Everyone knows the interest rates banks are paying savers are terribly low, barely matching the inflation rate – but it’s actually worse than that.
The combination of inflation and even the minimum tax rate means investors lose money by leaving it in a term deposit.
Inflation, even low inflation at a time of low interest rates, is the enemy of savers. Yet a healthy amount of inflation is vital for the rest of the economy and the saviour of those carrying big debts.
It is a particular cruelty of present government policy that it wants to punish savers with negative real returns while encouraging asset speculation, driving up real estate and share prices.
I’ll come back to how term deposits are destroying savings, but first the neatest explanation I’ve ever seen for the role of “Mr Inflation” taking care of debt.
Anthony Peters is an independent British analyst, a veteran of bond and other markets, a former fund manager and columnist who now enjoys the status of being independently wealthy and writing a private email newsletter for friends and acquaintances.
A kind soul trying to educate me sometimes passes the newsletter on.
Conservative by nature and politics, Mr Peters brings the rich perspective of experience to discussing markets, as shown here when discussing asset price inflation and what it does to and for individuals and governments:
“I occasionally refer to an elderly friend, long retired in Devon, who tells of the first house he bought for his wife and himself in Caversham by Reading for which he paid £5000. He watched it trade at £50,000 and some years ago again at £500,000.
“Had he, for argument’s sake taken out a £4000 mortgage when he bought it and had he, again for argument’s sake, never sold the place then, assuming the mortgage were still at the original level, been deleveraged from 80 per cent to 0.8 per cent. That is what I mean by inflation.
“The £495,000 which would have been added to his wealth would not be value-added created by him or by anybody else but a free gift from Mr Inflation.
“The pains of mortgage interest rates in the high teens and even low 20s which we paid in the 70s, 80s and into the 90s are easily forgotten. I certainly paid double digit interest on my mortgage which chewed up every penny which came in, leaving next to no discretionary disposable income but the result is wealth I could never have earned by hard work.
Asset price inflation debased debt and turned leverage on property into the best game in town.
“All the while the same was happening to public sector debt. With fixed cost debt on one side of the public sector balance sheet but tax revenues which were by the very nature inflation proofed – if the cost of an item or a salary rises by 10 per cent so does the VAT or income tax collected – the government is laughing.”
(Um, in that paragraph, Mr Peters underestimates the way income tax rises by more than the percentage of a wage increase with a progressive tax system – a common mistake I’ve explained in this space before.)
“Thus my argument that governments can run fiscal deficits with impunity in times of inflation but when it is absent they ought to be promptly following the German model of the black zero. Inflation doesn’t repay nominal debt. It repays real debt.
“My parents’ and my generation’s wealth were largely provided by eye-watering value increases in our homes and the concomitant debasement of the associated loan to value or LTV. This and not productivity has largely funded the rapidly rising standard of living – not to be mistaken for quality of life – of the past four decades.
“All the while the public sector debt mountain was being washed away by the same inflation. Everybody hated inflation but few appreciated to what extent it had created the prosperity not only of the rich.
“A significant part of the GFC and the ensuing sovereign debt crisis in Europe were generated by the decline in inflation from the early 90s onwards without the accumulation of debt ever being adjusted accordingly.
“Rules such as those enshrined in the Maastricht Treaty which seem to assume that a 3 per cent deficit to GDP ratio reflects healthy fiscal discipline are living proof that few understood that in a zero inflation environment any structural deficit at all is toxic.
“Keynes leaves room for cyclical deficits and against these I cannot argue. But structural deficits in a low inflation environment are too toxic to contemplate. The moment the deficit to GDP ratio exceeds inflation – which inflation measure is the right one to apply is a moot point – the future of our children and children’s’ children is being mortgaged away.”
(Over the past half-century, Australia’s government deficit as a percentage of GDP has averaged about three-quarters of one per cent, while inflation over that period has averaged closer to five per cent. And of course the federal budget is now in surplus. Under Mr Peter’s rule, that means there is room for government debt even at a 1.7 per cent inflation rate – if the government cared to stimulate the economy.)
“Let’s face it, our ability to spend all our salary and a large part of our bonus was made possible by our knowledge that the house we lived in would be providing a healthy chunk of our pension.
While Mr Inflation repaid most of our mortgages, the current generation has no such certainty.
“And more to the point, the public sector debt pile will need to be refinanced by them too. QE [quantitative easing] might have bailed us out but it does nothing to enhance the prospects of future generations other than it has helped them to grow accustomed to a lifestyle which they, going forward, will barely be able to afford.
“And as noted, we ourselves couldn’t have sent them to private schools, let them go on rugby tours to Australia and South Africa, taken them skiing in Verbier and put them through university with a car of their own without Mr Inflation having subsidised it all. Take him out of the equation and it all goes rather pear-shaped.
“When I hear the likes of young Miss Thunberg demand that we slow things down and revert to lifestyles more like those of our grandparents and great grandparents all I can say is ‘beware of what you wish for’.
“Modern Monetary Theory or MMT assumes that the borrowing can go on forever as long as nobody ever demands to have their money back. Seeing as that increasingly more savings will be needed in order to cover longer life expectancy, I suppose that’s where proponents of MMT take the thought from that nobody will ever actually want repayment.
“Tell that to the owners of the Argentina 100 year bond which two years after issuance and 98 years to run to maturity has lost around 60 per cent of its value.”
Mr Peters’ warning about QE is well understood by the Reserve Bank and has been explained by governor Philip Lowe. It’s part of the reason why I think the RBA won’t go there.
It’s bad enough that the RBA has been pushed into lowering rates here close to zero – and below zero in real terms for savers.
There are a few bank term deposit rates of two per cent still on offer, but they might not last long. A rate of 1.7 per cent is more common – and that is the inflation rate, so in real terms, the rate is zero.
But earn as little as $18,201 in a year and you become liable to pay 19 cents tax on every dollar above that level.
That means a 1.7 per cent term deposit rate only pays a dividend of 1.38 per cent after the minimum tax rate – negative in real terms.
And even a 2 per cent term deposit only plays 1.66 per cent after tax – also going backwards in real terms.
That’s the obvious driver for people to go searching for higher yields and that, in turn, is pushing up asset prices, creating bubbles based purely on the cost of money.
It’s not healthy in the longer term for the economy. It rewards the asset-rich, increasing our wealth inequality and forces savers to take greater risks that could be expensive when we eventually return to more sustainable inflation and interest rates.