-low interest rates over a lengthy period is a big problem for savers,” he said in New York.

Whether you are in a defined benefit pension plan, like many corporate plans in the US, or in a defined contribution plan, like most Australians in the post-1988 world, Stevens said the promises of a comfortable retirement are at risk.

“The implicit promises – even if made only to themselves – about their retirement incomes are in danger of not being fulfilled. It is not a very daring prediction to say that these issues will loom ever larger over the years ahead,” Stevens said.

That’s exactly Fink’s point. He simply says that these issues are already weighing on savers who know they need to save more now to compensate for lower returns on those savings. That’s consumption foregone now for savings.

But it’s not just older people who are impacted by the weight low rates puts on their expectations about the future of savings and income.

Business Insider alumnus Sam Ro wrote at Yahoo in the wake of Fink’s note that his 34th birthday had been ruined after reading it. That’s because even though he has a “reasonable amount” in his 401(k) – the US version of superannuation – it was nowhere near the amount Fink calculated a 35-year-old, Ro’s next birthday, needed to have a comfortable retirement.

Here’s Fink again:

A 35-year-old looking to generate $48,000 per year in retirement income beginning at age 65 would need to invest $178,000 today in a 5% interest rate environment. In a 2% interest rate environment, however, that individual would need to invest $563,000 (or 3.2 times as much) to achieve the same outcome in retirement.

Sam Ro said there was no way he was going to get there in the next 12 months.

It’s that realisation that Stevens says will eventually dawn on people and “loom large” over the economy in the years ahead.

That’s because “the future income against which people would borrow looks lower than it did, not to mention that the current income against which some already had borrowed has turned out to be lower than assumed”, Stevens said.

So savings, not consumption, need to rise to balance that out at a household level. The exact opposite of what the global economy needs.

But we are all getting older and living longer and that’s a further risk, Fink says.

“Workers and governments must also navigate the effects of increased longevity, as large segments of the population are increasingly unable to support themselves in old age and we have yet to find effective ways to fully harness their economic potential or longevity dividend.”

Stevens’ prescription is to get governments borrowing to build infrastructure and so spur growth in the economy again. But if growth isn’t reignited and if governments don’t invest in the economy, his message is people just won’t get the retirement they think they have been promised.

That is not good news.