This is the first in a series of
articles examining the economic costs of weak money
policies.
The destruction of
private savings through inflation
One of the reasons government fiat
currencies are facing eventual collapse is the savings
of private individuals are now insufficient to support
them through their old age. Unless Western governments
are prepared to tolerate the deaths of the aged through
starvation, neglect, inadequate heating and the cruel
withdrawal of healthcare facilities, the escalating
costs of welfare for the aged will fall to the state.
The way the politicians tell the story, the problem has
arisen through inadequate actuarial assessments of life
expectancy, the retirement of the baby-boomer
generation, and for private sector pensions, inadequate
investment returns.
While these factors contribute to
the welfare crisis, they are not its primary cause. The
primary cause is inflation, which has been instrumental
in dissuading investors from saving and has increased
their reliance on the state for retirement benefits.
There is no better way of
illustrating the point than by contrasting the value of
savings and their deployment in an environment of sound
money with the inflationary conditions we face today.
Using a spreadsheet to bring values back to comparable
real terms, it is easy to show that accumulated savings
in the mildly and naturally deflationary environment
that naturally accompanies sound money, such as a
properly functioning gold standard, have a greater
purchasing power than savings that have suffered an
erosion of value through inflation. We can compare what
actually has happened with a theoretical sound-money
situation.
Over the last forty years, or a
standard working life, an American saver investing
$1,000 per annum into the ten-year US Treasury bond
would have had an annually compounded savings value of
$224,150, at an average yield of 7.18% for the bond over
the period. It is this strong compounding effect that
attracts most savings advisers’ attention. But over that
time, inflation averaged 4.44%, reducing the true value
of this savings stream to $139,734, still more than
three times the amount invested. Simplistically, the
saver has suffered an inflation tax on the difference of
$84,417, while the same inflation has created the
illusion he is significantly better off.
By way of contrast, an economy
backed by sound money allows the long-run improvements
from manufacturing processes to lead to a general fall
in prices of two or three per cent per annum. This means
that after a lifetime of work a man saving regularly and
modestly will have enough capital to retire on
comfortably, and be able to pay for those vital things,
such as healthcare, which are an increasing financial
burden on the elderly as they age. Applying the example
of our forty years of annual savings contributions of
$1,000 per annum to a sound money environment, we shall
assume a compound return on the ten-year Treasury bond
of only 2.5%, to give a nominal value at the end of that
time of $69,088. With respect to prices, they can be
expected to fall as described above. So taking a price
deflator of 2% enhances the purchasing power of our
forty years of savings to $99,748 in real terms.
That is the position up to the
point of retirement. On the face of it, a real value of
$139,734 in the inflationary economy is a far better
outturn than the $99,748 in our sound money example.
However, the position changes after retirement. Our two
real values will now be spent, and we will assume our
retiree has thirty years to live in retirement.
Let us further assume our saver
purchases a thirty-year annuity, giving a fixed annual
income from his lump sum. In the inflationary example
our true value of $139,734 is so invested, giving a
total real income stream of only $63,949 net of 20%
income tax, and adjusted for inflation at the historical
rate of 4.44%. The reason for the loss of purchasing
power is partly due to tax deducted, but mostly the loss
of purchasing power due to inflation over the thirty
year period. Furthermore, the high yield of 7.18%
applies to a diminishing balance of capital, compared
with an increasing compounding balance while our saver
was saving.
By way of contrast, in our sound
money environment the lower lump sum of $99,746 in
comparable true money generates an after-tax income
stream of $112,816 in real terms. What our sound money
saver lost from the lower compounding rate of 2.5% on an
increasing capital sum, he has more than recovered from
his annuity’s increased purchasing power over the course
of his retirement.
From this we can draw some
important conclusions, the principal one being that in a
sound-money economy the saver is considerably better off
over the saving and annuity cycle, in our example having
nearly twice as much at his disposal in real terms from
the same initial input. We can also see that the saver’s
position is proportionately worse with a higher rate of
inflation, and becomes effectively destroyed with
accelerating inflation.
But there is also another point to
note of great importance: the saver in a sound-money
economy finds the purchasing power of his annuity
increases over time. Thus, when he first retires and
finds the purchasing power of his annuity at its lowest,
it will be natural for him to take on some part-time
work to supplement it; and when he ages and is generally
less able to work part-time, the purchasing value of his
annuity compensates by increasing. In an inflationary
environment, the reverse is obviously true, with the
purchasing-power of the annuity being greatest at
retirement and least in old age. We can therefore
conclude that not only is the value of savings enhanced
by sound money policies, but their increasing value over
time matches a saver’s practical requirements in old
age.
The contrast between the effects of
sound money compared with that of fiat currencies on
long-term savings could not be more clear. We have
identified the little-understood effect of inflation on
the complete savings and retirement cycle, and we have
seen that the improved position of the saver in a
sound-money economy has the potential to reduce or
eliminate his dependence on the state. In an
inflationary environment the obverse is true, with the
costs of the elderly who have saved increasing while the
true value of their savings falls. And the greater their
life-expectancy, the greater the gap grows between the
two.
But this is only part of the story.
The cost of unfunded schemes, such as pension
commitments for government employees and for the payment
of basic state pensions for all, have built up enormous
future costs, because these pensions and the associated
healthcare liabilities have to adjust for future
inflation. The various estimates of the total cost to
the US Government now amounts to many multiples of GDP,
and properly accounted for shows the Federal Government
to be effectively bankrupt, a finding which is becoming
more widely known, and which we can add to our reasons
for condemning inflation for its effects on savings.
With respect to savings there are
therefore no winners, only losers from the Keynesian and
monetarist policies that have sought to manage the
general price level by printing money and expanding
credit. Governments have discouraged private saving
through long-run inflation and taxation of interest and
capital gains. In socialist democracies, people now no
longer save, fully expecting the state to look after
them in their old age.
This has ultimately dumped the
financial burden arising from the destruction of savings
back upon governments themselves. The line of least
resistance for politicians will be to accelerate weak
money policies in the mistaken belief that it is the
only solution: as we have seen, an acceleration of weak
money policies will rapidly make things worse.
This is the true price of inflation
on savings and savings habits.
22 February 2011
