In 1981, the safest investment imaginable paid 19.5 percent.
Now discontinued, Canada Savings Bonds enjoyed decades as a reliable way to safely save money. But CSBs were never better than in 1981, a year when out-of-control inflation hit 12.5 percent.
Inflation is 8.1% today in Canada and reached 9.1% last month in the United States. But the best rate you can get for safe savings is 3 percent on a high-interest savings account and roughly 4 to 5 percent on a guaranteed investment certificate.
There is a strong argument against saving today in that your return after inflation is negative. Don’t pay attention. By saving – or more accurately, not spending – we help reduce inflation and the need for the kind of shock rate hikes we saw last week.
When the Bank of Canada raised its overnight rate by a full percentage point to 2.5 per cent, it was the biggest increase since 1998. But the early 1980s seem most relevant to today’s world of high inflation and rising interest rates. Think of this time as an example of what will happen if we don’t get inflation under control quickly.
The early 1980s brought the culmination of the soaring inflation of the 1970s, says Mike Moffat, an economist and assistant professor at the University of Western Ontario’s Ivey School of Business. The central bankers of the time had to respond with enormous force, which meant raising their benchmark interest rates to the economic stratosphere.
The Bank of Canada’s prime rate hit 21 percent in 1981, and the prime rate used by the big banks for elite borrowers peaked at 22.75 percent. The current premium is 4.7 percent.
Recent rate hikes by the Bank of Canada are an attempt to contain inflation before it takes hold in the economy, as it did in the 1970s, Prof. Moffat said.
“Inflation is going to run rampant if you expect prices to go up 7 or 8 percent a year,” he said. “You’re not going to save money — you’re going to go out and buy stuff right away. Because the longer you wait, the more the prices will go up.”
The Bank of Canada has been criticized for treating inflation as temporary for too long and thereby delaying a return to more normal interest rates from pandemic lows. But last week’s huge increase in the overnight rate shows a commitment to aggressively fight inflation.
Prof Moffat said much of our inflation problem was caused by high energy and food prices linked to the war in Ukraine and supply chain problems linked to the pandemic. But he also sees signs of an inflationary mindset among the population.
“There seems to be this belief that inflation is going to stay, and I think that’s making people look at their behavior — asking for pay rises and things like that,” he said.
It’s up to the Bank of Canada, not you, to create conditions where people don’t have to ask for a big raise to keep up with the cost of living. But the world of 1981 reminds us of what happens when inflation drives our economic behavior.
One-year mortgage rates hit 21.25 percent in the summer of 1981, Bank of Canada data show. In addition to this huge yield for CSB, a peak yield of 18.8 per cent was available from five-year Government of Canada bonds.
The result of such high interest rates was to pull back inflation and, in turn, interest rates themselves. Note the lesson here for savers in times of high inflation. The higher the rates on bonds and GICs, the greater the reward for buying them and locking them in for as long as you can. However, the moment of opportunity may not last.
“I think there will be a peak in prices, not a plateau,” Prof Moffat said. “We will reach some level where the risk of inflation is reduced and then interest rates can kind of slowly come down.” Anyone who locks in and buys five- or ten-year bonds at the top is going to do pretty well.”
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