In spite of the ups and downs of the economy, the average American’s wage has steadily risen over the last half century. Coupled with that, working-age women have increasingly gained a larger share of the workforce, rising from 26% in 1940 to 59% in 20091. Though monumental achievements, we find the economic realities leave little to celebrate.
Current economic trends are impacting our workforce and job providers. The decline of the U. S. dollar’s purchasing power has dramatically affected working lives and employer offerings. Monthly household expenditures suggest that most American families feel the discrepancy between wages and purchasing power, but they may not understand why this inflationary phenomenon is influencing their pay. When people seek answers about inflation, they often turn to the news media, which does not explain this complex economic topic well. This results in a lack of understanding of how the policies of the Federal Reserve directly affect our standard of living.
Many employer practices, such as those expressed in pay and benefits, have not been adjusting for the fluctuation of Federal Reserve policy. The Federal Reserve’s monetary policies and resulting inflationary effect on daily living expenses also negatively affect company sponsored retirement plans. Knowledgeable HR professionals who are able to make the macroeconomic connection between Federal Reserve policies and employee total rewards will certainly demonstrate their ROI to their employer. Those HR pros that can quantify this advantage by making changes in reward systems to allow for greater flexibility will ensure their organization’s competitive edge when competing for high performing talent.
What is the Federal Reserve?
The Federal Reserve System is the “central bank” of the United States, founded in 1913 to provide Americans with a safe, flexible and more stable monetary system2. Today, the Federal Reserve’s responsibilities fall into four areas: (a) conducting the nation’s fiscal policy by influencing monetary and credit conditions in the economy, (b) regulating banking institutions to ensure the soundness of the nation’s financial system and protect the credit rights of consumers, (c) maintaining financial system stability and containing financial market risk, and (d) providing financial services to the U.S. government and other institutions3. The Federal Reserve effects inflation by setting interest rates and regulating lending standards.
Inflation is the upward movement in the average level of prices4. This rise in prices is a direct link to money in the marketplace. If there is a lot of money or credit floating in the market, prices will rise. Should the Federal Reserve increase the money supply (called quantitative easing), the country will experience inflation because: (a) the money supply goes up and the supply of goods goes down, and (b) the demand for money goes down and the demand for goods goes up.
More money in the marketplace not only affects prices, it also affects wages and retirement investment returns. The debasement of currency (because of the increase in supply) as one of the Federal Reserve’s responses to our massive national debt is actually a silent tax on workers’ savings. Although these quantitative easing efforts have temporarily prevented total financial ruin, they could prove disastrous for the longterm value of wage dollars and most traditional retirement investments. How do interest rates, regulation and quantitative easing devalue wages? The simple answer is debt; uncontrolled on all levels; individual, corporate and government. Take a look at the following chart.
The U.S. has been building up debt for decades. The status of the dollar as the world’s reserve currency is what makes it easy for the Federal Reserve to print money without gold backing as was historically required, creating more debt and inflation.
Wages and Inflation
When the discussion of the American worker’s wage surfaces in the media, the distinction between real and nominal wages is rarely made. A real wage has been adjusted for inflation and is a better reflection of the actual value of what a worker earns. Real wages better capture what a worker can actually use to purchase basic goods. A nominal wage has not been adjusted for inflation. The terms nominal and real are also used when describing a return on an investment, such as a mutual fund or retirement account. These terms are important when understanding investment returns and the cost of living.
To illustrate the extent that the U.S. dollar has declined since 1950, a ratio method can be used in comparing the cost of goods to median income. When using data that is unadjusted for inflation, the ratio method presents a more realistic picture of actual costs. The following table compares the price ratio to nominal wages for a particular year.
This table illustrates that while median income has increased 11 times since 1950, the actual price increase was 21 times the median income by 2010. Using this format, one can clearly see the Federal Reserve’s effect on the dollar and goods. By 2010, the cost of living ratio stood at over 4 times the median income. This dramatic increase in cost of living due to inflation and artificially low interest rates has forced more working-age two-parent families into the workforce in order to afford a median standard of living and has impacted their ability to save for retirement. This is further supported by the Consumer Expenditure Survey on the U.S. median income to the cost of living7.
HR Can Help Fight Inflation by Providing Options in Retirement Savings Plans
To help fight inflation, the HR business professional can provide 401(k) or 403 (b) plans which maximize employees’ return on investment, while minimizing financial risk and impact from inflation on wages and retirement savings.
It is important that the HR professional provide employees with a wide range of strong investment options from experienced and proven investment companies that keep pace with inflation. Many organization retirement savings practices restrict choices of inflation-protected investments and limit contributions to a small menu of mutual funds that are overexposed to the dollar. Most company sponsored retirement plans offer limited investment options that protect against a falling dollar. The most recent available data from Brightscope, an independent consultant of 401(k) plans states that the percentage of 401(k) plans offering investments that hedge against inflation was fewer than 9% from 2007 to 20098.
This reflects a missed opportunity for HR, possibly because they may not know how to select a sound investment company that can guide employees. Retirement plan providers are often chosen based on fee structure and not on strong investment options that might be in the employees’ best interest.
Most employees are unaware of the inflation risk that threatens their financial health revealed in statistics showing where assets are held. It is a common belief that owning international mutual funds allows the investor to diversify out of the U.S. dollar. This is not the case. Most international mutual fund earnings are actually parlayed back into the U.S. dollar. Merk Funds’ chief investment officer, Axel Merk, states that a recent study by the Federal Reserve Statistics Department reveals that nearly 90% of the U.S. personal sector’s financial assets are highly susceptible to U.S. dollar risks9.The study also found that 70% of American Association of Individual Investor (AAII) members were most concerned about inflation and purchasing power. It is this purchasing power that HR can enable by choosing stronger, better and more flexible retirement plans and providers.
Over the last decade, certain asset classes such as gold, select dividend paying equities, and commodities have far outpaced inflation. These asset classes are proxies to a falling dollar and can be had by simply purchasing exchange-traded funds if they are offered in the retirement plan. As of this writing, the value of the U.S. dollar fared better than many commodities and foreign equities in 2011. However, the long-term performance of asset classes that perform well when the dollar is devalued has out-measured that of the typical U.S. stock or bond mutual fund currently held within many 401(k) or other similar plans. To illustrate this point, the largest inflation hedged mutual fund held in 401(k) plans annualized at a 16.1% nominal rate since 200110. Contrast that with the minimal 3.6% annualized return rate of the Standard & Poor Index during the same time period.
Simply choosing the right sponsor with the right types of plans allows HR to create the potential for a significant increase in net worth for all employees. This indirect “wage increase” gives organizations a competitive advantage when they can quantify the difference to employees and be a tool to attract and retain high performing employees who feel valued by an organization that supports financial retirement diversity.
If you are not sure where to start, begin your research by asking your retirement plan provider if they have mutual funds that invest in precious metals, commodities, foreign bonds and equities. This should not affect costs as they are simply adding or replacing one mutual fund with another. If they do not, ask them about opening a brokerage window within the plan. A brokerage window allows employees to make purchases of any kind of stock, bond, or mutual fund instead of being forced to choose from a limited menu. If these two strategies are unsuccessful, consider switching providers.
HR can counter the Federal Reserve’s inflation by understanding that money is never lost or destroyed, it simply finds another home. In every negative economic event, assets flow away from one type of investment into another. HR can and should address this trend and stay ahead of it by assuring better inflation hedged investment choices offered through their plan providers.
Benjamin Lindsey, MA is a veteran sales and training professional in the financial services and insurance industry.
He is currently a Learning Consultant with Coventry Healthcare in Tampa, Florida.