Since the “Financial Crisis,” the hope was that inflating asset prices would trickle down into economic growth. Unfortunately, after a decade of monetary interventions and artificially suppressed interest rates, the wealth gap has exploded. More problematic is the Fed has forced investors to take on excess risk due to the lack of alternatives.
I previously wrote an article on retirees’ primary problem: the 4% Rule is dead. To wit:
“The 4% Rule has long been used as a guideline for retirees in determining how much they should be able to withdraw from their retirement account while still maintaining a balance that will allow for the same income stream to flow through their golden years.”
The 4% rule originally suggested that once retired; portfolio allocations shift to ultra-safe Treasury bonds. Such an allocation shift provides for the income required to live on, plus a guarantee of the principal.
Here’s the problem.
When the 4% rule originated, Treasury yields were 5%. Today, they are just slightly above historic lows set during 2020.
Such is a massive problem for retirees today. As shown, $1 million will no longer generate a $50,000 income for retirement. Today, it is just $17,250/year, much better than the paltry $5500 set at the lows in 2020.
However, that is a deceptive number due to the lack of an inflation adjustment. When we look at “real rates,” the problem for savers becomes more apparent.
With “real” rates currently negative, what are “savers” supposed to do?
The question we should be asking is, how did we get here?
For that answer, we have to go back to 1982 as President Reagan launched a mission to break the back of spiraling inflation and interest rates. At the same time, he was working to restart the U.S. economy following two back-to-back recessions.
For this task, he joined forces with then-Fed Chairman Paul Volker to start using active monetary policy to fight inflation and create employment. Reagan engaged in deficit spending to fill gaps in the economy, cut taxes, and deregulated the banking system. It worked, he produced more than 9-million jobs, and inflation and interest rates started falling, leading to a pickup in economic growth rates.
What he didn’t realize then was that he had just opened “Pandora’s box.”
Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the change in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.
We can view the impact of debt on the economy by analyzing the economic growth created. As shown, it takes an increasing amount of debt to generate each dollar of economic growth.
Below Trend Growth
The deterioration of economic growth is seen more clearly in the chart below.
From 1947 to 2008, the U.S. economy had real, inflation-adjusted economic growth than had a linear growth trend of 3.2%.
However, following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Unfortunately, instead of reducing outstanding debt problems, the Federal Reserve engaged in policies that expanded unproductive debt and leverage.
Coming out of the 2020 recession, the economic trend of growth will be somewhere between 1.5% and 1.75%. Given the amount of debt added to the overall system due to the pandemic, the ongoing debt service will continue to retard economic growth.
The Fed’s Dilemma
The “debt problem” is also why the Federal Reserve has found itself in a “liquidity trap.”
Interest rates MUST remain low, and debt MUST grow faster than the economy, just to keep the economy from stalling out.
Before you argue that point, ask yourself this one question:
If the economy was strong, employment was full, and financial prosperity was high, then why did it require almost $39 trillion since 2009 to keep a $20 trillion economy afloat?
However, the following chart more clearly shows the amount of support required over the last decade to keep the economy from faltering.
Given the economy is driven by “consumption,” the Fed believed that promoting “asset inflation” would lead to increased “confidence,” thereby creating economic growth. Such was the exact point made in 2010 by Ben Bernanke,
“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”
Bernanke, then Yellen, and Jerome Powell failed to grasp that the “trickle-down effect” never trickled down. While consumers piled on more debt to make ends meet, those in the top-10% with money to invest got substantially wealthier.