Steven Patterson and his family moved to Vancouver from Cambridge, Ont., in mid-2008, just as the financial crisis hit. After years of saving to pay off their first mortgage, they had earned a tidy profit when they sold the Cambridge house and put the proceeds into GICs, where the money would be safe and easily accessible should they decide to buy another home in B.C. Three years later, Patterson, a 42-year-old IT manager, is still sitting on the sidelines, renting, while real estate prices march ever upward in a city where a three-bedroom bungalow covered in warped siding can fetch $1 million.
That might seem like a prudent move in an uncertain economy, but Patterson says his cautious approach has come at a steep price: all his money is steadily being eaten away by inflation, which the meagre interest income from his GICs can’t cover—particularly after the taxman takes a cut. Meanwhile, several of Patterson’s friends have taken advantage of those same low interest rates, loaded up on debt, and bought into Vancouver’s frothy housing market in recent years. And they have enjoyed a windfall—at least on paper—as the value of their homes continues to climb. As for Patterson, “I’m only a few thousand dollars ahead—minus inflation,” he says, clearly frustrated. “So actually, I’m way behind, and I don’t have a house.”
Welcome to the world of ultra-low interest rates, where profligacy is richly rewarded and saving is, well, for suckers. Those who’ve opted to be austere with their personal finances have found themselves on the losing end as governments and central bankers have worked to get people to borrow and spend in the wake of the global recession. While emergency interest rate cuts were to be expected after the financial crisis seized up lending markets, it’s been nearly four years since central banks started slashing rates to the lowest levels in history. For that matter, over the last 10-year period, following the 9/11 terrorist attacks, the Bank of Canada’s benchmark interest rate stayed above four per cent for just six quarters (in 2006 and 2007), while the average headline rate of inflation over that time was 2.1 per cent.
As a result, those saving money have seen almost nothing in the way of returns for a painfully long time. In fact, after accounting for inflation, anyone who dares to be prudent risks seeing the value of their money decline. If one were to put $10,000 into a five-year GIC at two per cent this year, and assume headline inflation goes no higher than the current rate of 2.7 per cent, the future value of that investment in 2016 will have shrunk to around $9,670. (The consumer price index the Bank of Canada uses when setting interest rates is lower than the headline rate because it excludes volatile items like fuel and food, which is fine, if you don’t drive, or eat.)
For seniors and others living on fixed incomes in particular, low rates threaten to wipe out their savings. Yet it’s also depressing for those in the second half of their careers who don’t have an appetite for risk but feel they now have no other choice. “People in their 50s are worried about what they’re going to retire on,” says Susan Eng, vice-president of advocacy at CARP, which works on behalf of aging Canadians. Between the carnage in stock markets and the collapse of interest rates, “there’s a huge amount of anxiety. You’re asking for a lot of trouble with this situation.”
Some will argue people like Patterson are simply bitter because they didn’t buy into Vancouver’s soaring housing market. And yes, those who take risks should enjoy the potential for greater rewards. That principle is at the heart of capitalism. Only, in the current environment where central banks have pushed down interest rates to abnormally low levels, and government policies encourage consumption over thrift, the dynamics of risk and reward have been severely distorted.
This isn’t how it’s supposed to work. From the moment children are given their first penny, it’s driven into us that saving is a virtue and the path to financial security starts with that ceramic piggy bank on the dresser. Only now, with policy-makers in a desperate race to reignite economic growth, all that has been turned on its head. Yes, Bank of Canada governor Mark Carney and Finance Minister Jim Flaherty have repeatedly warned Canadians not to take on too much debt, but their policies, and those of their colleagues in countries like the United States and Great Britain, have had the opposite effect, encouraging people to buy homes, cars, flat-screen TVs or take a plunge into volatile stock markets—anything, that is, but save.
“We’ve got ourselves into a position where debt and spending seem to be highly valued, but saving, which is prudent and helps people plan for their futures, seems to be almost looked down upon,” says Simon Rose, who works with Save Our Savers, a British organization that’s taken up the fight for downtrodden penny counters. “It’s unfair that the problems of the economy should be disproportionately shouldered by savers rather than those with a tendency to borrow too much and get into trouble.” No one is saying Canadians should abandon thrift and go on a wild spree of gluttonous consumption. Indeed, Ottawa has set up tax-free savings accounts to encourage people to save. But the competing priority of spurring economic activity means the interests of savers have taken a back seat and made it that much harder to act responsibly. What’s more, while central bankers have undone basic thinking about saving in the name of juicing the economy, a growing chorus of critics claim that strategy has not only failed to turn things around, but the dogged pursuit of low rates might be weakening the recovery
Sometimes Lee Tunstall wonders why she bothers saving at all. A child of parents who grew up during the Second World War and instilled in her the importance of living within her means, Tunstall, a consultant in Calgary, has rented the same apartment for 17 years and dutifully contributes to her conservatively managed RSP account. Yet all around her, friends have piled on huge mortgages and run up towering lines of credit debts in the past few years to buy homes and new Bimmers for the driveway. “If you are a saver you’re absolutely losing money to inflation, and if you go into the markets you’re losing money there too, so why bother?” she says. “Sometimes I think, ‘Why don’t I just join the herd and do what everybody else is doing, buy the toys and live it up like everybody else?’ ”
Tunstall would have plenty of company were she to give up her frugal ways. Gone are the days when Canada was a nation of savers. In 1980, the personal saving rate peaked at above 20 per cent and was still around 13 per cent in 1995. Today it stands at just 4.1 per cent. At the same time, over the last decade Canadians have increasingly relied on debt to maintain their lifestyles. The average household now owes $151 for every $100 of disposable income, a higher level than even American households reached in 2007 as the air rushed out of the U.S. housing bubble. This week, Moody’s, the credit-rating agency, said it is increasingly uneasy with the consumer debt mountain rising in Canada. “We are concerned that Canadians are relying on low interest rates to support high debt levels,” the agency said in a statement.
Much of that growth in debt has taken place since 2007, when the Bank of Canada cut its overnight rate from 4.5 per cent to a low of 0.25 per cent in 2009. The dramatic cuts, along with stimulus programs targeted at the real estate sector, revived house prices, which had begun to tumble. As of June, the Teranet-National Bank House Price index has nearly doubled over the last decade, while in markets like Vancouver, prices have soared a whopping 140 per cent. That shouldn’t have been a surprise; reckless behaviour gets a boost when government and central bank policies punish individuals for not taking part. But while the cuts were a boon to mortgage borrowers, they’ve sideswiped the saving crowd.
While the Bank of Canada’s interest rate policies have been credited with helping Canada quickly recover from the recession, in America unemployment is still stubbornly high while house prices have continued to fall. Raghuram Rajan, a finance professor at the University of Chicago and the former chief economist at the International Monetary Fund, sees this as evidence that perpetually low rates—a long-established tool for repairing broken economies—are simply failing this time around. Instead, he believes an overlooked cause of the recovery’s sluggishness lies with America’s devastated savers.
Consider the example of China for why that is, says Rajan. For years, China has kept interest rates artificially low—well below the rate of inflation—partly to drive down its currency but also to make it easier for manufacturers and builders to access capital. That’s had the unforeseen consequence of sapping consumer spending, too, which has shrunk as a share of the economy from 50 per cent in the 1990s to just 35 per cent today. When Chinese families who are saving for their children’s education, or to take care of an elderly parent, see their savings eroded by low rates and inflation, they have responded by spending less and saving even more.
Rajan believes the same phenomena could be at work in America today. “Your traditional spenders are hesitant about splurging again, while low rates mean your savers are cutting back because their incomes are falling,” he says. “Giving savers a better deal by raising rates from abnormally low levels may help rather than hurt the economy.”
Years of ultra-low interest rates have punished savers, rewarded spenders, and now might be smothering any hopes of recovery. Once interest rate starts rising the spenders may be doomed. Do everything in moderation.