Near Zero ECB Interest Rate Cuts Hit Savings Hard
As the European Central Bank pushes interest rates to a new low, Germans are growing increasingly concerned about their savings. The money in their accounts is losing value and life insurance policies are yielding lower returns. Investors and central bankers feel trapped.
Jens Weidmann seemed visibly uncomfortable in the role of rock star. The officials with the Frankfurt Cooperative Association had taken great pains to stage last week's appearance of the president of Germany's central bank, the Bundesbank, as a show event.
The lights were dimmed in the "Jahrhunderthalle" convention center, the venue for an upcoming concert by the heavy metal band Motörhead. Trapeze artists hovered in the air as Michael Bockelmann, the association's chairman, set the tone with some sharp words against the European Central Bank (ECB). Because of low interest rates, he said, more and more people are losing interest in saving for the future. Bockelmann left no doubt that Weidmann is the last hope for German savers.
But the much-vaunted central banker began his appearance by tripping on the steps up to the stage, and then he voiced his disapproval of the notion that the magical powers of alchemists could be ascribed to central bankers. And when he finally took a cue from the man who had introduced him and invoked the dangers of a low interest-rate policy, he sounded defensive, almost a little clueless.
He could understand savers' concerns about "creeping expropriation," said Weidmann. He noted that low interest rates are a nuisance, and that relaxed monetary policy also creates risks for banks, insurance companies and the financial markets.
Reverberations of a Frankfurt Bombshell
But as consolation, Germany's top monetary watchdog could only offer a vague promise at the end of his speech, when he predicted that interest rates would eventually rise again.
It's been less than two weeks since ECB President Mario Draghi reduced the European base rate to the lowest level of all time. But the reverberations of the Frankfurt bombshell are still audible today. Until recently, politicians, investors and economists had hoped that the euro crisis would soon be over, as would the era of low interest rates. Now it is becoming apparent that savers will have to endure even more pain, and that the economic divide within the euro zone is deeper than ever.
In the north, savers and investors worry that the yields on their financial investments are close to zero. In the south, by contrast, rates on construction and commercial loans are still so high that there is very little new investment. The consequence is a persistent recession, which has also worsened the mood in Europe's monetary authority. Sources at the ECB say that a serious conflict could erupt if Draghi tries to push interest rates down even further.
The tense climate in the ECB Governing Council dovetails with the grim mood among German savers. The inflation rate is already higher than the rate of return on many investment products. Although this does not formally qualify as expropriation, savings are gradually losing value because prices are rising faster than interest income.
There is a growing sense of perplexity in the investment industry, which thrives on optimism and promises for the future. The powerful insurance companies are at a loss as to how to achieve the returns they have promised to their investors. Banks and savings banks are fighting with frustrated customers, and investors are desperately trying to figure out how to at least preserve the current value of their assets: with stocks, gold, or, perhaps even better, with the purchase of big-city real estate?
Prospects of a Comfortable Retirement Darkening
Only a few years ago, Germans were convinced that they could offset the cuts lawmakers had made to government-mandated pensions by saving more money on their own. They invested heavily in insurance policies and so-called Riester retirement plans, purchased shares in securities funds and paid portions of their salaries into company pension plans.
Now they are forced to look on as the euro crisis and the central banks' low interest-rate policies eat up the gains they had envisioned and darken the prospects of a comfortable retirement, especially at the lower levels of the income scale.
Sabine Müller (named changed), a secretary in Munich, knows all too well what this means. She bought a life-insurance policy when she started her first job in 1984. Even at that time, a statutory pension seemed everything but assured. Everything went smoothly at first. The anticipated benefits grew "slowly but surely," as Müller wrote in a recent letter to the Hamburg Consumer Center. In 2009, her insurance company told her that she could expect a sum of about 40,000 ($54,120) when she retired. But by 2010, the sum had already declined to 38,000, and in 2012 the company was projecting a future benefit of 37,000. According to the latest notice, she can now expect no more than 34,000. In other words, the secretary's assets have essentially declined by 15 percent in only four years.
Many people are in the same position as Sabine Müller. Over the decades, they have accumulated 5 trillion in monetary assets, along with more than 6 trillion in real estate and tangible assets. Because Germans tend to be risk-averse, they invest most of their money in savings deposits, life insurance and fixed-income products. Safety first was long the motto of German investors, but that is precisely why their savings are now melting like an iceberg in times of climate change.
There is a picture of a severe-looking snowman hanging on the wall of chief economist Ulrich Kater's office on the 41st floor of DekaBank in Frankfurt. Kater, with his sharp nose, sideburns and friendly-looking face, explains the phenomenon of "cold expropriation."
"A person who has deposited 1,000 into a savings account is pleased to see his 1,000 still in the account at the end of the year." But that, as Kater explains, is an illusion, because the saver is ignoring the loss of purchasing power. Savings can only grow in real terms if the interest rate is higher than the rate of inflation.
Investing in Federal Bonds a Losing Proposition
Some 900 billion of monetary assets consist of deposits, which can be withdrawn immediately and earn an average of about 0.42 percent in annual interest. At an estimated inflation rate of 1.6 percent this year, these assets will see a 1.18-percent decline in value, or about 11 billion. The situation is slightly more favorable for savings deposits or fixed deposits with terms of up to two years, but even here the real rate of interest is often negative. Investing in federal bonds is also a losing proposition for Germans. In the case of five-year bonds, for example, interest rates have also fallen below inflation.
This also affects many insurance companies and pension plans, which together account for more than 1.8 trillion of German monetary assets. They, too, invest most of their money in government bonds, which means that the returns on life insurance policies are declining from one year to the next. Guaranteed interest rates, which were at 4 percent in 2000, had dropped to 1.75 percent by 2012.
"Savers still benefit from the fact that their policies are backed by previously acquired bonds with higher fixed-interest coupons," Kater explains. "But the longer the low-interest-rate phase lasts, the more fixed interest rates will expire, and the bigger the losses will become from year to year." If the structure of monetary assets doesn't change and the low interest-rate policy continues for another 10 years, the total loss to savers could grow to 60 billion.
"In Germany today, people can no longer provide for their retirement by saving," says Walter Krämer. A statistics professor in the western city of Dortmund, Krämer initiated a call for protest by 282 German economists against the euro bailout policy last year, and this summer he followed up with a letter of complaint titled "Cold Expropriation."
Krämer assigns the blame to the ECB. "Savers pay the price for the fact that the ECB is determined to rescue comatose banks," he says. According to Krämer, banks are being charged too little to gain access to ECB funds, so that they have no incentive to offer more to savers.
An Unsustainable Demographic Makeup
But that is only part of the truth. The dilemma had its beginnings years earlier. "Interest rates are as low as they are today because the key economies loaded up on debt until 2007," says DekaBank economist Kater. In the financial crisis, it then became clear that these nations, as well as companies and citizens in many countries, had amassed too much debt, which could no longer be reduced by higher economic growth as it could in earlier years.
There are also demographic reasons for this. The percentage of young people in the population is shrinking, and yet they must generate greater economic output to reduce the debts they are inheriting from the current generation.
Because this is unsustainable, a redistribution from creditors to borrowers, or from savers to the state, is now occurring, as Kater explains. The operative expression is "financial repression." The government makes money when interest rates on government bonds are lower than inflation. Its debt burden is decreased, while savers are left to foot the bill, with their assets losing value in real terms.
The consequence is a massive redistribution. McKinsey, the consulting firm, has calculated that the governments of the United States, Great Britain and the euro zone already saved $1.6 trillion between 2007 and 2012 as a result of low interest rates. This is offset by a loss to private households of $630 billion. Older citizens are losing more than younger people, because the latter tend to have more debt and fewer savings.
As much as savers are being fleeced, there are also those who profit from low interest rates. People who own real estate have benefited from increases in value in recent years, while stock owners have seen Germany's DAX share index climb from one record high to the next. But this primarily benefits those who are not worried about having enough retirement income.
- Part 1: ECB Interest Rate Cuts Hit Savings Hard
- Part 2: A Transfer of Assets From the Poor to the Rich