Using their assumptions Social Security will run out of money in 2037 and Medicare in 2017.
Robert Reich has a good take on the relative problems. I agree that Social Security is a much smaller problem (about 1/4 the level of projected underfunding) which can be addressed with tax tuning or pushing out the retirement age. Medicare is a much bigger problem - which the country will have to deal with ASAP - it’s primarily a function of health care cost growth (which is unsustainable) and the increasing length of lifespans (people are around to consume even more health care).
Dusting off some Milton Friedman from 1979 on Phil Donahue. Worth watching to get his perspective on how self interest and greed can drive positive change. I don’t think that taxing wealthier investors and businesses and giving those resources to bureaucrats to use is going to fix our current situation. We need to innovate our way out of this mess and get people incented to invest and work hard vs. hunker down just focus on how to protect their dwindling assets and resources. (Some redistribution of wealth is probably required, but at a certain point it’s counter productive - see Laffer curve
I live in a pretty wealthy area full of nice houses where the median price is around $1M, which to date has been pretty insulated from the housing price downturn.
So it was more than a little surprising to hear that some people in our area are lining up to get a bailout on their loans - some of which are Negative Amortization Interest Only loans. Whether or not they’ll be successful is questionable since the Refinance option is only for Fannie and Freddie owned conforming mortgages - however the Loan Modification component looks like it may help anyone. We have heard stories of people in this area getting their Jumbo(> $729K loans) written down to 3-4% for 30 years and in some cases principle reductions. Here’s the executive summary for the Homeowner Affordability and Stability Plan.
Most Americans are current on their mortgages and are paying their debts - many of them have taken big hits to their retirement savings account and other investments. I understand the idea that you want to prevent the blight of foreclosed houses in areas where there are no buyers. However in towns like ours and many others that are attractive to people - there are plenty of buyers out there - many of whom have been renting due to the recent housing bubble. By subsidizing people who bought houses they can’t afford - we are perpetuating artificially high housing prices and rewarding poor decision making and supporting the heads I win / tails you lose philosophy that promulgated excessive risk taking by Wall Street and Sub Prime borrowers. It’s the same problem - people saw no downside and if we use tax payer dollars to pay down million dollar mortgages - we are just continuing the problem.
If we allow markets to hit and clear at their natural prices - then we’ll create sustainable communities and healthy markets. If we do otherwise we create all kinds of incentive problems and turn everyone into a welfare seeker that is focused on how to get their bailout vs. how to contribute constructively to society. Some people may “lose” their homes (which in many cases they don’t have equity in), but people need somewhere to live so investors will buy the houses and then rent them back out for a profit, which brings private capital back into the markets - so people shouldn’t be homeless they just won’t “own” taxpayer subsidized houses.
This is along the lines of the Barron’s interview. Private indebtedness increased 300% faster than GDP from 1970 on. Total public and private sector debt is over 355% of GDP. This debt cannot be serviced out of current cash flow; we either need to restructure the debt on a massive level (bankruptcies, refinancing of short term to long term debt) or inflate so nominal GDP increases fast enough to service existing debt.
Still, given the commodities induced inflation scare in the middle of ‘08, the path of inflation might not be a given or a free lunch either. High inflation would probably squeeze margins for companies in the face of weak demand and increase the amount of money needed for living expenses, leaving less for debt servicing by consumers.
I imagine the Fed really is trying to walk a fine line between deflation and inflation. Either course would wreck the economy for years to come. However, the Fed will feel real pressure from congress. What congress wants is another matter altogether. Treasury and the administration I think understands that you can’t keep gorging banks on loans to get it out of this mess. That’s why the Geithner TARP revamp didn’t have specific requirements for increased bank lending from government money. But they’re hesitant to take decisive action on this. People know some of the largest banks are insolvent but we’re still playing the Fannie and Freddie game of last summer with them. Congress of course wants increased lending and wants Fannie and Freddie and FHA to swallow or guarantee every defaulting loan out there and for the Fed to drive mortgage rates down to 0. The administration also had to reign in their own party in the overreaching salary caps put into the economic stimulus bill.
The question is not just economic anymore, but also political so I don’t know if massive private bankrupcties will be tolerated well either. I think I heard something like 2000 economists signed a letter against Smoot-Hawley during the great depression but that peice of protectionism went through anyway.
What’s your vote - deflation or inflation or do we get a series of bankruptcies and write downs first?
On November 24, President Elect Obama announced that it was necessary to “jolt” the economy with large cash infusions. Both government and industry want us to spend more money fast.They also believe the economy will recover relatively quickly, perhaps in less than a year.Here’s why that’s impossible:
Motivated by political pressures and the need to show a sharp increase in securities markets, the government will be inserting trillions of dollars of borrowed money into the economy.Never mind that this will increase the national debt by 20% or so in less than one year or that commitments will be made for increased entitlements which are already far beyond our ability to pay. The combination of national debt and unfunded obligations for Social Security and Medicare now total to almost $200,000 for every man, woman and child in the country. As if that’s not bad enough, that doesn’t count any personal, mortgage, or commercial debt–all of which we must also pay.
The fact is that, as a nation, we have been living far above our incomes and the need to stash some money away for retirement.Even our children and grandchildren will be unable to pay just the ongoing costs of these obligations unless everyone is subject to staggering tax rates.The tax problem will be exacerbated by the demographics leading to the inevitable increase in the aged relative to the working population.
The problem started to be evident in 1985 when the national savings rate started its precipitous drive from the historical 9% to virtually zero in 2005 and has stayed that way ever since.In order to recover those lost savings and get back to what 9% would have provided over the past twenty years, people would have to save over 20% of their income over the next twenty years.The only time our country has saved that much was in World War II when there wasn’t much to buy, even food was rationed, and Rosie the riveter worked in a defense plant.Everyone invested in Savings Bonds, even school children.
The fact is that people should be saving more than 9% today.The reason is that a lower percentage of people are getting pensions.Further, over 40% of pensions are for government employees.The majority of the people don’t work for the government, don’t have a pension, and have fewer health benefits than government employees.Now we’re promising the equivalent of Congress’ health insurance to over 40 million uninsured people even though they now get free medical care, and those of us who pay for our health insurance don’t have benefits as good as Congress.
After the decline in savings became apparent, the financial firms discounted the importance of the national savings rate. One argument was that savings rate wasn’t important because the next generation was going to inherit so much.When people found they wouldn’t get any of Bill Gates or Warren Buffet’s money, financial firms said the value of stocks had increased so much that people didn’t have to save anymore.After the stock boom ended financial firms said that the best investment people had was their house which would provide much of their retirement needs.Right now, the government and industry say what’s important is to preserve jobs and keep spending up so that businesses can thrive.Forget savings.
Come on!At some point we have to take our medicine for such imprudent spending.As individuals we should be living within our income.So should our government. Hasn’t anyone heard about cutting expenses?I’ve gone through a number of Boeing financial crises.You learn that there are many things you really don’t need.Congress recently, and correctly, criticized the auto and union representatives for coming to their hearings in private jets.Yet Congress itself is bloated with all kinds of perks and overmanned with aides.There comes a time when Congress and the Administration must lead by example, then slash the spending of every government department severely. Just like Social Security and Medicare are entitlements, the lavish cost-of-living-adjusted government pensions are entitlements and will last as long as government employees live.
If we want change, let the change come from more prudent spending individually and by the government.Are we ever going to get away from politics where those running for office say they are going to give more benefits if elected?I’d like to see politicians give an honest and verifiable cash statement that would not only end deficits but reduce the horrible obligations that we’ve already left to our children and grandchildren. How about a twenty year plan to pay off the national debt and a fully funded trust for Social Security and Medicare?
The “Jolt” is more of the same shortsighted view that we’ve had for a long time.It may get us to spend more for a short while, but the reckoning will come.My thought is that the reckoning will be led by the baby boomers who have to learn relatively soon that they can’t retire without savings.As that reckoning comes, industry and the government will have to be smaller, but we’ll still be stung with a huge income tax burden because there will be fewer workers, even more people begging for handouts and the need to fund overly generous entitlement programs.
If you are expecting a quick recovery from the market problems that began in 2000 and have brought both losses and great volatility, don’t count on it!Those financial firms selling securities would have you believe otherwise.Without security sales, their income is zip, a big zero!
So what will really happen?
First, the government will have to stabilize the credit markets.This could easily take several years because foreclosures will be spread out in time.Even though home prices may be less than mortgage values, people do not decide to abandon a home on quick notice.They have to carefully consider their alternatives including whether the housing market will recover and the desirability to move to a different location.This is extra tough when people can’t qualify for new mortgage because their credit rating was destroyed by abandoning a mortgage.
It can’t be long before credit card defaults hit the banks really hard thereby aggravating the situation.The top six credit card companies hold $639 billion credit card debt.Then there are $365 billion securities backed by that debt.These are bundled into groups of credit-card receivables and sold to investors, insurers and hedge funds which likely find their way into other derivatives.It’s the mortgage problem all over again because about 30% of credit card debts are from low-credit-score people.Business Week (10/20/08) predicts that this is the next big blowup ahead.
In the meantime, people should develop a better appreciation for the fact that they should be saving.The decline of savings started two decades ago from 9% national savings rate to minus numbers today.Failure to increase savings rates is surprising because of the large number of baby boomers who are starting to reach retirement age and the long-term trend of industry to go from pension plans to savings plans.
As a consequence of saving too little, incurring large debts and losing conventional pensions, people will have to save more—lots more and start quickly.
When the savings rate finally increases to the extent necessary, much of the resulting investment would help the stock market. It would also bring back some of the national debt from overseas, thereby strengthening the dollar and reducing the cost of imports.But this will take years, not days or months and will be softened by slower business growth.
By necessity, many are going to have to retire much later.This is good news if they still have updated skills and the physical capability, but they will face a difficult labor market.On the one hand, demographics show there will be proportionately fewer young people entering the work force.That would bode well for seniors trying to retain jobs.On the other hand businesses will be facing many difficulties.This is likely to be overwhelming for a number of years.
Businesses will have lower volume when consumerism declines—as it must with increased savings!At the same time, employers will also face higher taxes, at least at the state and local level if not at the federal level.Heavy industries will face costly capital improvements for environmental and energy reasons.All of these things put pressure on labor as well as encourage businesses to look abroad for less expensive sources of materials and components–if not total assembly.Lower market volumes mean less need for commercial real estate, so there will be trimming there as well.
Another new impediment is put on businesses that offer pensions when the stock market falls and shows definite signs of slower growth.As an example, suppose that a pension trust’s securities fall 10%.Then the company has to either come up with 10% more funds (think of a huge number) to add to the trust.If the forecasted growth rate for their securities in the trust drops only 1% point, they will need about 15% additional assets in the trust.Firms like General Motors and Ford are already reeling from pension promises that are beyond their capability to fund.This is also likely true for government pension promises—only more so because most government pensions have cost-of-living-adjustments which require higher reserves than fixed pensions of private enterprise.
Another consideration is that the cost of government itself will go up. More regulation and health insurance administration will add significant government employment.Many government employees enjoy automatic cost-of-living adjustments to their paychecks.And government employees on the average make more than the average employee in the private sector.If the business share of higher government costs goes up, the product costs go up thereby aggravating inflation.
Some people think that higher corporate taxes reduce will reduce personal taxes.Not so, higher corporate taxes are simply passed on as higher product costs so that everyone pays—just as with a national sales tax.
The net result of reduced consumerism, increased savings and higher taxes will take some time to evolve before business earnings stabilize at a lower level.When that happens, stock price-to-earnings ratios likely will seek lower values than the historical norms for decades.That’s because of at least two factors:(1)People have got to make up a large part of the savings shortages of the last two decades or face poverty in retirement, and that will take many years of cumulative effort.(2) The outlook for growth will be tempered by the consequences of an aging population that has a much different budget distribution than that of the youth.Consumerism is a disease of youth.Lower price-to-earnings ratios combined with lower earnings do not bode well for the stock market for a very long time.
An aging population brings lower national income, more government outlays for entitlements, and a disproportionate increase in the need for services, particularly medical related services.The service industry does not have as great a multiplication factor for support jobs as does manufacturing.Further, it means a significant increase in the number of retired people to the number of workers.In a couple of decades the number of retirees will be one retiree for every two workers compared to one retiree for every three workers today.By itself, that means a 50% increase in individual workers’ burdens and even more with more people on government welfare.
The part of the economy that will continue growing is the government, but it is the least productive part of the service industry.It has virtually no productivity gain.Politicians are reluctant to propose cuts in government payrolls, in part because they are part of it, but also because government workers probably constitute at least 20% of the voting public.Benefits for government workers grow disproportionately as well.Government pensions most often have cost-of-living adjustments, i.e., COLAs, and savings plans too.80% of private sector employees do not have pensions at all, and virtually none have COLA pensions.The number of government employees with pensions is fast approaching the number of people in the private sector that have pensions.That’s because of the double whammy of the private sector reducing the number of pensions while the government’s size is increasing.
The changes from these effects do not occur in days or months.They take years to evolve.To recoup the lost savings of the past twenty years in the next twenty years would require more than a 20% reduction in consumption.This implies savings rates comparable to that only achieved in World War II when most things you could buy were rationed and little else was available.Further, virtually everyone worked and provided income for the family during the war.Saving was politically correct and even school children saved stamps to accumulate savings bonds.
No, don’t look for any rapid improvement in the stock market.There may be spurts as occasional good news is highlighted to improve the economy, but the long-term effects described above will dominate the economy for several decades.There is no quick fix for our past savings deficiencies, record borrowings, unstoppable government growth, automatic entitlement growth and inevitable demographic creep to an aging population with greater demand for services, not hard products.
At the same time, even though stock prices will seek a lower level and grow more slowly in real terms, stocks may still be one of the better hedges against inflation.Inflation will increase the apparent earnings and business assets.Since we are living in a world of ever increasing prices, everything is relative.Inflation is very hard on fixed-income investments because the real value of the principal goes down.Owning a house with a mortgage may be one of the best investments since the value of equity increases disproportionately as the price escalates with inflation and the relative value of the debt goes down.Of course this assumes that we are willing to sell our houses later on, go into smaller homes and invest the savings in something that’s liquid so we can spend it.
As bleak as the picture is as painted above, it can get worse.One of the ways to solve part of the debt problem is for the government to let inflation increase above what we consider to be acceptable levels today.That has happened to numerous other countries and our own as well.Inflation is particularly hard on retirees who are trying to live on fixed incomes.It’s not so bad for government retirees that get a kick upward every year.
It was very poor public policy to pressure lenders to make loans to people who could not afford them.The resulting boom in housing prices made it seem that a home was a great investment and worth some speculation—even by those who could not afford the payments, much less all of the other costs of home ownership.People started to consider their home as their primary retirement resource even though a house is about as illiquid as an investment can be and has negative interest.Further this policy exacerbated the lack of mobility of our work force and made people look furtively for new jobs only close to their homes.
But some good came from the resulting crash.My view is that this mortgage crisis has kick-started us on a better path in the long run. It’s better in that less consumption eventually will help provide more for the aging population and less of a burden on our children than continuing this economic madness for many more years.We’re all going to be poorer, but less poor than we would be otherwise.We may still live more comfortably than most other nations.Hopefully the troubles we suffer in the meantime will bring more economically savvy politicians into office.Perhaps they will reduce government growth and entitlements that otherwise will be an unbearable tax burden on future generations.
Let’s start with some of the known problems before we go to the consequences and actions needed to protect individuals from something I believe is inevitable for the U.S. as a whole.
At the federal level, we have amassed at least $55 trillion of national debt and unfunded obligations for Social Security and Medicare.That’s $184,000 for every man, woman and child in the country.
This does not include international balance of payment deficits nor state, county and municipality debts nor unfunded future obligations.It does not include company indebtedness that we pay for with reduced stock returns and higher product costs.Nor does it include personal debts such as home mortgages, home equity loans, reverse mortgages, student loans, auto loans and credit card debts.Whether it’s been greedy companies buying other companies, individuals on a consumerism binge, importing more than we export, government overspending or employers/government promising far more employee future benefits than they can pay, the debt obligations are horrific.
Now we see that the credit markets are in dire trouble, so the government is anticipating a $700 billion bailout after already paying about $300 billion to salvage Bear Sterns, Fannie Mae, Freddy Mac, AIG, Lehman Bros., Merrill Lynch, and Washington Mutual.This is supposed to cover unsupportable home loans including ARMs and option ARMs which were destined to be disastrous from the beginning.
This is only the beginning.The AIG $85 billion credit default swap infusion was a drop in the bucket compared with some estimate as $58 trillion of unregulated credit default swaps in the rest of the finance industry.There are other derivatives that will start showing their ugly heads.Consider Exchange Traded Notes, ETNs, the cousin of Exchange Traded Funds, ETFs.These notes don’t even have to own the securities implied by their description.Or how about the high-risk part of the tranches of Collateralized Debt Obligations held by many seeking higher returns?Or those who bought factored loans?
It’s certain that pension trusts now are much below the amounts required to sustain future payments.Furthermore, the pension trusts’ projections have depended on ever-hopeful forecasts of returns from future glorious stock market returns as well as bonds that won’t lose value.Because of Accounting Board Standards, this means that states, government and industry are going to have to start pumping lots of cash into pension trusts—and many industries like the auto producers just aren’t going to be able to do this—and will come begging to the government.
Then there is the as-yet-unquantified number of people that will be added to the government payrolls to investigate and administer as-yet-undefined procedures.All we can say for sure is that this can be more costly than the mandated Medicare overhead that outweighs the costs of the actual medical treatments and can take years to get payments to doctors.Further, we know that the average person in government is compensated about 50% more than the average person in private industry, in part due to lavish government COLA pensions and extensive health insurance benefits.So government will grow by leaps and bounds.As those of us who spent a lot of time working in the defense industry know, surveillance cost are high both for the government and the companies that have to respond to the mandates, data and reviews imposed by the government.
Let’s just make the terribly oversimplifying assumption that the average person’s share of this country’s debt and unfunded obligations is $250,000 per person or $1 million for a family of four.Considering all of the above, this is probably a huge understatement.If we don’t do anything to retire any of the debt and obligations, and only pay interest at say only 4%, that’s an interest burden we bear a cost of $10,000 per person per year.If, in addition to paying the interest, we set about to retire those debts and obligations in 30 years, we would each have to contribute $14,500 each year.So a family of 4 would have to make annual payments of $40,000 each year just for interest or almost $58,000 a year if we don’t want to leave any of this problem to our grandchildren.
Some think that we can pay for this by relegating the payments to the top 5% of our population.If that’s so, every family of 4 supported in that top 5% would have to pay $800,000 just for the interest and $1,160,000 to pay for interest and principal.That’s PER YEAR for 30 years.So even without any additions to social programs, there is no way that those who make under $250,000 a year will not see higher taxes.This is a problem that is going to be solved ONLY if people start saving money and everyone pays something in higher taxes.
We are clearly talking about the end of the consuming generation of reckless spenders.These include people at all levels that have their own image of being able to live like the Jones.Low income people just can’t enjoy the benefits of higher income people, and higher income people just can’t afford to live like royalty.
The end of consumerism has a huge impact on the economy as we know it now.When we become savers, we have to stop spending as much.If we would start a full fledged recovery program right now with the objective of having individual finances get back to where savings rates were a little over two decades ago, and if we wanted to recover the lost savings during those two decades in the next 20 years, our national savings rate would have to exceed 20% per year–plus we’d still have to pay at least the interest on all of the debt we and our government have incurred.Consumer spending constitutes 70% of our gross domestic product so that if we use 20% of our income to pay off the national obligations, our economy will contract sharply.
There has only been one time in our modern history when people had a national savings rate of 20% in this country.That was during World War II when almost everything was rationed from gasoline to sugar, there were no new cars, store shelves were empty, all able people worked at a job, and it was patriotic for everyone to save war bonds—even school children.There’s more on this in my book, Getting Started in a Financially Secure Retirement published by John Wiley & Sons, 2007.
The only people who may come out of this situation with some semblance of the American Dream are those who have already saved and those who will start saving and stop spending NOW!That’s true if we don’t have something like the revolt against imperial Russia where real estate ownership disappeared, homes were shared by many families assigned by the government, and savings were taken away and consumed largely by the government.
Those that will save, and those who already have saved, will be asking, “Where shall we put our money?”I certainly don’t see the financial market future any better than anyone else, so I can only tell you what I am doing.I effectively divide my investments into three parts.The first part assumes that I want to be able to live through the Great Depression II.The second part assumes that it will take people a number of years to wake up to the problems, so this part is very conventional mix of stock and bond funds. The third part assumes that we will have hyper inflation.Only the Great Depression II and hyper inflation provide environments to solve the huge debt problem:the former by defaulting on loans and the latter by so cheapening the value of the payments that debt payments are a small part of a huge income denominated in almost worthless money.
The largest part of my own investments is conventional, but the amount I have in the hyper inflation portion and Great Depression II are sufficient to get me by, especially if the conventional part ends up having some value and not wiped out entirely.Those who would do similar splits would end up with the sizes of the three parts dependent on the extent of their savings, age, employment security, expectations for the future and probably lots of other factors.
Understand that I don’t pretend that I am wise about what to do in either of these extremes.Still, my own choices for a hyperinflation scenario include candidates like leveraged real estate, stocks, I Bonds, TIPS and inflation-adjusted immediate annuities. I have been thinking about this for years and so built up my supply of I Bonds when you could buy large amounts at interest rates of over 3% plus inflation. I know that others more venturesome than I am would now add commodities as well as metals such as gold and platinum.Very wealthy people often gain inflation protection by saving valuable art and rare collectibles.Art and collectibles are beyond my financial capability, just as some of my choices are beyond the capability of other people.For example, a young person probably doesn’t have the resources to buy an immediate annuity and should never buy one in the first place.
The Great Depression II portfolio is much more difficult.My choices here would include money markets, CDs, EE Bonds, treasuries and debt-free real estate.I know that my parents would add another category.My parents were struggling young adults during the great depression and gave us children strong encouragement to learn at least one musical instrument so we could earn something even if we lost our regular jobs.I played the piano, flute and trumpet—not knowing what I might need.I learned something about diversification even then.
Perhaps the best protection during the Great Depression II outcome would be strong and varied work skills.Even non working spouses and older children should learn some work skills that could bring income if necessary.Think Rosie the riveter during World War II as opposed to soccer mom.Learning to be frugal combined with doing as many home, car and clothes repairs yourself is important in a depression environment as could be supplementing your food supply with a home garden.You might want to store some vegetable seeds for next year.
The nation’s debt problems are so large that the sky will fall on the majority.I firmly believe that to survive, people will have to save—lots.They will also have to invest it well.We can’t tell which direction the economy will turn, but we know it has to make drastic changes.Hence, in addition to having good work skills and savings lots, it’s important to be well diversified and include some things that might help in the Great Depression II or hyper inflation.
Of course, we could also have both Great Depression II combined with hyperinflation, sort of stag-flation cubed.Don’t wait to start your own defensive actions.Do them now!The reductions in future benefits will be small if the economy would turn around quickly (which I doubt), but the benefits from taking action now will be huge otherwise.
This is a contribution from Bud Hebeler who runs Analyzenow.com
To our children and grand children:
These can be good financial times, not bad times!
The stock market is falling.It may be bad for many retirees and those that will lose their jobs as brokers or from bankruptcies but not for many people—IF
·their investments have been widely diversified, and
·they have set a tolerance band for reallocating their investments.
Over my almost fifty years of investing, I have seen markets drop many times.In my first fifteen years I learned the lessons the hard way—by losing money.I followed the market.When it got high, I bought.When it fell precipitously, I sold.Ugggh!I was supposed to do just the opposite.
Eventually, I found a way to do better.I set upper and lower limits to the amount of stock (including stock funds) that I would hold at various ages.The formula was simple:I would not let the stock as a percent of my holdings get below 100 minus my age.That was the bottom side.Then I set a limit for the top side, namely, 110 minus my age.So, at age 40 (about when I first started this) my stock allocations were between 60% and 70% of my investments.
After a while I added real estate investments to my portfolio.I count the equity (price less debt) as a “stock” because, after all, stock is equity as well.I did not count the equity in my home as an investment because I reasoned that I would always need a home.Besides, my home was quite modest.
Now, at 75, my equity limits are much lower:between 25% and 35% of my investments using the very same formula.The remainder of my holdings are in bonds and money markets.Using these limits over all of these years has given me a portfolio return that is higher than if I had steadfastly held to an equity limit of 105 minus my age.That’s because I bought stock when prices were low and sold them when prices were high.I described the performance differences in my book, “Getting Started in a Financially Secure Retirement.”
Not long ago I was on a radio talk show in New England.I talked about my allocation limits.The talk show host said I was old fashioned and dismissed my conservatism.He felt, as do many, that even retirees should have much larger stock allocations.I thought to myself, “He’ll learn!”
I can’t see the future any better than anyone else, so my conservative bent could be wrong.I base my stance now on something very simple indeed.That’s the deplorable decline in savings rates over the past 20 years and the almost inevitable changes in demographics.These embody the effects of overdone consumerism, excessive debt and the forthcoming reduction in the ratio of workers to those who will be retired or trying to retire.
In “Getting Started in a Financially Secure Retirement” I show that it will be impossible for the average person to save enough over the next 20 years to be comparable to what the 9% historical savings rate yielded.We would have to equal the kind of savings we had in World War II when virtually everything was rationed, there was nothing on the store shelves to buy, everyone worked, and buying savings bonds was the politically correct thing to do.
My simple analysis of necessary savings rates does not count the great reduction in the percentage of workers who will get pensions over the past 20 years.The only major segment of our society where the pension benefits are increasing is the government sector which not only is increasing as a percent of our labor force but also has cost-of-living-adjusted (COLA) pensions that are backed by a sovereign power with the ability to tax.
On the demographics side, the ratio of workers to those over 65 will go from 3 now to 2 in the next few decades.Again, the effects are very simple to visualize.That part of our taxes (the largest part) used to support the elderly will have to increase 50% for working folks.That by itself will be debilitating for the economy unless government benefits are trimmed with a meat ax.
On the debt side, by the end of this year every man, woman and child will have a federal debt obligation of over $180,000.This includes only the national debt, Social Security and Medicare.It does not include mortgage and personal debts nor state debts and unfunded obligations.A family of four could easily have an equivalent debt approaching $1 million including mortgage and personal debt obligations.At an average interest rate of 5%, that would be equivalent to an annual cost of $50,000, just to pay the interest without retiring any of the debt.The median family now earns about $70,000.That leaves about $20,000 for living expenses, state taxes and retirement savings.
Of course that assumes that income and taxes are evenly distributed.Since 40% of workers pay no income taxes at all, the burden will be 67% more on those who do pay income tax.
So, what do I think will happen?I believe that not only will income taxes go way up, so will every other form of taxes go up including ones that haven’t yet been invented.As has already happened in several places in Europe, the government will also have to reduce benefits.
Further adding to the problem will be increased inflation.That’s because I believe that the demands for higher wages will increase as will the price for goods both because of higher industrial taxes and higher labor rates.Productivity growth will slow because of increased demand for U.S. labor content.Finally, the feds will silently applaud inflation growth because it will, as always, reduce the apparent size of the national debt relative to GDP.
So why then wouldn’t I advocate holding any stock if the economic future is so bleak?The reason is that stock represents owning something tangible that will increase eventually with inflation.The same is true of investment real estate.If you have been following my past recommendations, you might be buying stock now, not selling it.
Do I think that things can get worse?Absolutely.That’s why I do things incrementally.When in doubt I go half way.That gives me an opportunity to talk about the part that did well and ignore the part that didn’t.After all, isn’t that way the finance industry promotes its performance achievements?(Smile!).
Caution:I can’t see the future any better than anyone else.But I can testify that (1) if you don’t save anything, you won’t have any savings, (2) that regular savings grow faster because of reverse-dollar-cost-averaging, (3) that diversifying investments helps savings growth over the long-term, and (4) that allocation control really pays.
This is a contribution from Bud Hebeler who runs Analyzenow.com
Last night I went to the movie I.O.U.S.A. followed by live commentary from Warren Buffett, Pete Peterson, Dave Walker (headed GAO and was Controller General), William Novell from AARP, William Niskanen from the CATO Institute and an Economist whose name I can’t remember. You’ll have to pardon the errors in this because I was taking notes in the dark and found later that it’s almost impossible to read them.
The commentary that followed was handled by Becky Quick from CNBC’s Squawk Box show who fielded questions from the audience.The movie was loosely based on the book, Empire of Debt, and was actually exciting—quite a surprise for a financial show.It even got our local movie audience clapping and laughing.The show was financed by the Peterson Foundation and starts out with a lot of material from the Concord Coalition.It was non partisan.
The more I think about the conclusions of the experts (Buffett, Walker, Peterson, et.al.) at the conclusion of the movie I.O.U.S.A., the more I wonder about their almost universal opinion that the main solution would be to increase the federal tax rates and moderate Social Security and Medicare payments to solve the $53 trillion government obligation problem.Nowhere did they mention the other main debt problems:personal debts, business and financial firm’s loans, State obligations including unfunded public employee pensions, and the sorry state of our transportation infrastructure.These have to be satisfied as well.As bad as the national condition was portrayed, our share of the total obligations was far understated.
One position that was mentioned was a mandatory savings program although the small percent cited would do little to solve our huge savings problem.After all, Social Security costs us 6.2% plus another 6.2% from our employer—and that isn’t enough to keep the program solvent.Further, as I have cited in Getting Started in a Financially Secure Retirement, the savings rate (not including Social Security) has to be well over 20% for the next two decades just to make up for the lack of savings in the past two decades of consumerism.
There are those that would only tax the rich, but as much as I dislike the extreme over-compensation of the top executives in major companies, those people eventually have to spend their money, and in so doing enrich the rest of us.They and their children may live what we consider (or wish we could achieve) obscenely ostentatious lives, but their incomes (less taxes) eventually come into the economy.
On the other hand, government spending and wealth redistribution do little to increase productivity.In fact all of the paperwork, additional government employees, even more private sector employees to respond to government regulations, and the imposition on our personal time all hurt productivity.That’s not to say that some innovation doesn’t come from government sponsored research in medicine, military and space activities, but there is lots more that comes from the private sector where competition and necessity are the stimulus for invention.This is well illustrated by the modern examples of nations that have converted from pure welfare states.Russia and China now have booming economies by comparison with their past under totally controlled economies.
Higher taxes and increased savings have to reduce economic activity.Some other alternative solutions are particularly unappealing:Government bankruptcy, revolution, and hyperinflation.Bankruptcy destroys much of the world’s economy with it.Revolution ends the way of life we and few others know.Hyperinflation puts those on fixed incomes into poverty.Yet, in my view, a little of each of these horrible extremes is the medicine that might be necessary to at least end up in some reasonable equilibrium.
How about some real government changes to same money?The Congress should start by setting the example and cutting its overgrown and bloated staffs by 50%.Then it should act to change all federal pensions, including their own, to fixed pensions like all of those in the private sector.(Only one in five private sector employment earns a pension, and they don’t have cost-of-living-adjusted pensions like federal and most state pensions.)Stand up to your unions.Let them strike.That would reduce cash outflows too.Then deny state largess from the federal coffers unless the states do likewise.Don’t stop there.Demand IRS 1040 simplification so that the IRS can cut its work force in half and we don’t have to use accountants and computer programs to do our taxes.Simultaneously, get Medicare to do the same thing so that both government employees and the private medical facilities can cut their own staffs with less paper to handle.Then sell off the excess office buildings.Give up your perks.These are the kind of things we have to do in the private sector in order for a business to survive.You’ve got to save a country—that’s even more important!
This is not “change” as envisioned by current political parties.Current political “change” is aimed at things that increase government spending and control.In my view, change should be moderately more inflation than now considered acceptable, reduced bailouts of industry and financial firms, meat-ax reductions in government personnel, and much increased foresightedness in Congress and personal financial planning –together with some tax increases and entitlement reductions.We all have to consider much longer horizons than hours or days in financial markets or a few years as in elected office terms. We even have to think in terms longer than decades as we did in our Boeing planning. We have to think in terms of generations and life-expectancies, just as in the insurance business.
Everyone is going to get hurt, but we all have to understand that a little pain now is a lot better than a lot of pain if we wait longer to take our medicine.Perhaps the only Congress and Administration people willing to take such long range positions might be those nearing retirement, but certainly not the others and especially their supporting staffs which provide all of the advice and “smarts” on which government officials depend.These all need their jobs to feed their families, and most are terrified of leaving their jobs to seek private sector employment and much lower benefits than the government provides.Further, they have demonstrated that they have no interest in solving the additional problems of personal savings to replace debt, business debt, State obligations including public pensions and the sorry state of our transportation infrastructure.
That said, here are my notes from the movie, I.O.U.S.A., and the comments from some of the more powerful people in financial circles and former government executives.I feel all citizens should hear this message—and consider some of the points I have made above.
Of course, the movie is mostly about debts this country has incurred to date as well as the history leading up to our current situation. Before the movie began, they had a digital display showing the current national debt as it was actually changing.It was increasing by millions as we watched. The only time this country was out of debt was 1830. At the time the movie was made the total unfunded obligations of the country were $53 trillion or $175,000 for every man, woman and child in the US.By 1/1/09, it will be $55 trillion and $184,000 for each person.
$10 trillion of this will be the national debt at the end of the year.44.5% of our debt is owned by foreigners, principally China.The other time the country reached levels of national debt to GDP like we are now was at the end of WWII, but that debt was owed to ourselves, largely as savings bonds.Unlike now, the people were willing to make great sacrifices because they had experienced the Great Depression and had come out of the War where most things were rationed.So much of the debt got paid.
One of the few periods in modern times when the government was not outspending its income was in the Clinton administration supported by a Republican Congress.The movie came down hard on President Bush for not containing spending, especially for approving Medicare drug assistance with Part D.It showed clips of Secretary O’Neill who was very upset about being fired for his disagreements with President Bush.
All commentators agreed that the current problem was largely due to excessive consumption.Our national savings rate is now -2.9%.The graphics showed the highest savings, about 23%, occurred during WWII.Most of the time savings rates in the past have been about 9% to 10% through good times and bad.
There was a considerable amount of material on inflation with laudatory comments about Paul Volker raising the interest rate to 20% to combat what had occurred in the Carter years.There were also clips of Ron Paul railing the government for printing money.
Social Security was highlighted in the movie as well as the commentary.Various solutions were suggested such as raising the full retirement age from 66 to 70 or doubling the Social Security tax on the work force.After 2017, without action, the Social Security Trust Fund will no longer be able to support cash flows for things other than Social Security as it does now because the trust funds won’t be there.As most of us already know, the trust fund is a fiction.It’s full of IOUs from the federal government.One person said that the trust fund is neither a fund, nor can it be trusted.
The movie showed street interviews with ordinary people.It was shocking how little they knew not just about the country’s financial conditions, but even simple financial terms like deficit.The movie and all commentators (except Warren Buffett) felt it was grossly unfair to have our children and grandchildren and following generations have to pay for our current excesses.Buffett felt that the ingenuity of our people would come up with things to solve the problems so that our children would actually have better lives than us.The movie and commentators showed how poor our schools were compared to all other developed countries.We are particularly deficient in math and science.After seeing the movie, I’d add that they are even worse in teaching basic finance and money management.
The movie also made some dramatic points about the trade deficit.It showed a US scrap yard where the manager said the majority of his scrap was being sold to Japan and China who were manufacturing things to be exported back to the US.
Foreigners that hold our debt hold it in dollars, so if they sell it to another foreigner, the other foreigner will have the same debt in dollars.It’s like a tar baby.The risk is not the foreigners dumping the debt; the risk is the interest rate and being able to get them to take on more of our debt.
Walker pointed out that one of the things that made the debt problem so intractable is that 68% of the national budget is on autopilot (e.g., automatically adjusted for inflation) and only 32% is for the things originally intended by our founding fathers to be what the federal government was supposed to do—like defend us.Also, Congress was supposed to be a part-time job where the congressmen went back home to their regular jobs the rest of the year.Now, congressmen work to preserve their congressional jobs and have a very short term perspective directed at whatever it takes to get reelected.
Most of the commentators agreed that the solution to our problem relies on national leadership—and it just isn’t there.Politicians are campaigning with programs advocating more government spending, not less.Medicare is currently the largest single unfunded liability—and it looks like the finance problem not only will not get solved—it will get worse with all of the add-ons.
The $53 trillion debt and unfunded liabilities is made up (as I recall the numbers) with $10 trillion national debt, 7 trillion Social Security, $26 trillion Medicare parts A and B, 8 trillion Medicare part D and some miscellaneous items.I don’t remember how they accounted for the trade deficit, and there was no mention of State debts or industrial debts which must exacerbate the problems.
If you get a chance to see a replay, I’d urge you to see it yourself.It has a very compelling message that should be understood by all citizens including those in high-school.We need better government leadership and we must greatly increase personal savings.
This is a contribution from Bud Hebeler who runs Analyzenow.com
Hidden government costs FAR exceed that which we think we pay in sales and income tax. See the illustrations below:
So you may think you are only paying income, property and sales tax.Wrong!You are paying for the government labor to administer and collect the taxes.You are also paying for all of the taxes on the materials used to get you the final product. And you are paying for the additional effort required by the retailer to administer and collect the taxes.
The additional administrative costs problem may be the worst in the medical field where medical offices now employ many more people than the professional staff in order to handle the bookwork of Medicare patients.Of course the major exceptions to this are those medical professions where Medicare doesn’t cover the costs, i.e., dental, hearing and eye care.Still they require some effort to cover those things covered by private insurance, but they don’t have to provide all of the incremental labor associated with submitting the bills to Medicare, waiting for a reply, resubmitting the result to a Medigap insurer, waiting for the insurer’s reply, and then finally billing the patient for the incremental cost that’s left.
Our family and retired friends have found that many times, the interval between the visit to the doctor’s office and our final bill can exceed a year.Since all of the medical staff and their suppliers must be paid before the doctor’s office finally gets the checks from Medicare and the Medigap insurer, your medical bills have to include the cost of borrowing the money in the interval.Throughout this process we get a number of reports on what’s allowable and what’s not–almost always aggregated with other items still in progress in a mess that’s virtually impossible to untangle.I remember that my father used to just throw all of these reports unread in his top drawer and discard them when the drawer got full. This used to drive my sister nuts, but it probably was the most practical thing to do.
Medical costs may be the least problem to you who are young and healthy.You don’t get off scot free from hidden government costs though.Let’s first look at sales taxes.
We only see the sales tax on the retailer’s bill.However, the retailer must pay sales (or “use”) tax on the goods it sells.The retailer pays sales tax on the goods it buys from the wholesaler.The wholesaler pays sales tax on the goods it buys from the manufacturer.The manufacture pays sales tax on the goods it buys from subcontractors.The subcontractor pays sales tax on the materials it uses.And so on down to the point where the basic material comes from the ground—and property taxes are due.Actually, property taxes are involved in every step of the way, but we’ll leave those out to simplify the results.
In a product area where the labor costs and profit are a small part of the costs, say only 10% of the total cost, then a 9% sales tax like we have in our area really is a 24% sales tax when considering the product passes through only four hands on the way to your home.A 5% sales tax translates to a 13% sales tax in the same situation.
On the other hand, a product that has a high labor content, say 50%, at each of the four steps with a 9% sales tax would really cost you 12%.If the labor content was 50% and the sales taxes were 5%, the net sales tax to you would be 7%.
How do income taxes come into this?You pay income tax on all of the labor that went into the product at each step along the way. Suppose the labor content was 50%.If the average income tax of the workers was 20% and the profit was 10% at each of four steps, you would be paying 14% of the price for income tax along the way.If the income tax was 10%, you would be paying 7% of the price for income tax.Remember that the income tax includes that of the top bosses, administrators, and hands-on labor.Also remember that we haven’t accounted for Social Security and Medicare.
So, leaving out property taxes, Social Security tax and Medicare tax, if the sales tax is 9% and income tax is 20%, we are paying 24% tax for a low labor product and 26% for a product that averages 50% labor and profit at each of four steps.At the other extreme with 5% sales tax and 10% income tax, we are paying 13% tax for a low labor product and 19% for a product with 50% labor and profit at each step.Of course these are just rough figures because everything we buy is going to have different net taxes.
One of the main ways that the federal government has to reduce taxes is to push responsibility down to the state level.Medicaid is a primary example of this, but it also applies to many other areas including education and law enforcement.
The main point is that actual taxes on the things we buy are far greater than that sales tax number we see printed on the receipt. By analogy, the same is true of our property tax rates. So when someone says that the federal government is going to increase its services but not income tax for the average person—Watch out!The average person will pay for it one way or the other.
The other point to keep in mind is that increased government services and regulations can have a far greater effect than the increase in government payroll.This in itself is costly because both the average pay and retirement benefits for government workers far exceed the averages for those in the private sector.But the greatest effect is on the increase in labor needed in the private sector to satisfy the government requirements and administrative effort.The medical profession is a prime example of this, but it’s not the only one.I worked for thirty three years in the military and space fields.For every government oversight person assigned, we had to employ many more of our own employees to respond to the government’s questions.
All of these things are hidden costs.It’s impossible to find out the total, but almost anything we buy has hidden sales tax, income tax, Social Security tax and private sector overhead costs that far exceed that which we think we are paying in that simple sales tax number!
