The Federal Reserve has doubled down and in so doing has forced investors to follow suit. To keep interest rates low, the central bank announced plans to buy as much as $85 billion of mortgage-backed securities per month through year-end and expressed willingness to keep rates low through mid-2015.
This leaves savers with slim chances for earning positive real returns unless they invest more heavily in risky assets. Conservative investors, who have traditionally relied on CDs and short-term Treasuries, can currently earn a whopping 0.05 percent (1 month Treasury bills) and 1.8 percent (10-year Treasury notes) before inflation. Meanwhile, year-over-year price inflation (CPI) through August was 1.7 percent. Worse still, AIER’s Everyday Price Index increased 1.6 percent in August alone.
Stocks surged on the Fed announcement, which apparently was part of the Fed’s plan. In his September 13 press conference, Fed Chairman Bernanke was direct:
“…if people feel that their financial situation is better because their 401(k) looks better or for whatever reason, their house is worth more, they are more willing to go out and spend, and that’s going to provide the demand that firms need in order to be willing to hire and to invest.”
This is fine for risk-tolerant investors who have the means and the stomach to ride out stock market gyrations. They can shave off capital gains periodically in order to meet their spending needs. Homeowners with equity, who can now refinance or borrow at lower rates, also stand to benefit. But for elderly investors with small nest eggs and low-income renters trying to keep pace with rising prices, the Fed’s policy leaves little recourse but to embrace market risk and hope for the best.
Meanwhile, the same banks offering depositors negative real rates have, since 2008, enjoyed an effective subsidy, courtesy of the Fed. As Senior Fellows at the Hoover Institute recently pointed out, the Fed now pays interest of 0.25 percent on bank reserves it holds, to the tune of $4 billion per year. This transfer is not a loan but a grant, and one which circumvents the need for Congressional appropriation.
As the Fed’s power expands, its policies are coming to resemble central planning. With that power comes the awesome responsibility of deciding who will win, and who will lose.
Also in This Issue:
Treasury Fails Econ 101
Is Gold a Safe Haven?
Fixed Income Investing: Bonds Versus Bond Funds
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles
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