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General Interest Rates, Share Prices and Pensions


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General Interest Rates, Share Prices and Pensions

Money moves towards a better investment. If interest-paying investments give a better return than dividend-paying shares, people will buy interest-paying investments and sell their shares. Interest-paying investments are then in demand and their prices increase, shares are not in demand and their prices drop. Share prices may then continue to drop until the amount of the dividend payment (in currency units such as USD) represents a return <6> from the share which is the same as the interest paid by interest-paying investments.
<6> Return:  Dividend payment expressed as a percentage of the price.

So increasing the general interest rate reduces share prices, and reducing the general interest rate increases share prices. The return from shares (dividend payment as a percentage of share price) tends to move towards the new interest rates. As follows:

Figure 1      Share Prices and Interest Rate changes

Price of share   (USD)     100            
Return from share <6>   (Percent)   5        
Dividend received   (USD)   5        
General interest rate   (percent)   5        
New general interest rate   (percent)       8   2
Dividend received (No change)   (USD)       5   5
New return from share (matches interest rate)   (percent)       8   2
Corresponding new price of share   (USD)       62.5   250

This sample calculation illustrates the mechanism. However, share prices also depend on other factors such as the risk associated with the investment, and the country's creditworthiness as reflected in currency exchange rates. Profits tend to increase in measure with inflation and profitability also determines share prices.

So share values may increase steeply, and may be kept up artificially, by reducing interest rates and by keeping interest rates low.

As interest rates were reduced and as share values increased, corporations (companies) have withdrawn corresponding 'surpluses' from their company pension funds and added them, or a substantial part of them, to shareholders' profits.

As share prices fall, pension funds can become underfunded. Companies may then be obliged to make up the underfunding to some extent. It appears that the likelihood of this happening may be a factor when companies change, or advocate changing, established pension schemes.

See the full report:
Inflation, Balance of Payments and Currency Exchange Rates
(Including: Quality of National and Local Government and Worldwide Inequality)
by Manfred Davidmann

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Short Descriptions

Title   Description
Inflation, Balance of Payments and Currency Exchange Rates   Describes, reviews and illustrates the underlying relationships. How inflation affects currency exchange rates and trade. How interest rates determine share prices and pensions, and thus also the extent to which pension funds are in surplus or underfunded. Discusses multinational operations such as transfer pricing, inflation's burdens and worldwide inequality. Clear diagrams and worked examples.
See 'Press Notices'.

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Manfred Davidmann

Manfred Davidmann is an internationally well-known and respected scientist and author of a number of books and reports which have had and are having considerable impact. His work usually breaks new ground and opens up new understanding and is written in meaningful and easily understood language. Outstanding is that his work is generally accepted as factual, objective and unbiased.

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