Barry’s Pickings: Living With Interest Rates: Money Versus Time

Michael Barry, president of O3 Plan Advisory Services LLC, discusses how interest rate movement affects retirement savings and what retirement savers should consider.
Art by Joe Ciardiello

Art by Joe Ciardiello

“I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.” (James Carville)


Interest Rates vs. Working-Age (15–64) World Population Growth

Source: Retirement Savings Policy – Past, Present, and Future, Michael Barry (De|G PRESS, 2018)






At the end of June 2019, the yield on 10-year Treasuries is down 70 basis points from the end of last year. For DB plans, the fall in interest rates this year translates to a 10% to 15% increase in the value of liabilities. On the plus side, assets are up—the S&P 500 earned more than 18% in the first half of this year. These asset gains may (depending on the portfolio) offset (or even outperform) interest rate losses. Much will depend on what happens—to interest rates and assets—for the rest of the year.


Why—for retirement policy—are interest rates such a big deal?


Interest rates represent, conventionally, the “time value of money.” I used to think about this simplistically—that having a dollar to spend today was (literally) worth more than having a dollar to spend in the future, and the time value of money was what someone had to pay you for not spending that dollar today. With that view, the steady decline in interest rates since the early 1980s seemed to me, in some way, an attack on savers and (in effect) a preference for spenders.


After more than 40 years of living with interest rates, my understanding of the time value of money has gotten significantly more nuanced. I now see interest rates as simply a market price for different time preferences. And those preferences—e.g., for spending vs. saving in different generations—may change over time.


With a demographic and neurobiological legacy stretching back hundreds of thousands of years, we generally “instinctively” view money available to spend now as worth more than money that is only available to spend in the future.


But we live in extraordinary times. Our current demographics—a rapidly aging population—are unique. And this development has flattened out the value of different generations’ time preferences. To put that less abstractly, interest rates are at historical lows for some powerful fundamental reasons. I believe that the most significant of these is the “dramatic increases in the ratio of retirees to workers in a number of major industrial economies.” (The Global Saving Glut and the U.S. Current Account Deficit, Remarks by Fed Governor Ben S. Bernanke, 2005.)


How much do I have to pay someone now to take care of me 30 years from now?


The time-value-of-money (or, the time preferences of different generations) is perhaps the most important fundamental factor affecting retirement savings policy. Because the act of “saving for retirement” (as opposed to, say, investing or speculating in the stock market) boils down to this question: how much do I have to pay someone today (that is, “how much do I have to save”) to take care of me in the future (that is, “to buy the goods and services I will need when I can’t work anymore”)?


The chart at the top describes the change-over-time of this calculation vividly.


The decline in interest rates, beginning in the early 1980s, reflects the fact that there will be—because of the (worldwide) decline in the growth rate of the working age population—relatively more demand for money in the future (in the form of retirement income), and relatively less goods and services, than there has been in the past. The result: the cost of saving for retirement has gone up. And the index of that is interest rates. That’s why those two lines in the chart—interest rates and the rate of growth of the working age population—map against each other.


This phenomenon has directly affected defined benefit (DB) plans. Lower interest rates equal higher liability valuations. Put differently, the cost of financing retirement has gone up as interest rates have gone down.


The effect of interest rates on defined contribution (DC) plans is more obscure. But the focus in recent years on getting participants to understand their DC account balances in terms of retirement income is (in part) an effort to get participants to focus on the higher cost of saving for retirement. Interest rates directly affect the price of annuities.


Moreover, asset returns have also declined—as they generally do (in the long run) when interest rates decline. (Yes, a decline in interest rates is associated with a write-up in asset valuations, but that write-up reflects the reduction in long-run returns.)


Is there any way out of this mess?


Given the decline in interest rates, a fair guess is that the cost of saving for retirement has (at least) doubled over the last 20 years.


At some point, this situation becomes unsustainable. Consider that the cost to a middle income couple of raising a child through high school is $233,610. The rate of college tuition inflation is around 200 basis points higher than general inflation. And health care price inflation is three time the general inflation rate.


How, in these conditions, is a family going to devote twice as much of its income to saving for retirement?


In any case, “saving more/spending less” by itself is not an adequate answer. If everyone simply saves more, and that savings does not generate an increase in future productivity (future goods and services), then all that will happen is that those future goods and services will cost more. The Keynesians call this the “paradox of thrift”—“An individual act of higher saving without a corresponding increase of investment only redistributes saving among agents.” (A Penny Saved May Not Be a Penny Earned: Thinking Hard About Saving and the Creation of Wealth, Fazzari, 2007.)


Thus, the effectiveness of retirement savings is dependent on the capacity of the capital markets to convert those increased savings into increased productive investment. Indeed, I believe that the retirement savings revolution is as much a consequence of changes in our capital markets (e.g., the development of the mutual fund) as it is of changes in retirement policy (e.g., the development of the 401(k) plan).


For what it is worth, my guess is that the decline in birth rates is going to result in a decline in the rate of production of new ideas. I have no data to support that—it just seems to me that if there are fewer fresh young minds there are going to be fewer new ideas.


Plans B and C


Another obvious solution is for those with inadequate savings to work longer. There are objections to this as policy—generally, that many people will be unable to work in old age because of a worn-out physical capacity or a decline in cognition. But in reality, this will be Plan B for most individuals when they reach age 65 and realize that they don’t have enough (or as much as they’d like) to live on.


And, to state the obvious, working longer increases productive capacity—on June 30, 2019, the Wall Street Journal published an article on this new feature of our economy: Gray Wave of Workers Gives Slow-Growing World a Boost. Quoting Petia Topalova, an International Monetary Fund economist: “You need more people, a greater share of the population to join the labor force, so you can produce the same amount of output …. It’s very much needed for most of these [developed] countries because populations are projected to decline in most of the advanced world over the next decade.”


Plan C (it seems to me) is to wait out the current situation—at some point, the demographics will have to stabilize. For a lot of us alive today this will translate into living on less.


* * *


In the end—I believe—our ability to meet these challenges will depend on the dynamism of our economy and our own ability to adapt. In those, I have great faith. Quoting Warren Buffet (from his 2015 Letter to Shareholders): “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs. America’s social security promises will be honored and perhaps made more generous. And, yes, America’s kids will live far better than their parents did.”



Michael Barry is president of O3 Plan Advisory Services LLC. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly about retirement plan and policy issues.


This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.