Interest Rates - Will they ever go up again?
Go to school, get a job, work hard, save money in the bank with a good interest rate and then retire.
Sound familiar? It was the mantra for most of the 20th Century but is it really good advice today?
The rules have changed
The rules of the game have changed and the worst thing is that no-one even told us about it.
One of the primary functions of money is as a store of value. We work hard, create value for someone else and then, rather than accept some form of their value in return (like in a bartering system), we accept money because it stores value which can be used in the future.
The very nature of that process dictates that whatever form that money takes, in this case paper currency or electronic digits, it must be valuable.
If we accumulate enough, we loan it to the bank through a deposit account and get paid interest on it. Simple. I mean we have all seen Mary Poppins at some point right?
As a teenager I would have been paid 5%, whilst my parents tell me it was more like 15% when they were my age, which seems like a good deal. I have something valuable that I have worked hard for, I lend it to you and you pay me a decent amount in return for my loan.
So why am I being paid 0.1% by my current bank and how am I supposed to retire off that?
To understand this we need to understand that the interest rate is actually the price of money, so is a reflection of the value of money. We all know that when renting a car, a 4 door saloon is going to cost you more than a 2 door hatchback, because the saloon is more valuable. When the Interest rate is going up and down its actually a reflection of the price of money. Therefore the money itself is less valuable today in a 0-1% interest rate environment than it was back in the world of 5% or even 15% and by a considerable magnitude.
The £20 or $20 note looks the same, feels the same, is the same piece of paper as it was 50 years ago then why has its value, (through its price), fallen through the floor?
The answer lies in scarcity, through which stores of value derive their value. The less scarce something becomes, the less it holds value. Over the last decade in particular, but a trend that has been happening for decades, Central Banks and Governments have been expanding the money supply at an alarming rate. So it isn’t that the notes and coins you hold have changed at all, it is the environment in which they exist and the total supply of money.
So to understand try and consider that when I pour cordial into a glass and then top up with water, that rich colour and flavour gradually reduces as the glass fills. We all know that the taste slowly disappears until eventually we can barely distinguish it from water. Well that is akin to the value of our money, it has been washed away through the expansion of the money supply and quantitative easing and if that tap isn’t turned off, the value does go to near enough zero.
Since the value of the money has declined over time, so too has its price and with it the interest rate. The bank no longer needs to pay you those higher rates because quite simply, your currency doesn’t have the value it used to.
Will interest rates go up again? In my opinion not in the foreseeable future. It is a complex system so never say never but I would certainly reconsider the use of cash in the bank as part of your retirement plans.