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Photo Gallery: Economists at Odds Over Interest Rate Cuts

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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.
Von SPIEGEL Staff

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.

A Transfer of Assets From the Poor to the Rich

In this way, the low-interest-rate policy doesn't just lead to a transfer of assets from citizens to the state, but also from the poor to the rich. "This type of redistribution is an extremely anti-social instrument," says Kater. That's because affluent households are in a better position to shift their focus to stocks, real estate and other investments than those with average incomes.

The process is in full swing, as was evident last week at the Highlights International Art Fair held at the opulent former Munich palace known as the "Residenz," where the city's glitterati rubbed shoulders with the new moneyed elite from Asia and Russia. A Picasso for €8.5 million? No problem. And for the smaller budget, drawings by German-American painter Lyonel Feininger could be had for less than €100,000. Works by Max Beckmann, Joseph Beuys and others were priced somewhere in between.

"Because of the low interest rates, there has been a strong focus on tangible assets in recent years, which has also benefited the art market," says Peter Raskin, the head of international private banking at the Hamburg-based Berenberg Bank.

Nevertheless, it was probably more of a coincidence that a triptych by Francis Bacon ($141 million) and Jeff Koons' "Balloon Dog" ($58.4 million) fetched record prices at auction in the days following the reduction in the base rate. The art market is on a roll, apparently with no end in sight. "Despite the very high price levels and growing number of record prices, we still don't feel that the market is overheated," says Raskin.

But for both small investors and major capital investors, the art market is not an alternative. Even the world's largest investor, the Norwegian Government Pension Fund, is experiencing how difficult it is to achieve a palpable yield with solid investments. The fund's managers have more than €500 billion to invest, and they are investing less and less in government and corporate bonds. The share of these investments in total fund assets has declined considerably in the last few years alone, to the most recent figure of 35 percent. The fund is increasingly investing billions in real estate and in booming stock markets, which enabled it to achieve an enviable return of more than 13 percent last year.

Fighting a Losing Battle

Comparable returns are out of reach for most Germans. Instant access and passbook savings accounts, with their pitifully low interest rates, are still the most popular forms of investment. Only one in nine Germans has invested money in the stock market, either in the form of individual stocks or mutual funds.

No matter what happens to the markets, there is one constant: Germans have an aversion to equities. This explains why Martin Weber, a professor of banking management at the University of Mannheim, is probably fighting a losing battle.

In his lectures, he constantly advocates people investing a portion of their money in securities. "There is a fundamental misunderstanding in Germany," says Weber. "We view stocks as a form of gambling, and yet they are nothing but investments in a company."

Nevertheless, the situation is surreal. "We have the most successful companies in the world in many fields, and yet almost no one in this country wants to invest in them," says Andreas Beck, who founded the Munich Institute for Asset Accumulation. Foreign investors take a completely different view. They now own more than half of all shares in most companies listed on the DAX.

The longer the low-interest phase lasts, the more menacing it becomes for banks -- which should actually benefit from the ECB's policies -- and insurance companies.

Interest Earnings in Decline for Many Years

This is alarming to Andreas Dombret. A member of the Bundesbank Executive Board responsible for financial stability, last week he accomplished the feat of both appeasing and issuing strong warnings to the financial industry.

Because of intense competition in Germany, interest earnings, once the most important source of income for banks, have been declining for many years. Now the policy of cheap money is only exacerbating the problem. Dombret also fears that banks, in their pursuit of higher returns, could accept excessively high risks in areas such as mortgage lending.

Dombret believes the consequences of low interest rates are even more dangerous for insurance companies. For more than a year now, yields on long-term government bonds, in which insurers invest a large portion of their money, have been lower than the guaranteed interest rates on newly concluded policies. As a result, the policy providers are increasingly drawing on their assets for income. The Bundesbank has simulated scenarios in which up to 32 life insurance companies, with a market share of 43 percent, would no longer be able to fulfill statutory capital reserve requirements if the low-interest-rate phase continues. "Life insurance companies must examine the level of distributions and bolster their equity capital," Dombret warns.

He also fears that the low interest rates will lead to further growth in the poorly regulated shadow-banking sector. Recent figures prove him right: Last year the assets of hedge funds, money market funds and other providers in the industry, some of which are involved in commercial activities related to banking , grew by $5 trillion.

Although cheap money reduces the revenues of banks and insurance companies, it also keeps financial groups and many companies that ought to have disappeared from the market by now artificially afloat. In light of the low interest rates, investments that generate very low returns are still worthwhile. In this way, capital is being wasted.

Fatal Consquences for the Entire Economy

This can have fatal consequences for the entire economy. When money is invested in a way that yields very small returns, economic growth declines in the long term, because zombie banks and companies are being supported. Japan, which has seen virtually flat economic growth despite years of low-interest-rate policies, is a case in point.

This presents a significant challenge to the ECB . On the one hand, there is a risk that the euro zone economy will slide into deflation, a spiral of constantly falling prices and shrinking economies. On the other hand, the ECB's loose monetary policy could ultimately exacerbate the risks already apparent today.

Not surprisingly, the rift within the monetary authority continues to grow. Countries in the southern crisis regions, in particular, are pushing for even lower interest rates, in the hope that this will provide cheaper money for their domestic economies. The cash-strapped governments of these peripheral countries also expect lower rates to give them greater access to funds.

Representatives of the northern member states, especially Bundesbank President Jens Weidmann, hold the opposite view. They fear that the glut of money resulting from low rates will cause inflation and deter the ailing southern countries from enacting reforms.

ECB President Mario Draghi  vacillates between the two positions. In June, his chief economist, Peter Praet, proposed lowering interest rates to 0.25 percent. But then he abandoned his plan, at least for the time being, in the face of growing opposition from Weidmann, German Executive Board member Jörg Asmussen, Luxembourg member Yves Mersch and the heads of the central banks of Austria, the Netherlands and Slovakia.

Interest Rate Could Be Cut to Zero

In the week before last, Draghi decided that it was a favorable time to bypass the opponents of lower rates. A sharp decline in the rate of inflation had prompted the Slovakian representative to change his position.

The step is an alarm signal for the group headed by Weidmann and Asmussen, who would have preferred waiting another month to make the decision. Now they fear that a majority in the ECB Council will want to push interest rates to zero when the ECB economists present their next forecast in December. Based on current indications, they will likely predict an increase in prices of just below 1.5 percent for next year and the following year, which is much lower than the ECB's inflation target of close to 2 percent.

This is why a large segment of the ECB Council believes that there is plenty of latitude for pushing the base rate closer to zero in the near future.

Many council members from the south even advocate pushing rates on deposit accounts below the zero mark. In that case, banks that maintain liquidity with the ECB would effectively be paying a fee to hold onto their customers' money.

The proponents of this step speculate that the lenders will withdraw their balances from the central bank and instead will return to lending more money to each other. In that case, citizens would literally be forced to raid their accounts and both consume and invest more, which would in turn revive the economy in the entire euro zone. "We want to frustrate savers," a central banker bluntly admits.

Italian Credit Sector the Biggest Winner

Two worlds are colliding. Weidmann and his supporters from the north are attempting to protect their domestic savers from even greater harm. The central bankers from the south, on the other hand, are concerned about the sick economies and ailing banks in their countries.

The main beneficiary of the most recent interest-rate decisions is the Italian credit sector, large parts of which are in trouble. Lenders in Draghi's native country were greatly relieved when the costs of new loans from the central bank were cut in half.

But Draghi is also making it easier for the Italian government to raise money. Last week, yields on 12-month bonds fell to their lowest level since the end of World War II.

Possibly the most dangerous consequence of the most recent interest-rate decision is that it increases mutual mistrust within the euro zone. Citizens of the crisis-ridden countries are increasingly furious, because despite substantial austerity measures, they still see no light at the end of the tunnel. In the north, ordinary savers and retirees are noticing that they are now experiencing the first measurable losses as a result of the euro bailout policy.

The battle lines among economists are also as hardened as ever, as Marcel Fratzscher, president of the German Institute for Economic Research (DIW) and Hans-Werner Sinn, president of the Ifo Institute for Economic Research, demonstrated in a SPIEGEL debate. Germany is "the greatest beneficiary" of the monetary union, claims Fratzscher. On the contrary, says Sinn, "Germany is no euro winner."

BY SVEN BÖLL, MARTIN HESSE, CHRISTIAN REIERMANN, MICHAEL SAUGA AND ANNE SEITH. TRANSLATED FROM THE GERMAN BY CHRISTOPHER SULTAN.

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