Please ensure Javascript is enabled for purposes of website accessibility

Is the Fed Ruining Our Future?

By Dan Newman – Updated Apr 7, 2017 at 1:23PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

A look at how future policy could negatively affect the economy.

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.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$29,358.78 (-0.78%) $-231.63
Starbucks Corporation Stock Quote
Starbucks Corporation
$85.43 (1.50%) $1.26
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
$3,672.25 (-0.57%) $-20.98
Caterpillar Inc. Stock Quote
Caterpillar Inc.
$163.41 (-0.51%) $0.83
Chimera Investment Corporation Stock Quote
Chimera Investment Corporation
$5.99 (-8.77%) $0.57

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/26/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.