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?

Courtesy of Yi

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.

The current economic mess:

Debts

“Households have used 30% or more of their available credit –considered a risky percentage by the industry– has risen to more than one-quarter of all card users.

Average revolving balance is $9,890, up from  $8,069 just four years ago.

US households now hold an average of 2.8 cards—compared with 2.4 cards four years ago.”  Bottom Line Personal, Feb. 1, 2008, p. 15.

“The past 10 years will go down as one of the greatest consumer-lending sprees ever.  Adjusted for inflation, consumer debt – including mortgages – rose an average 7.5% per year since 1997, far faster than the 4.2% rate of the previous 10 years. . . If Americans had kept borrowing at the pre-1997 pace, they would have had about $3 trillion less in debt.”  Business Week, 2/4/08,  p. 27.

“the average debt-to-income ratio for middle-class Americans now stands at 141%, double what it was in 1983. . . the U.S. hasn’t faced a credit crunch like this in 25 years.”  Business Week, 2/18/08, p. 34, 36.

“Eighteen percent of workers had a loan outstanding from their retirement plan in 2007, up from 11% in 2006….[T]he average unpaid balance at the end of 2006 was $7,300 according to  the Employee Benefit Research Institute.”  Wall Street Journal, 2/18/08, p. D1.

Surprise retirement costs

“Caring for parents can cost children: …People who don’t prepare to care for their sick and aging parents could fall victim to what economists call “negative inheritance.”.. It is when costs to children caring for their relatives outstrip any gifts or bequests they might receive in return.”  Wall Street Journal, Personal Finance: “When Inheritance is Negative.”

Public employees enjoy security at our costs.

“Public jobs see pay gains. ..State and local government workers now earn an average of $39.50 per hour in total compensation …Private workers earn an average of $26.09 an hour. . . From 2000 to 2007, public employees enjoyed a 16% increase in compensation after adjusting for inflation compared to 11% for private workers. . . The nation has 20 million state and local government employees [+ 2.7 million federal workers not including the military or supporting contractors].  About 116 million people work in the private sector.”  USA Today, 2/1/08, p. 1.

“public pension funds have $3 trillion in assets but unfunded liabilities of $440 billion…An economic slowdown would only aggravate the situation for many funds…” Wall Street Journal, 2-28-08, p. C1.

Medical costs increase naturally as we age—but so does the unit cost.

“The survey of 1,000 Americans over the age of 65, conducted for Medco by Directive Analytics, found that one in three retirees say medical and drug costs far outpaced expectations. Results also showed that one in four retirees spend 10% or more of their monthly retirement income on medications alone.”  Reported 2/13/08 on FoxBusiness.com.

Taxes

“Eliminating the 75-year Medicare deficit would require an immediate 122% increase in the 2.9% Medicare payroll tax, a 51% cut in benefits, or a combination of the two.”

American Academy of Actuaries quote from USA Today 1/17/08, p. 3B.

“Daunting future for Medicare.  Spending will soar from 3% of gross domestic product now to 8% of GDP in 2040, according to Boston College’s Center for Retirement Research.  By 2040, income tax rates will need to rise by 20% to cover the government’s Medicare costs, and out-of-pocket costs will devour more than half of the average Social Security benefit.”  Kiplinger’s Retirement Report, January 2008, p. 9.

“If today’s tax rates remain in place, 76% of all federal income tax revenue in 2050 [vs. 8.6% in 2010] will be soaked up by [Social Security and Medicare] –before a penny is spent on defense, national parks, health care for the poor or haircuts for congressmen.”  Money, 3/08, p. 88.

“Senior benefits costs up 24% [above inflation in last 8 years.]  The average Social Security benefit per senior in 2007 was $13,184…The [total] cost of government benefits for seniors soared to a record $27,289 per senior in 2007, according to a USA TODAY analysis.”     USA Today 2/14/08, p. 1.

Inflation

“If you start measuring inflation after the Great Depression, inflation has been 4%, not 3%.  Long periods of recent history had over 6% inflation.  My father retired in 1965.  He lived to 96.  During those years his purchasing power declined 80%!  In the first ten years of my own retirement, my fixed pension lost 30% of its purchasing power–and that was in a time of supposedly low inflation.”  Inflation Can Destroy Retirement, www.analyzenow.com, Helpful Articles by Henry K. Hebeler.

Retirees inflation greater than the CPI

“By 2017, total health care costs will double to more than $4 trillion a year, accounting for one of every $5 the nation spends…The 6.7 percent annual increase in spending – nearly three times the rate of inflation – will be largely driven by higher prices and an increased demand….That [$4.3 trillion] would be about 20 percent of the U.S. gross domestic product….In 2006, people and the government spent …an average of $7,026 a person.  In 2017, health care spending will cost an estimated $13,101 a person.”  Seattle Times, 2/26/08, p. A4, referencing report from Centers for Medicare and Medicaid Services.

 Investments

“Corporate Earnings.  Yes, there’s been a profit boom in recent years….But here’s an unfortunate truth – the profit surge has been mainly in one area, financial services.  Financial institutions have benefits from the consumer credit boom, the proliferation of new financial instruments, and relatively low rates.  By contrast, the earnings of nonfinancial companies over the past decade have averaged …about the same since the mid-1980’s.”  Business Week, 2/4/08, p. 27.

“In 2003, 10 big Wall Street firms paid $1.4 billion in fines and penalties to settle civil charges by securities regulators that they issued overly optimistic stock research to win investment-banking business from companies they were supposed to analyze separately.”  WSJ, 2/16/08, p. B1.

Your home as an investment

“As baby boomers retire, home markets will hurt. . .The math is simple:  79 million boomers have driven up housing demand.  That trend will reverse itself when boomers are age 65 to 75;  there will be three sellers for each buyer.”  Dowel Myers, Prof. of policy, planning and development, USC.  USA Today, 1/16/08, p. B1.

Count on energy problems

“Our energy problems will not go away—at least in our lifetimes.  Our dependence on foreign oil is too great and our political process too weak to permit mobilizing solutions. It is virtually impossible to develop domestic oil fields, increase refineries, build dams, construct power plants, lay pipelines, string high power lines, open coalmines, dispose of urianium, and the like.

“Industrial and commercial growth has always demanded more energy.  We have seen it here, and we are starting to see it in developing countries.  China by itself is going to be a massive user of energy—even bigger than the United States.  India is going to add to the problems.”  Getting Started In A Financially Secure Retirement, Wiley & Sons, 2007.

The average person can’t recover.

It’s important to understand the history of national savings rate, that is, the percent of disposable income (gross income less income tax).  During the Great Depression, savings rates were about 4% and dipped below zero for only two years.  The Great Depression was followed by World War II.  During the war, the national savings rate was its highest value ever averaging about 25%.  After World War II and until 1985, the national savings rate was generally between 8% and 10%.  The exceptions were the couple of years immediately after the war when the savings rate was only about 5% to 7%.  That was when people once again had an opportunity to buy automobiles and previously rationed items.  Still, the savings rate was not negative, and debt was a bad word.

The fuse to our financial disaster was lit about 1985 when national savings rates started an abrupt decline until savings became virtually non existent from 2005 on. Consumption increased at a mad pace as men, women and children raced to get the latest electronics, large houses and vacation expenses far beyond their means.  Debts increased as well as people stretched to borrow on the remaining assets to be like their friends and the “Jones” across the street.  Grade school kids had to have cell phones.  High school kids had to have cars.  Mom and Dad had to have a bigger TV and cable connection to the internet.

“The financial industry, intent on keeping an image of ever upward growth, makes one excuse after another to minimize the importance of national savings. At one time, financial “experts” said people didn’t have to save because they were going to inherit so much.  When the stock market was booming in the late nineties, these same experts said people don’t have to save because what they have already saved had grown so much.  Then the next excuse was that people have made tremendous savings from the growth of their home equity.  After watching all of these theories fall apart, these experts must have crawled into the woodwork, because their silence is deafening after the tide has turned in each instance.

“So, how much would people have to save in the future to make up for lost savings over the past 20 years?   To get this answer, we have to calculate what they would have accumulated with 9% savings over both the past 20 years plus the number of years ahead when they will retire.

“Let’s first assume that they have 20 years ahead to save.  Over the past 20 years plus the future 20, they would have accumulated what amounts to 10.9 times the final year’s after-tax wages—if they could get a consistent return as high as 8% in a deferred-tax account and preserve 3% wage growth over the entire period. (10.9 times final wages might finance a retirement income of 40% to 50% of working wages.)  In order to get 10.9 times final wages using the actual past 20 year’s savings rates, they would have to save almost 21% of their disposable income for the next 20 years.  Starting now!

“Can you imagine the difficulty of getting the national savings rate to 21%?  The only time it has been that high since the Great Depression was during World War II when virtually all people, wives included, were working and there was nothing to buy.  Industry was focused on weapons production, not goods for civilians.  Further, almost everything was rationed.  It was politically correct for everyone, including school children, to invest in savings bonds.  It took that kind of environment to achieve such high savings rates, all in spite of the highest income tax rates we’ve ever had.”  Quotes above are from www.analyzenow.com from the Economics page of Helpful articles.

In fact saving 25% of disposable income took more than war conditions.  It took a nation that had just come out of the Great Depression where people were conditioned to a harder life.  Most people had very little.  There were no television promotions of a more desirable lifestyle or media advertisements for innumerable pieces of intriguing electronics.  Further the nation had a cause: the possibility of being overrun by aggressors just as was happening in Europe.  People were patriotic and united.

One would think that people would be saving more as employers abandoned pensions in favor of savings plans.  For the most part, the government jobs are the ones that still have both pensions and savings plans.  Not only that, but most of the government pensions have cost-of-living adjustments, COLAs.  These are very rich pensions indeed—usually supported by strong government unions.  Together they form an extraordinarily powerful voting block that will surely not support a reduction in their jobs (many with tenure), compensation or benefits.

With almost one out of every five people working for the government, four out of five must pay for their support—adding to the problem.  This ratio will rapidly deteriorate as the working population decreases when the baby boomers retire and the size of government continues to increase, both in ratio and in absolute numbers.  Remember, too, that the government sector has wage and benefit levels about half again higher than private sector employment.

The way out of this economic mess:

We won’t be able to solve the nation’s problems, but we in the private sector can do something as individuals to help ourselves.

“Forgo the Joneses’ lifestyle,

Make conservative plans,

Preserve some funds as reserves for unknowns,

Shift to fixed income investments [as we age],

Ladder immediate annuities late in life,

Repeat planning process every year.”

Points are from “Getting Started in a Financial Secure Retirement,” Wiley & Sons, 2007.

Actions like these will make what is inevitably an unbearable situation for the average person in the private sector to something that’s tolerable for those who save, invest conservatively, and plan for a difficult economy.  This is much of the theme in the Web site, www.analyzenow.com.

The final point is the often cited 1787 quote supposedly from Alexander Tyler, a Scottish history professor at the University of  Edinburgh.  There is no evidence of this being an actual quote, but the thought is something to consider.

“A democracy will continue to exist up until the time that voters discover they can vote themselves generous gifts from the public treasury.  From that moment on, the majority always vote for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy.”

I hope that this is not the final outcome of our future years, but the alternative outcome often cited seems quite unlikely.  That alternative outcome is a booming economy with relentless consumerism that provides enough money to support our government’s largess, thriving business and retirees without savings.  This dream will fade as the majority of baby boomers count on Social Security as their primary retirement resource and a financially failing Medicare for their health needs.  All this while the private sector work force reduces and tries to bear ever increasing government costs.

Note:  Many of the things above are covered in more detail in “Getting Started In A Financially Secure Retirement,” Wiley & Sons, 2007, as well as in the Helpful Articles section of www.analyzenow.com.