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Banks, Interest Rates, & the TINA Trade

Hi, Cullen (and anyone else who would like to comment).

I just discovered your blog and am looking forward to reading all of the content.  I just have one question:
What would be the effect of a federal law that requires banks to pay savings accounts an interest rate equal to the rate of inflation?
It seems to me that several outcomes might result:
1. Banks might lose money, so they would stop offering savings accounts.  To prevent this, the government could backstop losses for the banks by making up the difference.
2. Stock prices would fall, because the "TINA" trade is gone.  I would argue that this would restore realistic asset pricing in the stock market.
3. Bond prices would fall (in other words, yields would rise).  Again, as in the case of the stock market, I would argue that this would restore realistic asset pricing in the bond market. Is a company's debt riskier?  Then it's yield would have to compensate investors for that risk.
4. People would be encouraged to save rather than spend, slowing consumption and therefore slowing the economy.  As a near-retiree, I would argue that this would increase spending.  I would be more likely to buy entertainment related big-ticket items if I could count on my savings account to keep pace with inflation as I continue in retirement.  As it stands now, the TINA trade forces me to account for potential stock market drawdowns by holding a larger account balance (so not spending).
5. Money would flow from billionaires (due to the declining stock and bond markets) to Main Street savers.  While this is true, it is the biggest hurdle for my idea to clear.  What Congress person is going to vote for the very thing that would hurt his or her largest campaign donors?
It is because of item 5 above that I think that this is all just an interesting scenario to play "what if" games around, rather than something that could actually happen.  I would just be interested in your thoughts about it, including why it couldn't or wouldn't happen, and even why it is a bad idea.
Thanks in advance,
Steve W

Hi @bikeeagle1

Thanks for reading.

I'll try to answer point by point.

  1. Yes, this would end up basically being a govt subsidy as the Fed/Tsy would have to make it a sustainable operation. So, for instance, if the Fed is paying 0% on reserves then the banks have a harder time making a profit if they're paying the rest of us 2%. Their net interest margins suffer and they end up having to make up the difference elsewhere because the reserves are a net drag on their ability to remain well capitalized.
  2. I'm not sure what would happen to stocks to be honest. The govt would essentially be paying more interest which adds to the deficit which adds to corporate profits. But there could be other knock-on effects. I personally don't love reasoning from interest rate changes. Rates are mostly the result of other things, not the driver of those things.
  3. Bond prices would still depend mostly on inflation. Sure, some shorter duration bonds would adjust to the Fed's policy, but in the long-term inflation would be the main driver of rates and bond prices.
  4. I've never seen it like that. I have literally never looked at my bank account and seen a higher interest rate that made me say "gee, I'm gonna save more now". I save some quantity of my income and allocate that to the assets I think will best protect it. So, not sure I agree that higher rates make people save more.
  5. Maybe? I actually think there's a chance that the govt would just end up paying a lot more interest to rich bondholders. But again, I don't like trying to understand things like inequality from the perspective of interest rates. I think it puts the cart before the horse.

Hope that helps some.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Thanks for the reply, Cullen.

The idea for my question came from a conversation I had with my brother (who is also retired) back in 2018.  Interest rates had crept back up to around 2%, and he was excited about how much he was earning in interest in his cash allocation in his investment accounts.  He commented that he had reached the point would never need to withdraw anything from his stock allocation, because he was earning enough in interest on cash to pay all of his expenses.

I cautioned him that while interest rates had gone up, inflation might also, resulting in his interest income no longer supporting his lifestyle.  I also mentioned that interest rates could always be lowered again, and almost certainly would be if and when the next downturn came.

Well, we all know what happened next.  Then-President Trump complained that our interest rates were higher than everybody else's, putting us at a disadvantage.  Over the course of 2019, Powell began lowering rates again, resulting in a gain in the S&P 500 from 2350 to 3385, or 44%, to its peak just before the covid crash.

As a saver, my brother saw a reduction in income caused by the reduction in interest rates, while investors with large stock holdings gained 44%.  To us, it sure felt like money was being taken from frugal savers and given to rich investors.

Anyway, all of this is of course more complicated than I've described, but it seemed reasonable to me to at least wonder what would happen if the reverse occurred, and savers were at least compensated enough to keep pace with inflation without being subject to stock market volatility.

Another benefit of my idea that just occurred to me would be a reduction in dependence on social security.  I plan for social security to absorb part of my spending needs as I age, but 3% interest in a savings account would completely eliminate my need for any social security at all.