Sunday, November 17, 2013

Our Government Has Destroyed Compound Interest

To quote Albert Einstein, “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.” But there is one caveat, only as long as the return rate is reasonable. As interest rates approach zero, there is less and less incentive to save for the future.

Banks can’t really function at very low interest rates, most of their borrowers are short term and most of their loans are long term. In the early 1980’s the Savings and Loan industry wrote 30 year loans at 6% and saw all of their short term depositors withdraw their money and put it in the money market funds at 9%. Old Bill Seidman got the S&L’s out of trouble at a cost of several billion to the taxpayer.

It becomes extremely difficult for insurance companies and retirement plans to fulfill promises made to people 20 years ago. Their projected income streams from anticipated rates have dropped drastically. If you examine the rule of 72 where one divides the interest rate into 72, the resulting number is the number of years it takes to double the principle. CalPERS is still claiming an 8.5% return on their investments which would indicate that the funds principle would double every 8.4 years if left untouched. Of course if we assumed a 3% return, that would be 24 years and if we went to 2% figure 36 years. So it isn’t hard to figure out that CalPERS is probably miss stating their returns on equity, hoping that interest rates begin to rise drastically. At the current interest rate returns, their past funding projections made 20 years ago will leave them broke inside of 12 years.

What are we left with? Retirement plans that won’t even be able to pay back what the retirees put into them and a national debt payment that will consume all of our income taxes paid-- just to cover the interest.
The real issue with very low interest rates, is that there is no incentive to save money for retirement, especially if there is inflation. In fact low interest rates will probably stimulate the average person to consume beyond their means and pay the money back with inflated dollars later.

One peculiar thing is that gold and silver are no longer just commodities. The person who chooses to possess gold and silver coins, is not losing much in interest. Short term bank deposits are paying ½ of 1 percent a year—the interest on 50k for a year won’t even buy lunch.

The stock market seems to be the last game in town to play right now. Where else can you put your money and make a dollar? Of course, at one time a dollar would buy 4 packs of cigarettes but I digress. There doesn’t seem to be any risk, the DOW continues to surge higher. Everybody is going to get rich, Oh goodie, I can hardly wait!

Compound interest was a tool used by private citizens to enhance their retirement years. The present interest rates sound very depressing to people about to retire, but let’s play the government game. Reduce your registered cash in the bank. Keep it in a safety deposit box and have a couple of co-owners (like your kids) who can empty it out if you check out early. File for disability before you retire, it increases your Social Security benefits. If you “deplete” your savings, you probably qualify for SSI in California. If you’re married and can get better benefits being single, claim being single, the bureaucrats only want proof of a marriage license if you want spousal benefits. It’s no crime to “think” that your husband is dead and you don’t know who the new guy in the house is. That’s an extra $40 of food stamps a month right there.

Right now, even Suzi Orman is suggesting ways seniors invest more aggressively for retirement. They need to take more risk to avoid losing their principle. I tend to agree with her, but I think the logic is flawed. The government is our biggest risk. This Ponzi scheme cannot continue forever.

I’m suggesting that silver and gold need to be considered as options in any retirement plan, and I am not selling a newsletter. I believe that silver is a better buy right now and I like it because 1000 ounces is kind of heavy about 70 lbs., so it is rather awkward to steal. But gold and platinum are other options of purchase.

The thing I like, is that the government can’t print gold and silver, so if they need more money, they can print it (debauch the currency) or tax your earnings or tax your home, but precious metals are invisible.

So here we are with a very realistic bit of theory from Einstein about compound interest. It kind of makes you wonder, who’s in charge? We know who gets to pay the bills.


Joseph Oppenheim said...

BTW, in 1940, many years before Einstein's death, 10 year Treasuries were abt where they are now, and for abt 100 years before abt 1970 were mostly 3-4%. So, now is not so unusual. Sure, problems could happen, but as long as they are under 4%, pretty normal.

Also, the best way to value a quality stock is the inverse of the PE (the earnings yield) vs 10 year T rate. So, for a quality stock with a PE abt 20, that means it earns abt 5%, a pretty good return, plus if it raises its dividend each year and/or grows earnings just 2% each year. So, pretty good, especially for a company with low debt and almost no chance of bankruptcy.

Sure, a stock can tank anytime, so are they likely to come back. So, as for safety, a pretty safe investment, even now, for a long-term investor. Any drops are just opportunities to buy more.

Anonymous said...

I gave up on stocks. We were trained to look at fundamentals, but what drives the markets now appears to be coming from the manipulation by the FED , a private cartel. The PE ratio does not matter as much anymore.

Anyway, any PE analysis should include growth rate in addition to comparisons to interest yields, but I am sure you left that out for brevity rather than oversight.

dearieme said...

We have a handy law over here. If you buy gold sovereigns minted after 1837, not only are they free of VAT (a sort of sales tax) they are free of Capital Gains Tax.

How long this law will last, Lord knows.

Joseph Oppenheim said...

I included growth rate. As for manipulation, the Fed can't control long-term rates except marginally.

But, really everything has an art component....math...math is an art (that's why BA and MA's in pure math).

That's what separated Einstein from his of math....deduction vs induction...come up with an idea then see if it happens, rather than cause and effect.

That's even more important since globalization. Quantum physics rather than a cause/effect world...everything is connected.

dearieme said...

"That's what separated Einstein from his of math": oh what rubbish.

What separated Einstein was his genius at theoretical physics. He admitted to being a dud at maths by the standards of some of those around him.

Jim in San Marcos said...

Hi dearieme

There doesn't seem to be any taxes on gold or silver here--yet.

like you said, "How long this law will last, Lord knows."

I do know that it became illegal to own gold in the US after 1933 see Executive Order 6102. In 1974 it became legal to own gold again.

Where to from here? is my question.

Anonymous said...

You are not entitled to get interest on your cash's not divine right!

The fed res steered short term interest rates to zero in order to chase savings out into the market. CD's and such are dead money, and in order to increase monetary velocity, interest rates have been set to near zero.

In time it will adjust but no one is entitled to a certain percentage return on their savings.

Anonymous said...

Are we also not entitled to negative interet rates?

Jim in San Marcos said...

Hi Anon 7:13 and 3:38

We need to look at what people were planning on for retirement 20 to 40 years ago. What is happening now, has ripped the rug out from under them.

You can see a similar parallel with rent control. Original investors had a good deal until rent control, then they were screwed, they couldn't sell the unit and they couldn't raise the rent.

The Federal Reserve has changed things. We will see new ways to make money, they are just not the way we had been brought up to expect.

Anonymous said...

You want yield, then invest in emerging markets but no, you want the safety of the u.s. but the return of brazil, world doesn't work that way.

True, the fed is "screwing" people through inflation but that is the system we have. And when everyone else, and I mean every other country, is printing, we would be stupid not to do it in the u.s.
We do want to export things right or should we just isolate ourselves from the rest of the world.
Currencies are relative, as long as yours stinks the least, you are good. And for the 100th time, we don't need 50 billion in gold bullion to back our currency, all we need is a 50 billion dollar air craft carrier, 50 billion in roads and highways, 50 billion in the best universities, etc, etc....

We are in a new paradigm...

Jim in San Marcos said...

Hi Anon 10:33

I think you are confusing the word "paradigm" with the word "insanity"

Investment strategies changed when interest rates went to zero. Of course most retirement funds reacted too late and are doomed because of it. There are many "new" old ways to make money.

When you squeeze a balloon, it moves out into another area, and returns back to normal sooner or later.

The idea that it would be stupid not to follow other countries down the drain, escapes me.