Bank of England Pursues Looser Money

The Bank of England (BOE) just announced a cut in its benchmark rate from 0.5% to 0.25%.  The rate had been at 0.5% since March 2009, when the economy was still reeling from a recession.

Does this mean that the BOE thinks the economy is weaker now than it was in March 2009?

The BOE also said it will purchase an additional 60 billion pounds (about $80 billion) of U.K. government debt over the next 6 months.  It will also buy 10 billion pounds of corporate debt over the course of 18 months.

This isn’t quite on the level of the Federal Reserve during QE3 when it was purchasing $85 billion per month in new assets, but the U.S. is quite a bit bigger than the U.K. both economically and in terms of population.

Perhaps the most significant thing is that the BOE has indicated that there could be more rate cuts in the future.  This means it will likely go to zero or beyond.

And why not?  That is the world trend.  The European Central Bank and the Bank of Japan have engaged in massive monetary pumping and a policy of negative interest rates (NIRP).

The major central banks have done (or are doing) almost the exact opposite of what a libertarian/ free market proponent would recommend.  I would say it is straight Keynesian economics, but I am not even sure that Keynes would have supported this insanity.

On this news, the British pound fell in relation to the dollar and other major currencies.

Since the Fed does not want the dollar to strengthen too much, it makes it less likely now that the Fed will hike its own target rate.  Many think the Fed will not hike at all in 2016.

These central bankers have this goal of increasing price inflation.  It is an absurd goal, which only makes us poorer in the long run.  It is also rather ironic in that these moves just tend to increase fear amongst the public, which can oftentimes just leads to an increased demand for money, despite the monetary inflation.  This means a decline in velocity and lower price inflation, at least in the short run.

Despite the Fed not raising its target rate, other than 25 basis points back in December, it is the only major central bank that is anywhere close to a sane policy right now.  Sure, it approximately quintupled the monetary base from 2008 to 2014, but at least its monetary policy has been tight for almost two years now.

This is all a disaster that is just getting built up.  The more these central banks inflate, the more that resources are misallocated.  At some point, there is going to be a major correction.

And a correction is really what we need.  We need a return to sanity. We need for resources to properly align with consumer demand.  We need for the asset bubbles to pop so that prices are no longer distorted.

While a major correction will be painful, it is basically inevitable at this point.  This includes the U.S.  But the U.S. is in far better shape than Japan and parts of Western Europe.

The only thing worse than the correction itself is the possible responses from central banks and central governments.  It could bring more authoritarianism.  It could bring even more money creation and more debt, if that is even possible.

While the Brexit vote was a small positive step towards liberty, it doesn’t change the fact that the British people are just as much under the thumb of central bankers as everyone else.  And the BOE is doing virtually the opposite of what it should be doing.

Janet Yellen and company now have another excuse not to raise its target rate.  They probably don’t want to change anything right now anyway, at least until the election is over.  If the economy were to tank before November, it could mean a Trump victory, which they do not want.

This will all be entertaining in a sick kind of way.  It is important to watch Japan, as I see the Japanese getting hit the hardest of all when everything implodes.

401k Accounts and Opportunity Costs

There are pros and cons to having a workplace 401k plan.  It is an option people have to shelter some income, and options are always good.  And unlike Social Security, you are not forced to participate in it.

Still, 401k plans are widely touted as great investment vehicles, even by the establishment media.  Any time something is this widely praised, you should proceed with caution.

First, there is the issue of potential confiscation.  With ballooning government debts and unfunded liabilities, the U.S. government is going to be looking to get its hands on extra money more desperately than ever in the somewhat near future.

I don’t think outright confiscation is likely because of public opinion.  There are tens of millions of people with 401k plans now.  If there is any attempt at confiscation, it will be more indirect.  It will come in the form of higher marginal taxes, higher fees, bigger penalties for early withdrawals, and perhaps fewer choices.  The government may try to push people into “government-guaranteed bond funds” or something of the sort.  The only guarantee is that it will be a ripoff.

A second downside of 401k plans is that you are typically limited in your choices.  You generally can’t invest in individual stocks, ETFs, or options.  I will get to the other downsides later.

We know the advantages of 401k accounts.  They are a way to shelter income and capital gains from income taxes.  Sure, you will eventually have to pay, but there is no question there are strong benefits to this in choosing when to take your income.  You are also not getting hit with the taxes on the reinvested capital gains and dividends.

I often hear, especially from the “experts”, that if your company matches your contributions, you shouldn’t throw away free money by not contributing.  If your company contributes 3% of your income when you contribute 6% of your income, then we are told that you get a guaranteed 50% return.

But I would like to make clear that this is a one-time return on your contribution.  You aren’t continuing to get that return on your money.  The only return is on new contributions.

While this seems to be an unbeatable return, you need to consider your own circumstances and opportunity costs.

One of the major downsides of a 401k plan is that you are tying up your money.  If you still work for the employer that sponsors your 401k plan, then you typically can’t withdraw that money if you are younger than 59 and a half.  You may be able to get a hardship withdrawal (difficult) and you may be able to get a loan.

If you have most of your money tied up in a 401k account, you won’t be able to access most of it.  Are you going to quit your job in order to gain access?  And if you do leave your employer, you are going to then pay income taxes plus a 10% penalty for early withdrawal, assuming you haven’t yet reached the government-designated age.

In other words, this is all part of the nanny state.  You aren’t allowed to access your own money and you have limited investment choices. We wouldn’t want you making the wrong decisions.

Imagine someone in 2011 who had $300,000 in a 401k account with little else in the way of financial assets.  That person wants to buy a house, plus an additional investment property.  This was at the bottom of the housing bust when prices were really low.  But he doesn’t have the money to do so.  He doesn’t have a down payment or money for closing costs and other expenses.

If he had been able to access some of this 401k money, he could have bought houses at the bottom of the bust.  His return at this point would be a lot higher than having invested in mutual funds.

Better yet, imagine someone who wants to start a business and needs some capital, but doesn’t want to take on risky debt.  If all of his money is tied up in a 401k, he is out of luck, unless he wants to quit his job and then pay a penalty for early withdrawal.

The point here is that you have to consider your opportunity costs.  For some people, maybe putting a lot of their money in their retirement account is the best option.  Still, I would recommend it only up to the employer match.

But for someone young and innovative, you might want to consider keeping some money outside of your retirement account where you can access it.  I understand that some people will squander it on luxury items or things they don’t really need.  But even here, who am I to judge?  Maybe it is something that brings them great pleasure.

I know there are people though who can use liquid capital to fund a venture that will eventually pay great dividends in the future.  This could be real estate, gaining a new skill, starting a business, or investing in a start-up.

You have to make this decision based on your own personality and circumstances, but I believe it is always a good idea to have at least some money sitting outside of retirement accounts.  And make sure you factor in the opportunity costs of tying up your money.