The Devil of Low Inflation

     I recently had a bank CD come due and was bemoaning the fact that there's no place we can put our savings these days to generate any income. A 10-year Treasury bill pays less than 3 percent interest. The average stock in the S&P 500 yields less than 2 percent. And if you want to keep your hard-earned, carefully saved retirement money in a nice secure Certificate of Deposit, insured by the FDIC, you'd get less than 1 percent interest.

      If you had $1 million in your savings account at the bank -- that would be nice, wouldn't it? -- you'd receive only $700 or $800 a month to help with your living expenses. And you wouldn't even get that much because you'd have to pay income tax on that interest.

     Those of us who are more subject to the human frailty of spending most of what we earned while we were working and raising a family, and we have saved up, say, $100,000 in our retirement account . . . we'd receive $70 or $80 a month to help with our living expenses. As they say . . . big freakin' deal!

     So how's a retired person supposed to live these days?!?

     Then I started thinking, what's the alternative? Maybe there's a silver lining here. The main reason interest rates are so low is because inflation is low – just 1.5 percent for the last year, according to the Bureau of Labor Statistics. So . . . prices for food and energy have gone up somewhat, but costs for clothes, furniture, appliances and electronics have gone down, and even the cost of health care has moderated a bit.

     We retirees need to remember that low inflation benefits us more than any other group. In fact, low inflation actually penalizes workers as it puts downward pressure on salaries and tightens the job market. But it's good for people on a fixed income, and most retirees are on a fixed income. Our pension, if we have one, is likely not indexed to inflation. Social Security benefits are adjusted for inflation; but it's an uncertain thing -- there was no cost-of-living increase at all in 2010 or 2011, and this year the increase was just 1.5 percent. Meantime, while low inflation makes it hard on workers, they are better protected against high inflation since pay scales generally rise in line with inflation.

     But retirees are by and large not protected against inflation. Most of us don't have a job. And most of us do not have income-producing assets. Sure, if you own a rental property, you can raise the rent if inflation goes up. But only a small fraction of retirees own rental properties. The rest of us rely on savings that are squirreled away in an IRA or other savings account that does not increase with inflation.

     Yes, most retirees -- some 80 percent of us -- own our own home. If inflation goes up, then the value of our house goes up. But for most of us this hardly matters. It's a good thing for younger people who can ride the wave of housing inflation to greater affluence over a long period of time. But retirees have a shorter time horizon. We just need someplace to live, and if we're not going anywhere, it doesn't really matter what the cash value of our house is.

     Finally, inflation helps out people with large debts, because over time inflation depreciates the value of money, so people pay off their debt in ever-cheaper dollars. The higher inflation is, the faster the debt goes down. But most retirees carry little or no debt. They don't have a big mortgage – about two-thirds of retired homeowners have no mortgage at all – and they are not looking to borrow money to start a business or finance their education. So retirees do not benefit from the debt reduction that automatically goes along with higher inflation.

     Of course, some people think that the inflation rate is higher than the government claims, citing gas prices, utilities, health care, real-estate taxes -- not to mention the cost of food at the grocery store. And they feel a squeeze on their income by low interest rates, the parsimonious payback on an annuity, the low return on a reverse mortgage, or the drying up of any other source of funds.

     But remember the 1970s? How would you cope if prices were climbing 6 or 7 percent a year, and every time you went to the store the price of milk and eggs and meat went up, or you couldn't even think about buying a new car because the sticker price went up $1000 since last year?

     The devil we know may be better than the devil we don't.