Humans are uncomfortable with the unknown. So we make assumptions to comfort ourselves. We assume the future will look a lot like the past. Often, our assumptions prove to be valid. Sometimes, they don’t. We’re in one of those periods when assumptions fall short. And it’s going to impact all of us.
Probably no one would have thought people would pay a bank to hold their savings. We expect interest (“yield”). That yield supports retirees and other savers. And allows pension plans, college endowments, and insurance companies to meet their obligations. We assume yield will outpace inflation, that is, that interest earned will yield an actual income, not income that’s eaten up by the rising costs of goods and services. That assumption was never seriously questioned. Until now.
The financial crisis of 2008-09 changed everything — or more precisely, the events leading up to the crisis and that have unfolded since. We now find ourselves in a low-yield world, a world in which the purchasing power of our savings is actually falling. But it’s not due primarily to inflation. Rather, it’s due to low yield and, what has taken by world by surprise, negative yield.
About a third of all developed-country government debt is now trading a negative yields, which means if you buy certain bonds issued by the German, Swedish, Swiss, Japanese, Netherlands, French and Spain governments, you won’t earn any interest and the principal you’ll get back on the maturity date will be less than you paid for the bond. No one thought this would be possible. Yet it’s our current reality.
Sovereign debt (that is, government debt as opposed to debt of private companies and individuals) yielding negative interest has surpassed $10 trillion. Again, no one thought this would be possible. And where yields aren’t negative, they are pathetically low.
What it means, of course, is that some retirees will have a lot less to live on than they had planned.
It also means insurance companies will have less income, driving up the cost of insurance coverage (especially life, disability and long-term care insurance). Some insurers probably will fail.
It puts more pressure on colleges (who will have less endowment income and depressed levels of donations) to increase tuition to make up the shortfall and to cut faculty, staff and programs. Some will have to merge or close. Some already have.
It means many pension plans will not have enough income to support their payment obligations. Some will go bankrupt, and their beneficiaries will have even less income to support their retirement than they thought they’d have.
It means more investors will be tempted to take greater risks in reaching for yield, and likely will end up losing money in investments they never should have made in the first place.
It means bubbles will form. We’re already seeing it in certain real estate markets (e.g., Vancouver). The bubble likely will grow until … . Well, we know (or should know) what happens when bubbles burst. It isn’t good. And there are many casualties.
Whether low yields have pushed stocks to unsustainable prices is a subject of much debate in the global investment and finance communities. May we be at risk of a financial crisis akin to 2008-09? Could it be worse this time? No one can be sure, but most knowledgable people agree the risks are elevated.
So what’s the point, Vera? It’s this:
- Be aware that humans assume a lot but that not all of our assumptions will prove correct. We often confuse assumptions with knowledge. The smart people know we know a lot less than we think we do. Be one of the smart people.
- Don’t assume the future will look like the past. Usually, the similarities are considerable; however, at certain points in history, re-sets occur. We take sharp turns. It’s impossible to predict those turns with any degree of accuracy. Prepare for turns even though you won’t know with certainty when they will occur or in what direction they’ll take us.
- Be skeptical of people who act as though they know what’s going to happen. The world is full of such people. Some are merely misguided yet honest. Some are charlatans. The vast majority will prove to be wrong. If someone acts like they know, it’s apparent to me that one of two things is going on. Either they want to sell something and their story is designed to nudge people to buy it, or they’re just not very smart. The really smart people deal in probabilities and risks, not absolute predictions. Read and listen to the really smart people. Shield yourself from the chatter of the misguided. Be extremely wary of the charlatans.
- Get comfortable with uncertainty and ambiguity. This is a tough one because we humans seem to have an innate discomfort with both. Yet I think comfort with uncertainty and ambiguity is something you can foster. Be well grounded. Financially independent (or as much so as possible). Make conservative assumptions when deciding how much debt is reasonable for you (no debt is best, of course). Live below your means. Save. Attend to your inner life. Hold precious the things in life that truly matter. Resist the quest of happiness based on acquisition. Develop skills and talents that can’t be replicated by machines (robots and computers). Realize your greatest asset is your nurtured talent and ability to contribute to another person or enterprise’s success.
- Be courageous. We don’t know what the future will bring, but we do know that fear diminishes our lives immeasurably. Nurture the courage within you.
The future likely will resemble the past in many respects. But it’s possible it will look very different. We don’t know. No one does. But that’s O.K. Prepare as best you can for an uncertain future, and then live life courageously and compassionately. If you do, the odds are that things will be just fine.