Commentary: Long-term interest rates are low and some fear going lower. This has important implications for investment and savings. It will affect our retirement and will affect our children
Globally, the yields paid by governments has turned negative. Japanese, Sweden, France and German, for example, all have negative 10-year bond yields, meaning that an investor who buys these bonds and holds them to maturity is guaranteed a loss.
Long-term interest rates in the United States haven’t turned negative but are still very low by historical standards. The U.S. 10-year government stands at 1.6%, down about 100 basis points since May. Yields on private bonds are also down. Triple-A bonds are paying less than 3 ½%.
Economists have long thought that sustained negative interest rates were not possible. People were thought to be impatient, preferring to consume now rather than in the future. This made since in a world where people lived short lives and there was concern about feeding one’s children. Waiting to consume when the future was uncertain could mean not consuming at all.
But that is the world of the past. In our modern society, people expect to live into old age. People aren’t as worried about meeting their immediate needs so focus more on saving for retirement. There is high demand for low risk assets, government bonds being an example of this, that can be used to convey savings into the future. Thus, there is a global savings glut.
Meanwhile, there appears to be a shortage of high return investment opportunities. The savings glut is more than adequate to fund all the high-yield, low-risk projects—what you might call the no brainers—with still plenty of savings left over. Savers next turn to more hairbrained schemes, with either low return or higher risk.
Low interest rates favor businesses that rely on debt for growth. The low cost of borrowing makes these sorts of business more profitable than they would be otherwise. This has the potential to reshape the economy.
Take the oil boom in Eastern New Mexico. Low interest rates that allowed drillers to borrow heavily to fund fracking. Thus, the New Mexico economy is much different today than it would have been had we not been in a low interest rate environment.
But lending to high debt, high risk business is but a band aid. Low rates threaten our retirement and may mean significantly less affluent lifestyle in the future. Low rates make it harder to accumulate wealth over time.
Historically, financial planners have assumed a long-term yield of 8%, when yields are about half that right now. The consequence is that a dollar saved today in twenty years will be worth about half of what a dollar saving in the past was worth.
Individuals will have to save twice as much to ensure the same retirement income. More ominously, for pensions, this means when today’s workers retire, there may not be enough to cover the promised payments.
Christopher A. Erickson, Ph.D., is a professor of economics at NMSU. His most oft taught course is Money & Banking. The opinions expressed here may not be shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu.