Saturday, July 21, 2012

Artificially low interest rates not the way out of our current malaise


The U.S. Central bank follows a policy of artificial low interest rates and the Bank of Canada follows. In Europe, the large sovereign debts of many countries have come home to roost and the U.S. is not far behind.  Is 7% interest rates the magic limit for Italian and Spanish debt?  Who knows and who cares.  While both U.S. governments and European governments scale back their hiring, corporations are flush with cash but afraid of using it.  In the meantime banks and insurance companies see their profits stagnate due to either too low a profit margin on loans or over-anxious lending practices that make only the very rich credit worthy.
Is this the way out or is this the way to prolong today’s economic malaise?  Let’s look at baby boomers – the Canadian baby boomers. They are reaching retirement age, but how much is needed to retire?  The average Canadian household spends around $50.000 per year; 3% of households have a net worth over $ 1 million with the average household net worth set at $370K or so. Where is most of that net worth invested? It is tied up in our homes.
Think about it. Only the top 3% of households owns a million and most of that is in real estate. So how much are the liquid funds that generate retirement income? The average Canadian house is worth around $350K; millionaires have probably houses in the $500,000 to $700,000 range.  So how much retirement income is their non-real estate assets generating at 1% percent per year interest rates? Yep, around $3,000 to $4,000. The stock market hasn’t been very good for most Canadians over the last ten years – many are barely breaking even. Is that freedom 55 at $3000 to $4000 per year?  Oh, and then one has to pay taxes and one has to re-invest to keep up with inflation.  So how many baby boomers can live of $1,000 per year? Once our 'affluent' babyboomer is sixty five, or better sixty seven, add to that a 'generous' Canadian pension.  For that flamboyant lifestyle the baby boomer needs a $1million net worth or more. And that is for only 3% of the babyboomers what about all the others?
Really, the low interest rate policies of the central banks are costing baby boomers dearly. No wonder they have to work longer.  Yes, it is also social interaction and a longer healthier live that has baby boomers abandon their early retirement dreams. But above all it is plain economic necessity. Finally the kids are out of the house and now the golden earnings years where many people start to save more seriously for retirement are here. But guess what, trying to cling on to these supposedly easy savings is a lot tougher than many expected. You’re doing well if you’ve broken even since 2008.
 The baby boomers keep on working longer and thus there is no big job vacuum for younger generations to fill up. On the contrary the youngsters have to compete against the much more experienced baby boomers. They have to compete with their Mom and Dad for jobs. No wonder, youth unemployment is fairly high in Canada and sky-high in some European countries. On top of it, in its infinite wisdom governments are implementing austerity measures reducing the number of jobs even further and companies do hire but as little as possible because no one seems to know what tomorrow brings and everyone is risk averse to the extreme.
The need for a diversified portfolio has never been higher. I don’t mean a diversified stock portfolio but rather a portfolio of all kinds of investments that have one thing in common:  they create positive cash flow. Whether it is from mortgage investment companies paying yields of 6 to 8%; from real estate rental income yielding between 3 - 6% or dividends yields of 3% or more on large conservatively run companies such as Canadian Banks, real estate companies such as Brookfield; conglomerates such as Power Corp, BCE, TELUS, Rogers, GE, Kraft, JNJ. And last but not least our Low PE and moderate dividend portfolio. A 1% GIC won’t do unless it is cashable and available at a moment’s notice. 
You will need the patience of Job and overtime this mess will be sorted out. 1% won’t do. You’ll need an overall portfolio cash flow of 3% plus appreciation (however slow) protecting you over the long run from inflation. More austerity leads to even fewer jobs and the prolonged low interest rates won’t stimulate the economy such as demonstrated by all those companies that have more cash than they’ll need.  So, urge your private sector leaders; your politicians and your central banks of stopping these low interest rate games because it impoverishes everyone. Artificial low interest rates should be raised to above the current inflation rate and with the historical profit margin added. That means in my books an interest rate of 3 to 4%. Still low but not artificially low. At least then, some of Canada’s baby boomer can afford to retire and in turn allow more youngsters to enter the work place.

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