Is the U.S. Waging a War on Savers?

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A recent consumer survey found that 41% of respondents had less than $500 in savings available on short notice. And the more comprehensive Survey of Consumer Finances released by the Federal Reserve in June calculated that only 52% of American families are earning more than they spend – that’s the lowest figure in 20 years. Moreover, the Fed found that fewer than 40% of families save money on a regular basis (as opposed to putting away a year-end bonus, say). So one has to wonder, is there a reason so many people are failing to save? And more specifically, are there misguided government policies that actually discourage saving?

There are, of course, perfectly good reasons that people are unable to put money away. Despite more than three years of economic recovery, many Americans still face tight monthly budgets. Wages adjusted for inflation have fallen in six of the past 12 months, according to the Bureau of Labor Statistics. Moreover, real average weekly earnings are down 1.3% over the past two years. The reason for this continuing deterioration has been the uneveness of the recovery. Incomes are up for the top 20% of the population, but are falling for the middle class. In addition, the typical American family suffered a 39% drop in net worth between 2007 and 2010, which demoralized all those who saw their long-term savings vanish so quickly.

(MORE: Are You Saving Too Much? No, Really)

While it is harder for many Americans to save regularly, that isn’t the whole story. Many people would doubtless start rebuilding their net worth if they could find attractive enough places to invest their savings. Unfortunately, the extreme low-interest-rate policies that the Federal Reserve is using to try to stimulate the economic recovery actually penalize savers. And prospective changes to the tax laws add another disincentive to save and invest. Here’s a closer look at those factors:

Ultra-low short-term interest rates mean meager returns. Standard operating procedure for the Fed during an economic slowdown is to reduce the Federal Funds rate – the interest rate banks pay to borrow money for one day. The goal is to encourage lending to both businesses and consumers. But this policy has been pushed to a nearly unprecedented extreme. Fed Funds are now close to zero, the lowest level in half a century, and most other short-term interest rates have followed that benchmark rate down. At the same time, inflation has picked up from less than zero at the end of the recession to around 2%. Result: The inflation-adjusted cost of money is negative, which means that borrowers are being paid to take out loans, while savers are actually losing money when they put it in a bank.

Bonds no longer look like a good deal for savers. The Fed’s policy of quantitative easing – basically creating money and using it to buy bonds – pushed down long-term interest rates. Since bond prices move in the opposite direction from interest rates, quantitative easing boosted bond prices enormously. Yields on long-term Treasuries are now less than 3% – an exceptionally low level, considering that inflation is 2%. Sooner or later, the Fed is likely to let long-term interest rates rise. And when it does, bond prices will fall. With low current yields and the likelihood of an eventual price decline, bonds don’t seem like an attractive alternative for savers.

The growing likelihood of future inflation. In order to keep interest rates as low as they are, the Fed has had to buy so many bonds that its balance sheet has ballooned. In fact, the Fed’s holdings of Treasury bonds have more than doubled since the recession. Unless this trend is slowly reversed as the economy picks up, it is likely that all the excess money will begin to push up prices and create rising inflation. While inflation isn’t a problem at today’s 2% rate, any future increase would erode the value of savings.

Potential tax increases could hurt high-yield stocks. Under current law, the Bush tax cuts are scheduled to expire at the end of the year, which would mean a sharp increase in the tax on dividends, and some increase in capital gains taxes as well. Congress is likely to do something to prevent these changes, as well as the rest of the so-called fiscal cliff, from occurring next year. Nonetheless, some increase in taxes on capital gains and dividends is entirely possible. Not only would that lower after-tax returns for some taxpayers, it could also knock down the prices of stocks with above-average dividends. That means that high-yield stocks aren’t a great option for conservative savers, either.

There’s not a lot the government can do to address the ability of people to save, beyond general policies that try to promote economic growth for a broader cross-section of the population. But it should avoid policies that discourage people who can afford to save from doing so. Basically, this comes down to two issues. The simple one is that however the tax system is reformed – and even if changes have to be made that raise more revenue – it makes no sense to discourage people from saving rather than spending.

The more fundamental issue is that it is a mistake to ask the Fed to shoulder so much of the burden of reviving the economy. Many of the factors that are most hostile to saving stem from today’s exceedingly low interest rates. The Fed’s first job is to maintain the value of the dollar, which means preventing excessive money growth and the buildup of long-term inflation pressures. The Fed does have some leeway to encourage the economy, but that is better addressed through fiscal policy. In simpler language, Congress and the President need to fix discretionary spending, entitlements, and taxes and not just dump all the economic problems on Fed Chairman Ben Bernanke’s desk.

MORE: What Savings Rate You Need When Starting at Age 15, 25, 35 and 50

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