Most people yawn when they hear a word like "deflation"--which basically means that prices decline--and stop reading.
Sounds like a boon to consumers, no? What cost $2 last year costs $1 this year. Think of all the stuff that can be purchased with all of those extra $$$s! Whoopie...bring it on!
However, if those declining prices persist, a fairly predictable pattern emerges: Corporate profits fall, production declines, unemployment increases, incomes decline, and the number of defaults on loans to individuals and corporations increases. Suddenly, there's an economic contraction, recession, or worse yet, depression.
To get a sense of what deflation really means, Sagami wants his readers to focus upon those loans to corporations, especially for those readers who are formulating a financial plan for their retirement years.
Today, 16 nations have interest rates that are are <0%. For example:
- Sweden -0.85%
- Switzerland -0.75%
- Denmark -0.75%
- European Central Bank -0.75%
What negative interest rates mean is that those governments (and corporations) have to pay higher interest rates (a "premium") to those making the loans for the privilege of borrowing money, for example, as is the case with Germany and France today.
Now, this is where many of those who have persisted in reading find their eyes glazing over. But, hang in there.
Consider Sagami's data:
- JPMorgan Chase recently announced that its institutional clients will be charged as much as 5.5% on deposits.
- Other banks are charging corporate clients to hold their eurodollar deposits.
- Short-term US bond yields are barely above 0%.
- Yields on long-term bonds are near historic lows.
- The 10-year Treasury bond yield is <2%. The yield on 30-year Treasury bonds recently hit a new low of 2.44%. These yields are the lowest in U.S. history.
Get the idea? Interest paid on money that's deposited in banks is lower in a deflationary period.
Contrary to what the Chair of the Federal Reserve Bank, Janet Yellen, states about interest rates increasing at some point in the near-term future, Sagami expects they will not only go lower but also plunge as happened to those 16 nations.
Translated into plain English: Banks, pension funds, and institutional investors will not be generating the kind of return that's been factored into their economic models. Meaning? They will not be able to pay out the $$$s promised without going bankrupt. In short, retirees in deflationary periods must be prepared to take a hair cut on their retirement savings?
The end of the story: Is the logic of your retirement plan based upon receiving a 0.25%, 3%, or 5% return on investment?
In a deflationary cycle like that in much of Europe today and the one Sagami is forecasting for the United States, Sagami suggests planning on a 0.25% annual rate of return.
Those whose eyes glazed over and didn't read on, Sagami believes, may end up having to work as part-time Walmart greeters in retirement to supplement their real return on investment, not their planned return. Those whose eyes didn't glaze over and persisted in reading to the end of this post will start investigating dividend-bearing equities that will increase their annual rate of return during what Sagami forecasts to be a prolonged period of deflation.
The Motley Monk suggests considering, among others, Hershey's, Proctor & Gamble, McCormick, Microsoft, General Electric, Altria, Qualcomm, and AbbVie.
Let the discussion begin...
To read Tony Sagami's "Connect the Dots" post, click on the following link: