Life
    Money

    What will happen to your savings after coronavirus?

    22 April 2020

    What joy it has been to have some cash over the past two months. For gamblers, to be sure, there have been opportunities to take advantage of a volatile stock market (and even more opportunities to get it wrong and lose a packet). But cash is cash – it just sits there holding its value, without having to watch the markets with dread every day.

    Well, certainly over the short term. But history teaches us a painful lesson in these circumstances: while investing in stock markets is full of sorrows, investing in cash offers few pleasures. It is ordinary savers ultimately who were made to pay for the economic crisis of 2008/09, and doubtless it will be they who are made to pay for this crisis, too.

    Cash hasn’t been all that steady over the past two months, in any case. Moneyfacts has surveyed savings accounts and calculated that the average rate of interest on an easy-access savings accounts has fallen from 0.56 per cent in March to 0.44 per cent in April. But never mind nominal rates of interest, what really matters in the long term is the real rate of interest – ie after taking inflation into account. The Consumer Prices Index (CPI) currently stands at 1.7 per cent (leave aside the debate as to whether that is a genuine reflection of inflation or an attempt by Gordon Brown to fiddle the figures by switching from the generally-higher Retail Prices Index). Take CPI into account and your 0.44 rate of interest is minus 1.26 in real terms. At that rate, over 20 years your wealth is going to erode by a quarter over 20 years. You can fish around the market all you like, but you will do extremely well to find an account which preserves the value of your money, let alone allows it to grow.

    Negative interest rates have been a persistent fact of life in Britain – indeed around the world – since 2009. It is very different from the preceding 30 years. But for a brief blip in 1994, between 1980 and 2009 a savings account would have made you a substantial real-terms gain. In the 1980s, real interest rates stayed above five percent for substantial periods. Imagine having £1 million and stuffing it in the bank – and enjoying an index-linked income of £50,000 a year, free of risk to capital. It is a dream scenario, long gone.

    Prior to 1980s, however, and you wouldn’t have wanted to be in cash. The real rate of interest regularly dipped below zero, often substantially so – in 1975 real rates reached minus 10 per cent. In the past decade, by contrast, real rates have oscillated between minus one and minus two per cent. If inflation kicks off, however, we could soon be back in the days of much higher negative interest rates.

    Over the past decade we have often heard the suggestion that ultra-low interest rates are abnormal, with the inference that at some point normality will return. Certainly in nominal terms, interest rates have been at record lows – breaching levels they had never done in three centuries. But what about real interest rates. A fascinating long-term view – and this really is a long-term view, not just the last 300 years – is provided by an Bank of England staff working paper written by Paul Schmedlzing in January. He looks at the trend in real interest rates since 1300. His conclusion? That there has been a long downwards trend for almost all that time.

    The time to be a saver, it transpires, was not back in the 1980s with Abbey National or the Halifax – it was in the 1400s, when real interest rates averaged a whopping 9.1 per cent. Whether money lenders were quite so reliable in those days is another matter; difficulty in getting your savings back might go someway to explaining why rates were so high. Since then, real rates fell to 6.1 per cent in the 1500s, 4.6 per cent in the 1600s, 3.5 per cent in the 1700s, 3.4 per cent in the 1800s and 2.0 per cent in the 1900s. So far in the 2000s they have averaged 1.3 per cent.

    So ‘normality’ with real interest rates seems to be that they fall over time. It is hard to see why this should change in the near future. After all, governments are so heavily indebted that they have a vested interest in somehow engineering negative real rates of interest. Negative real rates help to pay off debt in real terms; positive real rates make debt ever more difficult to bear. Savers should not expect any relief for their steadily eroding savings – even if they escaped last month’s rapidly-eroding share values.