Archive for December, 2019

Through the eyes of a 10-year-old – The Fed’s Policy of Financial Repression is Suddenly Personal

Thursday, December 5th, 2019

I’ve written about the deleterious effects the Fed’s interest-rate setting policy is having on savers. Of course, as a saver, I have personal experience with the ramifications. But this weekend, my experience is about to get a whole lot more personal.

About a month ago, my 10-year-old son begged me to take him to the bank to open a savings account for him, like I had done the previous weekend for his older sister. Enamored with the idea that he would have his own savings and checking accounts (complete with debit card) he attentively listened to my explanation of how banks work, how savings and checking accounts work, and how interest rates work. He astutely placed all of his money into his savings account after determining there wasn’t anything he needed or wanted to buy in the near future. Plus, he really wanted his money to start working for him, to earn as much interest as possible.

For the next week, he’d ask me every day whether he had earned any interest, to which I would reply, “Yes you have, but the bank only adds it to your account at the end of the month, and if you recall our conversation about interest rates, it’s not going to be a lot, so don’t get your hopes up too much”.

In our house, I balance our accounts every 2 weeks, to coincide with my wife’s paycheck cycle. And as part of this process, I now reconcile the accounts my children have. I then print a report for each of them and we review it, talking about what they’ve spent, what they’ve saved, and their ending balances. I find that it serves as an excellent opportunity to talk to them about concepts like wants versus needs, savings goals (future consumption versus current consumption), and how much they’d like to set aside to give to others less fortunate than they are (philanthropy). This weekend I get to talk about the interest he earned on his account.

One penny, to be exact.

And this isn’t because the amount of money is his account is very low. He actually made a healthy contribution to his saving account, one, that it a normal environment, could reasonably be expected to generate enough interest income over the course of a few monts to buy a used video game. But alas, I get to explain to him that he earned a whopping 1 cent. I realize we could shop around for better rates, and I could introduce him to other products, such as CD’s that would offer slightly higher rates. But that’s not the point of this piece. I’m thinking about his reaction, the conclusions he’s going to draw from it, and by extension, what our “lower for longer” interest rate environment is doing psychologically to an entire generation of children, adolescents, and young adults.

We know that our experiences with money during our formative years dictate our relationship to money. We know that, for example, the Great Depression severely affected how an entire generation viewed stocks and banks – their distrust was so strong that many of them swore never to own a stock or use a bank. Ever. For young children, growing up in a family confronted with financial scarcity profoundly effects their worldview when they become adults.

So, naturally I’m worried about his reaction this weekend. I fully expect him to be disappointed, and rightfully so. But what I’m even more concerned about is the lesson he’ll take from it, and the decisions he’ll make going forward as a result.

If his hard-earned money (and I mean hard-earned, a lot of his money came from 10-hour days of physically demanding yard work during the fall) is earning virtually zero, what’s the incentive to save at all? Will he decide to “screw it” and scrap his savings goals and splurge on another video game or lightsaber?

Theoretically, we save because the benefit derived from future consumption is greater than the benefit derived from current consumption. An inherent aspect of this trade-off is the expectation that by postponing current consumption, future consumption will be higher. And in fact, due to inflation, it must be higher.

But how can a 10-year-old child, who is constantly bombarded with the temptation to embrace the American Consumerism lifestyle in all its glory make the prudent decision to forego spending his money today and save it for tomorrow, when there is no incentive to do so? In fact, although he isn’t aware of it yet, there is a clear disincentive to save his money precisely because he is losing purchasing power every day his money sits in a savings account. In order to simply break even on an after-inflation basis, he would have to purchase a 30-year U.S. Treasury bond – and at the age of 40, his money would be no better off then than it is today.

The financial advisor in me is tempted to try to convince him that “because interest rates are so low, it’s even more important for you to save your money”, but I’m not confident he’ll be able to comprehend that logic, and even if he does, that he’ll make the commitment to see it out.

And by extension, how will his generation, and the generation before him, react when they start saving money and experience first-hand the paltry payback to making the prudent decision? I fully recognize the goal of the Fed’s policy – to incentivize spending today, even at the expense of spending tomorrow. And there is something to be said for the Fed’s efforts in 2009 – 2012, when the U.S. economy was still recovering from the Great Financial Crisis. But here we are, 10 years later, with a U.S. economy that is growing at / slightly above its long-term potential, and we still have extreme financial repression.

The consequences of the Fed’s financial repression on the baby boomer generation is well-known, and tragic to say the least. But until this week, I hadn’t considered the ramifications for the youngest generation of savers who are growing up to learn that their hard-earned money is not going to work as hard for them as they did for it.

How will they react? Are we creating an entire generation that will view savings as a futile effort? That in order to preserve purchasing power and maximize utility, they should spend what they earn as soon as they earn it? Or that because borrowing money is so inexpensive, the rational course of action is to accumulate debt to ramp up current consumption and “improve” their lifestyle?

As concerning as these questions are for me as an advisor, there is one question that keeps me up at night as a dad – how do I answer my son when he asks “What happens if the U.S. Mint stops making the penny?”