Is the Fed Ruining Our Future?

Federal Reserve Chairman Ben Bernanke gave the markets a positive jolt on Friday after commenting that the central bank "should not rule out further use" of its stimulus policies. But more "quantitative easing," or buying things like Treasury bonds that push down interest rates and hopefully spur investment elsewhere, could hurt our prosperity in the long term while making it tough for savers to earn a respectable return.

This approach is called zero interest-rate policy, or ZIRP, and here's why it should trouble you.

Extremely low interest rates
You've seen the low interest rates in your savings accounts, where it's tough to find returns higher than 1% per year. That's happening because the Fed has lowered interest rates to nearly zero and pushed the yield of Treasury bonds to historic lows:

Since the central bank rate neared 0%, which theoretically stimulates the economy by offering cheaper capital to invest, the Dow Jones Industrials (INDEX: ^DJI  ) gained 40% and the S&P 500 (INDEX: ^GSPC  ) 45%.

However, while stocks can benefit from lower yields on Treasuries, those who have traditionally invested in Treasuries like pensions are finding it hard to earn returns. As Reuters reports, "in July the 100 largest company pension plans had their worst recorded month and now owe $533 billion more than they have assets to pay." Looking for what were traditionally Treasury-like yields of 4%, investors have had to take on more risk by investing into dividend-paying stocks, causing what some to say is a "dividend bubble."

Of course, the risk of investing in stocks and equities for dividend yields can bite back hard when both dividends are cut and stock prices decline. That's what happened with 14%-yielder mortgage REIT Chimera Investment (NYSE: CIM  ) , which has cut its quarterly payout five times while the stock price has fallen by more than 30% since 2010. Even with safer dividend yields like Caterpillar's (NYSE: CAT  ) 2.4%, investors have been burned by the share price's fall of more than 5% year to date.

Beyond current returns
There are many long-term worries over central banks' policies of keeping nearly zero interest rates, which the Fed plans on doing until 2014.

First, could the Fed raise rates even if it wanted to? Japan's central bank has held its rate below 1% since 1995 and has been unable to find a politically or economically receptive enough time to increase its rate. Of course, Japan has many different factors than the U.S., like a significantly aging population base. But given how markets react to more promised stimulus, Bernanke might find it hard to get the markets to accept increasing rates.

Another worry is the possibility that given another crisis, the Fed won't be able to further cut its rate and effectively stimulate the economy. This reality has already led to atypical solutions such as quantitative easing, but the Fed would have to come up with even more dramatic stimulus programs outside the norm -- perhaps purchasing the necessities for every household so that income can be spent on more luxuries?

Finally, there's the fear that any new monetary policy won't have any effect. With low interest rates, there's little difference between holding cash or investments, and cash holders expect interest rates to rise in the future. This situation is called a liquidity trap, because banks, consumers, and businesses would rather hold onto cash and keep their assets liquid instead of taking the risk of lending it out, buying a new boat, or building a new factory. So, no matter the amount of money pumped into the economy, it will build up savings accounts instead of creating new households, demand for boats, or new jobs.

Another energy drink for the economy
Whether Bernanke keeps trying to juice the economy or not, investors can help protect themselves from each Federal Reserve mumble by sticking with well-run companies that are reasonably priced. For example, Starbucks (Nasdaq: SBUX  ) recently went on sale after a disappointing earnings statement, but it offers a savings-account-beating 1.3% dividend yield on top of a growing business both in America, with 7% same-store-sales growth, and in Asia, with more than 30% revenue growth.

For three other companies that are well run and offer dividend yields that beat the regular savings account, check out our free report: "The 3 Dow Stocks Dividend Investors Need."

Fool contributor Dan Newman drinks, works in, and owns shares of Starbucks. He holds no shares of any of the other above companies. Follow him on Twitter, @TMFHelloNewman. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of and writing covered calls on Starbucks. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 02, 2012, at 6:33 PM, herky46q wrote:

    So we're supposed to buy stocks with our short-term savings? Not gonna do it.

  • Report this Comment On September 03, 2012, at 4:06 PM, henryyves wrote:

    None of this matters, as paper money will attain its intrinsic value - Zero!

  • Report this Comment On September 03, 2012, at 4:23 PM, MisterEC wrote:

    What the FED and most of the world governments seem to be in denial of, is that there is a built in mandatory depression to come. The boomers had a huge effect on whatever economic 'era' they were in, and when they age and die out it will be called the baby boomer DEPRESSION. WWIII may stimulate, and create the one world government Bush Senior told us of in the 1000s points of lights speech. Then you know what Einstein told us WW4 would bd fought with.

  • Report this Comment On September 04, 2012, at 6:38 PM, TMFHelloNewman wrote:

    @herky46q

    For returns that match what treasuries used to pay, equities are one of the only places to go. But of course, there's plenty more risk.

    @MisterEC

    I sure hope not, whatever windfall from estates and estate taxes will hopefully be recycled back into the economy. Although there was that recent report that almost half of retirees die with less than $10k in savings.

  • Report this Comment On September 04, 2012, at 7:28 PM, TheDumbMoney2 wrote:

    Hello, Hello,

    While the Fed's actions have indeed been "atypical," they are by no means unprecedented. For example, after WWII the Fed basically pegged interest rates at a super-low level for years and years, and at one point I think owned a majority of outstanding Treasuries. Worked out fine. Worry about a future crisis doesn't mean we shouldn't fight the current one.

    Our currency is best viewed as an airplane in flight. The Fed is the pilot. The cross-winds to right are forces of inflation during times of leveraging. The cross-winds to the left are forces of deflation during times of deleveraging. (This assumes you don't just have, Zimbabwe style, somebody literally printing millions of unrecoverable, un-unwindable physical notes to pay the government's debts). People who favor a gold standard are basically people who favor removing the pilot's control stick, incidentally.

    The Fed, as it did after WWII, has lately simply been steering the plane rightwards with QE, to counteract the leftward cross-winds of deflationary tendencies. Each QE, so far at least, has been preceeded by a steep uptick in deflationary expectations, and even today inflation in the U.S. is quite low, especially considering the drought's impact on commodity prices, and the geopolitical risk right now re: Iran/Israel.

    You comments about the difficulties pensions face are, respectfully, a re-hash of the "War on Savers" meme that has been making its way around the financial blogosphere for approximately the last one-and-a-half years. There is no more a "war on savers" now than there was in in 2007. Now they face more return risk. Then they faced more asset risk. Pick your half dozen.

    Moreover, because interest rates are so low now, and because pension funds must calculate their future pension costs based on a discount to present value using present interest rates, the liabilities of pensions are probably being exagerrated, assuming this state of affairs does not go on for decades.

    (In the meantime, the benefits of ZIRP include aid to companies who can issue bonds at super low rates, thus paving the way for future economic growth with lower WACCs, which will, inter alia, aid the pensioneer holders of these stocks over time.)

    And while you mention the timeframe in Japan, keep in mind many other things have impacted Japan, including a fiscal authority that has (arguably) declared victory prematurely multiple times.

    As to future crises, the Fed funds rate has of course been near-zero for years now, but it's not really relevant to Fed actions, or a limit on them. As to future crises, the Fed could do all sorts of things depending upon the direction the crisis went. The Fed could buy bonds held by Fannie and Freddie. The Fed could buy Euro bonds from Spanish banks. The Fed could sell all of its holdings of longer-term bonds (unwinding the twist). The Fed could manipulate the interest rate it now charges on reserves.

    The private process of lending and paying down debt creates and destroys 'money' all of the time. Stability is best gauged against the rate of deterioration in the value of money, not against the amount of money or M2, etc. or whatnot that is outstanding. Relatedly, you used the term "juicing the economy," which is a very populist view of what the Fed is doing, and is like most populist things, whether of the political Right or of the Left , wrong-headed. "Stimulus" is another word that is highly and similarly mis-used.

    A "stimulus" is when Obama spends a bunch of federal money really quickly, which is definitionally accomplished by adding to federal debt rather than by immediately taxing people (as raising taxes higher now would reduce their present net income, and be non-stimulative). That "juices the economy". That's Keynesianism.

    Fed policy is not about Keynes. Fed monetary policy is not designed to "stimulate" the economy, except at one order of remove, because what Fed policy is designed to do is....drum-roll....maintain a low and stable rate of inflation, and especially prevent deflation. The majority of economists, including many eminent conservative ones, believe that doing that ultimately results in a healthier economy, yes. So in that sense it's "stimulative."

    We find ourselves now in a situation where the Fed is currently trying to help keep our plane flying straight, just as it has done, sometimes successfully, sometimes not so successfully, in the past. I for one can't wait until Romney is elected, and Republicans suddenly become big fans of the Fed again, and Democrats start hating it. Then it will be the turn of Democrats to excoriate it for its "War on Savers" (they'll focus on CASPERS-like savers) and its "partisan" juicing of the economy, while both parties find ways to blame it for their own long-term fiscal incompetence. Should be fun.

    Cheers,

    DM

  • Report this Comment On September 04, 2012, at 9:29 PM, 1caflash wrote:

    I am perplexed by people who keep telling us that quantitative easing will help the stock market. It seems like investing in companies should happen because of their strengths, not because of anything the Federal Reserve does. Some of you know that I prefer small publicly-traded businesses, because I believe that one of the few ways larger firms will be able to grow during the next ten years or more will be through M&A.

  • Report this Comment On September 05, 2012, at 8:26 AM, TheDumbMoney2 wrote:

    HelloNewman,

    Here's another guy who doesn't get it, and he's a professional money manager:

    http://www.alhambrapartners.com/2012/09/03/bernanke-warms-up...

    He talks of "dollar debasement" even though inflation has remained pretty stable for the past few years (certainly far more stable than it was up to 2008...). He simply assumes, undoubtedly as a result of ideological reasons, that food commodity inflation and gas prices are the result of Fed action, even though we are in the midst of a horrible worldwide drought, including here in the U.S., a major refinery in CA was out of commission for months, and Israel is threatening to bomb Iran in October. To the extent he is actually selling or buying stocks based on his monetary/macro analysis, he is doing his investors a disservice, in the service of his political ego. He is by no means alone in this. The financial blogger with the best advice and thoughts regarding keeping politics out of one's investing is a guy named Jeff Miller, who runs the blog, A Dash of Insight. He has been terrific over the last two years. Guys like this and Bill Gross have been....embarrassing.

  • Report this Comment On September 05, 2012, at 3:26 PM, TheDumbMoney2 wrote:

    And this guy, writing for Time no less, hasn't got a clue what he is talking about. He doesn't even have his premises and assumptions right. Luckily he's not running money, though hopefully nobody is guiding their actions based on this drivel:

    http://business.time.com/2012/09/05/why-isnt-there-more-infl...

  • Report this Comment On October 14, 2012, at 11:44 PM, NickD wrote:

    Just invest in stocks if the major companies fail the world is ending so it won't matter if your broke investing is really just a win win game.

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