Wednesday, December 2, 2015

Times get tougher for the oldies

Glenn Stevens, governor of the Reserve Bank, is used to getting letters from angry citizens. Aside from the ones demanding to know why the Reserve can't solve all our problems by just printing more money, in days past most would have come from small-business people complaining about the latest increase in the official interest rate, which had taken their overdraft rate to ruinous levels.

These days, most come from angry retirees complaining about yet another cut in rates. Doesn't he realise people are trying to live on the interest on their savings?

That's the trouble with interest rates, of course, they cut both ways – a cost of borrowers, but income to savers. The media assume we're all borrowers, so they boo rate rises and cheer rate cuts, adding insult to the oldies' injury.

Like all central banks, the Reserve raises interest rates when it wants to slow the economy by discouraging borrowing and spending, and cuts rates when it wants to speed things up – as now. It jumps that way because households' and businesses' debts total a lot more than their savings.

When I was a young economic journalist in the 1970s, the retired were always complaining about high inflation. Their cost of living was rising rapidly, but they had to live on "fixed incomes" that didn't keep pace.

We eventually solved that problem. Interest rates caught up with higher inflation and, as well, we moved to adjusting pensions regularly in line with prices and then with wages. By the early 1990s we finally had inflation back under control.

How times change. These days, most people retire with superannuation or other savings, which they use to supplement – or occasionally replace – their pension. And since they need to live on the earnings from their savings, they need those earnings to be steady, not go up and down like the share market.

Thus the retired like to put most of their savings in interest-bearing bank accounts, term deposits or pension funds that have most of their money in bonds. So these days a lot of retired are back to living on "fixed incomes", meaning they hate to see interest rates falling.

Our official interest rate is down to 2 per cent, a record low, having been cut 10 times since late 2011. The rates paid to savers are only a little higher. Even so, our rates are relatively high compared with most advanced countries. They're near zero in most developed economies, and in parts of Europe you actually have to pay the bank a tiny percentage to persuade it to hold your money.

I'll let you into an open secret: Stevens will be retiring as governor next September, though since he'll only be 58 – just a boy, really – I doubt he'll be putting his feet up.

He said a few things last week that make you think he's turning his mind to retirement. And he doesn't like what he sees.

"My guess is that global interest rates are still going to be very low for a good part of the decade ahead," he told the Australian Business Economists.

It's likely the US Federal Reserve will raise its official interest rate a fraction this month. But Stevens doesn't see US rates rising far. The European Central Bank and the Bank of Japan were "a long way from even thinking about higher interest rates". And the Europeans are openly contemplating further cuts.

So the average official interest rate in the major money centres may be very low for quite a while, he said.

Trouble is, "in a low interest-rate world, the problems of providing retirement incomes will become ever more prominent".

The very low level of yields (returns) on government bonds and other fixed-interest securities means the prices of such securities are very high (it was actually rising bond prices that caused yields to go so low).

So these days it costs you or your pension fund a lot just to buy securities that pay such low amounts of interest. Which is another way of saying you now need to retire with a lot more savings than you did to maintain a given standard of living.

Added to that, we're living longer and so need our savings to last longer.

Stevens said the retiree can, of course, respond to the reduced attractiveness of fixed-interest securities by holding more of her savings in dividend-paying shares. This involves accepting more risk of volatility, of course.

Certain well-known Aussie companies pay big, steady dividends, which usually come with refundable income tax rebates (known as franking credits) attached. Most people would also be hoping to see these dividends grow over time, as inflation continues.

"It certainly seems that many Australian listed corporates feel the pressure from shareholders to deliver that, even some whose earnings are inherently volatile," Stevens said.

Can the corporate sector realistically promise growing dividends over a long period? Not without being prepared to take on greater risk by investing in new projects.

"How much of that risk an older shareholder base will allow boards and managements of listed entities to take is an important question," he said.

"Overall, in a world where a bigger proportion of the population wants to be retired and living (even if only in part) off the return on their savings, those returns are likely, all other things equal, to be lower."

A good argument for delaying retirement.