The Stunning Collapse In Interest Income

There’s no doubt that savers have been getting squeezed ever since the Federal Reserve ($FED) dropped interest rates to zero a few years ago. Normally, monetary policy like ZIRP would work to get us out of a recession. Even though we technically are not in a recession, we are however in a rare but deadly type of different economic malaise called the “Balance Sheet Recession” (BSR). I’m not going to get too deep into this, but it is important to know that monetary policy could only go so far during a balance sheet recession (BSR).

The $FED, just like all other times, is trying to ease as much as they need in order to get strong growth again. First they dropped rates. Then they tried Quantitative Easing (QE1). Then they conducted QE2. This was then followed by Operation Twist. Then they tried doing what Edward Harrison of Credit-Writedowns calls “rate easing” (committing to low rates for a specific amount of time). Now they are supposedly thinking about more QE, either sterile or in the more “traditional” way (Hello QE3!). All of these actions by the FED causes rates to stay low or head even lower. You can’t blame the Fed for trying, as its in their dual mandate (to lower unemployment along with price stability) and it has worked in the past. However, we are in an abnormal environment of the BSR and the Fed (as a whole) does not realize this, or cannot publicly realize this (I love political pressure, dont you?).

Having low rates means having less interest income. Low interes rates are also labeled as “Financial repression” on us by the FED. I don’t buy this argument (Where in the constitution does it say you have a right to high interest income?).Besides, the entity doing the financial repression is on the fiscal side (Hint: Congress). The Fed will raise rates once growth returns to its normal output, which will bring real demand-pull inflation (and not just inflation expectations caused by the Fed). Only then will we see this era of “financial repression” end.

One last thing about low rates/QE; They effectively act as a tax on the private sector due to the net fiscal effects (Watch Mike Norman explain it). What do I mean by this? We’ll, if there was no QE2, rates would have likely been a bit higher, and all that interest would have gone to the private sector! By removing the supply of bonds and thus lowering interest rates, the Fed is “Stealing” Net Financial Assets (NFA) from the private sector. And as we all know a decrease in private sector savings has never been good. Interestingly, QE technically lowers the deficit, as the Fed is required to turn over ANY profit to the Treasury, thus lowering the national debt (However, we do not want that, especially in a BSR)!


The Charts

The charts below show how devastating the collapse in interest income has become.

1) Interest income  

Here is just a simple chart showing the nominal dollars of Personal Interest Income in the economy. As you see, we are about 30% below the high. That means 30% of total interest income has been zapped away from the private sector (and continues to be).













2a) Interest income/GDP

Here is a better way of measuring, in my opinion. Interest income as a % of GDP. As you see, the collapse is really greater than the previous chart shows.












2b) Interest Income/Income

Similar chart like above, except this measures Interest income as a percent of total Personal Income. Similar trend.














3) Interest income/GDP & Interest income/Personal Income compared to Federal Funds Rate

While the correlation is not super-strong, both stats tend to follow the trend of the FFR. Both measurements of Interest income are very strongly correlated as well. The Fed lowers rates and interest income drops.














4) Personal Dividend Income

Interestingly enough, dividend income has stayed strong, even if you measure it up agaisnt GDP or Personal Income (To save space & not make a cluttered chart below, I wont post those charts). This is kind of what Bernanke wants. He wants people to invest in risky assets, and it looks like they are as dividend income has nearly recovered despite the market being about 15% away from its 2007 high.













Final thoughts

As the $FED drops rates, interest income falls with it (obviously). To exit this era of “financial repression”, Congress must act accordingly on the fiscal side of things and get the economy going again. The Fed can only do so much in a balance-sheet recession as monetary policy is pretty ineffective. Once the economy picks up, inflation will pick up with it and the FED will then be forced to raise rates. With that, we will see this trend of falling interest income reversed.



The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

blog comments powered by Disqus
Jerry Khachoyan Blog