Our nation is headed for trouble! Are you?
Henry K. Hebeler
2/29/08
If we get back to saving enough for retirement, consumption will plummet, industry profits will disappear, unemployment will soar and government debt interest will be impossible to recover without unbearable tax rates and sky-high inflation. These are facts that neither the financial industry nor the government wants you to know.
The fuse was lit about two decades ago when national savings rates started to decline until savings became virtually non existent. 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.
When people ran out of disposable income, they went to the lenders who willingly gave loans based on little or no collateral. Even the collateral was estimated at bloated values. Loan terms sported teaser rates that fitted unsupportable budgets without any provisions for inevitable unforeseen future events. Consumption went far beyond disposable income.
Greedy executives of major companies accelerated efforts to accumulate other companies so as to enhance their compensation. To maintain profits they started eliminating workers benefits, primarily traditional pension plans. They began offering employee savings plans which cost very little by comparison with traditional pensions. Few employees understood that they would need major increases in their own savings to compensate for the lost pension.
Oh, but not the federal and state governments. They did just the opposite. They kept their traditional pension plans and added or increased employee savings plans. Consider too, that the average government employee makes more than the average employee in the private sector. The government pension trusts are not fully funded. The unfunded obligations are backed by an imagined ability to increase taxes in the future. The size of these obligations is often unknown but estimated to exceed $440 billion. Not only that, but government pensions usually have payments that are adjusted upwards for inflation. Such pensions are worth more than 150% of a traditional pension over the average life span.
Congress and those running for office campaign on getting more Medicare and other benefits, never mind the fact that the government can’t afford its current obligations. Congress turns its attention to things such as going after sport players who may have used hormones in the past. No Congress member nor political candidate is brave enough to do the job that should be done, namely, establish a budget that is one we and future generations can afford.
Politicians understand that to be elected, they have to create the image that people will get more benefits for less of their income. The vast majority vote their pocketbook. Without widespread media attention to the financial realities of the future, people don’t understand what all of this may mean to them and their children a decade or more in the future. The non financial media is focused on relieving current social issues, not the kind of social issues that are likely to develop from future financial obligations. The financial media focuses on next quarter’s profitability and mutes protests of long-term views.
The voting blocks of those that feel financially oppressed are increasing. So are the government employees which are more than one-fifth of those in the private sector. These two blocks make it ever increasingly difficult for a political party to establish a financially conservative platform or to elect financially responsible politicians.
When the economy starts to go sour, few government employees lose their jobs, so the private sector’s unemployment increases disproportionately, and more rely on welfare. As welfare grows, future generations get stuck with paying the tax bills. The government’s employees are not going to advocate reductions that would cost them their jobs. Nor will welfare recipients volunteer reduced benefits.
We already know the difficulties of solving the Social Security problem. Medicare is in even worse financial shape, but politicians can’t win an election talking about taxes to solve our roads and bridges problems, Social Security’s unfunded obligations, much less those of Medicare. Rather, they have to talk about increasing Medicare benefits with the social media helping to wave the politicians’ banners.
So let’s look into what I think is going to be the major economic problem of the next few decades. Problems like roads, bridges, Social Security and Medicare will remain monstrous but may seem like mere aggravations in comparison to the absolutely deplorable conditions resulting from low national savings with an aging population.
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.
The fact is that for decades, our national savings rate averaged between 9% and 10%. Over this interval, rich people left estates to a few lucky people, stock markets boomed at various intervals, and home values went through spurts of growth. These things were not excuses to stop saving. Savings rates remained relatively constant, and retired employees often got pensions.
To attempt to quantify how big this savings problem is, let’s assume that people should have been saving 9% of their disposable income over the past twenty years. Now that’s certainly too low a number considering life without pensions and the need for more savings to support longer life-expectancies. If we can’t find a rational solution at 9%, we’ll never find a solution at a higher savings rate.
Let’s further assume that everyone could average 8% return on their savings. This is certainly on the high side for the average person who pays almost 1.5% of investment earnings for mutual fund fees and gradually gets more conservative with age. Study after study show that not only does the average person fail to get the average returns of the security markets, but almost 80% of professional fund managers fail to achieve the security market averages. Why? Because of costs and fees the financial industry draws from investments as well as inability of pros to select consistent outperforming securities. The problem is worse for the average investor because people tend to chase the market—buying when prices are high and panic selling when security prices are low.
The final key assumption is that wages will increase at 3%. There is no way of telling whether this will be optimistic or pessimistic, but it certainly will be an optimistic assumption for those who lose their jobs over this long interval. Readers will have their own view of their own personal situation including the future of their industry, health, skills, and so on.
Let’s consider how much people are behind right now after 20 years of declining savings rates. What’s the difference between what they would have saved over the past 20 years at a 9% savings rate compared to the actual savings rates over those same years?. The answer is they have accumulated 50% of what a constant 9% savings would yield. Unfortunately, each year that passes, this number gets progressively lower, so without some miracle increase in savings rate next year, next year’s value will be significantly less and the hole in retirement resources will get even deeper.
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.
Or looking at 21% from a different viewpoint, can you imagine what would happen if industry had to cut production by this amount because there was that much less consumption? Actually, industry would have to cut substantially more because the government population would likely grow, thereby exacerbating the situation.
This is not the worst. There are a large number of baby boomers with little savings that don’t want to wait another 20 years to retire. What if the average turned out to be 10 years to retire. Then the national savings rate would have to increase to 28%! That’s significantly above World War II savings and about three times the historical average.
Since this is not about to happen, many people will not be able to retire. They will work until disabled as did many of our ancestors. They will seek larger welfare benefits. They will try to get support from their children. They will live on budgets which many will consider absurdly low. They will try to recover money from their homes but find their loans exceed the price they can get. The federal government will try to push more obligations on the states and local governments. Tax rates will increase on everything and everywhere. Inflation will be let to increase as a way to reduce the apparent size of debt payments, and those living on fixed budgets will suffer an enormous blow.
Of course, I can’t see the future any better than anyone else, but I can see that hiding the problem of the national savings rate is worse than hiding the problem of funding Medicare. We may be able to keep our heads buried in the sand for yet a while, but we and our children will eventually pay an extraordinarily high price for a public that doesn’t understand the financial implications of all of this, industry that cares little about the average employee’s future, media that pleads for more social assistance, and politicians who can’t obtain or hold their offices without further adding to the problem.
What can people do if I’m right about this situation? They might have more in money markets than usual for a while. Or take advantage of the protection of our government by buying government inflation protected bonds. Or, if retired, buy immediate annuities with inflation-adjustments. Consider investing in some CDs backed by the Federal Deposit Insurance Corporation (FDIC). Although debt is not necessarily bad in a highly inflationary environment, you may do better paying down debt than investing more in stocks. Not until stocks hit very low price-earnings ratios do they increase with inflation.
My final words to those that believe there is some truth to what they’ve read above is: Start saving LOTS! You can’t invest in anything without having savings, and you’ll never be able to retire in the lifestyle you would probably enjoy without money in the bank. Once saved, WIDELY DIVERSIFY INVESTMENTS, not just with the conventional mantra of diversified equities vs. fixed income investments, but with an eye to having some things that could survive the Great Depression and some things that would preserve value in a highly inflationary environment. Further, plan CONSERVATIVELY! Think about a possible return of the high inflation and low returns those faced who retired in the mid sixties. You can find these illustrated in the planners on www.analyzenow.com.