Could negative interest rates catalyze a revolt?

I am in a July 4th State of Mind. After trying to be Joey Chestnut at the BBQ, I start to nod off in the hot California sun. A white rabbit runs by me saying, “Oh No. “I am late”to fund our pension system.” I follow him down the rabbit hole because after all this is “Curiouser and curiouser.”

As I am “Free Falling”(R.I.P. Tom Petty) I start to think about the old U.S.A. I love this country will all my heart and I always think about risks to our way of life. Over the course of human history, cycles of revolution, evolution and devolution abound. Each of these phases of societal movement is marked by common threads and themes irrespective of culture or civilization. If one were to spend a large percentage of their time on Twitter, they may be convinced that a state of war currently exists between rival factions in America, albeit in the ether. Groups use words like “resistance” to describe their purpose. There is no shortage of hills for which people in the social media universe seem willing to die. The good news is that there is an enormous difference between casting oneself as a change agent in the digital world and actually forcibly, and often violently, making that change.

I have wondered quite often as of late: How does the current state of affairs in the United States align with some of the common themes that led to revolts in other nation-states? Are the conditions in place for an actual revolution in America?

I have often discussed income inequality as a major issue for America’s future. There are numerous social issues that can lead people to revolt, but I am not going to focus on them. Today, I want to suggest that a rarely mentioned reason society could have a major stress on our system: The move by our Federal Reserve to take rates as low as possible.

Revolutions tend to have the most teeth under two conditions. First, when those in revolt believe they have nothing else to lose and / or are willing to die for their cause as opposed to live in the status quo. Second, when the military, police (law & order) sympathize with the populace and either join them or make no effort to stop the revolutionaries. As we have seen over the course of human history, it only takes a handful of people who are willing to pay the ultimate price to catalyze a change for millions.

I suddenly see a bottle on a table that says: “Drink Me.” 

“Who in the world am I” to say no. I have a few sips and start opening my mind to strange, rare events and I ask myself: “How the heck could low to negative interest rates lead to a revolution?”

I have been told to “Begin at the beginning and go on til you come to the end: then stop.”

First, what are negative rates and how close is America to them?

“A negative interest rate means that the central bank (and perhaps private banks) will charge negative interest. Instead of receiving money on deposits, depositors must pay regularly to keep their money with the bank.”(Source: Investopedia)

“Interest rates are typically assumed to be the price paid to borrow money. For example, an annualized 2% rate on a $100 loan means that the borrower must repay the initial loan amount plus an additional $2 after one full year. On the other hand, a -2% interest rate means the bank pays the borrower $2 after a year of using the $100 loan, which is counterintuitive. While negative interest rates are a strong incentive to borrow, it is difficult to understand why a lender would be willing to provide funds considering the lender is the one taking the risk of a loan default. While seemingly inconceivable, there may be times when central banks run out of policy options to stimulate the economy and turn to the desperate measure of negative interest rates.” (Source: Investopedia)

Right now, $13 Trillion in bonds are trading with negative yields. That number will rise. Most of those bonds are in Europe.

Have negative yields worked in Europe to stimulate the economy? No. Interestingly, instead of people going out and spending money as it beats a negative yield in the bank (which is the alleged purpose of taking rates below 0), people reacted in an opposite fashion, thinking that something must be really wrong with the economy and were willing to lose a little money in the bank then a lot in the market.

I believe by the end of 2020, U.S. bond yields out to 5 years will be trading with negative yields and 10 year bonds will eventually get there as well.

Currently, America’s bond yields are not negative, but they are getting closer and closer. This is happening for a variety of reasons but most of all I believe it is because the Federal Reserve has telegraphed that they are no longer independent and under incredible pressure from the Executive branch to lower rates. Other reasons are that the economy may be slowing and, that on a relative basis, U.S. Government yields look attractive, so buyers will take 2% for 10 years when the alternatives are negative in a lot of cases.

Perhaps negative yields would work differently in the U.S.A. Time will tell.

So how do we get from negative yields to a threat to our society? This is the leap. But, “sometimes I’ve believed as many as six impossible things before breakfast.”

Millions of government employees accept their salaries because they have been promised healthy pensions so they can retire comfortably after civil service and / or military service. 

There were approximately 1,056,200 local firefighters in the US in 2017. Of the total number of firefighters 373,600 (35%) were career firefighters and 682,600 (65%) were volunteer firefighters. Source: NFPA (National Fire Protection Organization)

There were over 1.36 million people in the U.S. military in 2018. (Source: Statista)

Public school systems will employ about 3.2 million full-time-equivalent (FTE) teachers in fall 2018 (Source: NCES: National Center For Education Statistics)

There were nearly 800,000 police officers in the United States in 2017. (Source: DataUSA)

Let’s continue on in Unfunded Land because “here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.”

What is the state of our Government Pensions?

Moody’s Investors Service recently estimated that public pensions are underfunded by $4.4 trillion. That amount, which is equivalent to the economy of Germany, accounts for one-fifth of national debt. It’s a significant concern for public employees who were banking on a fully funded retirement to get them through their golden years. (Source: Wharton: UPENN)

These lower yields force these pensions to force pensions to find riskier alternatives. Public plans have 72% of their portfolios in risky assets (equities and alternatives such as hedge funds). (Source: The Economist)

Average public pension plan reports a long-term return expectation of 7.6 percent. (Source: Two Sigma)

Pension plans need ~7% returns to pay their retirees. Negative yields will force them to take more and more risk with the money they have guaranteed people. That seems like a recipe for disaster.

I am coming out of my hot-dog coma now and confused and looking for the exit. I remember being told that “If you don’t know where you are going any road can take you there.”

I awake with many questions:

What would happen if people in the military and law and order are told their pensions are going to have to be cut significantly or altogether?

In that scenario, would the defense of our government be more or less likely to stop an uprising against the 1% or “the system”?

Could a charismatic leader unit the warring factions of populists on Twitter? What if they preach violence and say “Off with their heads” in a world where the military and the police lose morale? Could they actually overthrow a government?

Is this a four sigma event being priced like a six sigma event?

Do we follow in the footsteps of Rome?

I am leaving Underfunded land now. This theory is what one would call a SWAG in the military. I can now go back to the Barbeque and pray something like this is only a bad dream. But crazier things have happened.

After all: “We are all mad here.”(And I have the tattoo to prove it)