Jim Crum, with whom I have corresponded since the beginnings of the search for information about BO's birth certificate, has published an excellent piece with American Thinker. Jim comments on the inflation effects of the Fed's QE2 program:
The recently released BLS import and export report simply confirms what many of already knew was happening or was going to happen. Prices everywhere on nearly everything of substance are going up dramatically.
Jim adds that fuel and agricultural prices are both on the rise. American Thinker's Thomas Lifson adds to Jim's post:
Inflation, using the reporting methodologies in place before 1980, hit an annual rate of 9.6 percent in February, according to the Shadow Government Statistics newsletter.
If you are thinking of retiring, you will have to think strategically. Unlike Jim, who told me separately that he's bearish on the stock market, I am convinced that there will be a short term run up. The reason is the liquidity and ultra-negative interest rates that Helicopter Ben and the Fed are generating. One commentator on Kitco suggests that there will be a few week consolidation period followed by an additional run up in the stock market.
No increase is consistent. The silver market has been doing beautifully, and those of us who have partaken of the white metal have enjoyed the run. My portfolio is near its all-time high in February of 2008, when I had benefited from a short term run up in construction stocks that the late Howard S. Katz had recommended. However, I am not sure about silver's short term performance. Over the long term it will continue to rise, along with other commodities.
My recommendation to deal with Obama's declining America is to plan for retirement by purchasing blocks of commodities that reflect your anticipated consumption. For instance, if you are retiring at age 67 and you figure that you'll live until about age 82, you need 15 years' worth of commodities. If you spend $6,000 a year on fuel and gasoline, $7,000 a year on food, $2,000 a year on house repairs, $5,000 a year on property taxes and $5,000 a year on other consumables then you have a commodity budget of about $25,000 a year. The property taxes can be accounted for with gold or silver. The consumables and house repairs can be accounted for the with Deutsche Bank Commodity Index, DBC and/or the Deutsche Bank Agricultural Index, DBA. So you need to fund $25,000 x 15 = $375,000 in commodities investment before you retire. If you have ten years to go, you should fund $37,500 per year, $75,000 over five years, or put it all in now, depending on your theory of where the market is going to be going.
The commodities should not be used as speculation but rather as savings that you will liquidate over your anticipated retirement period. Whether commodities go up or down, your inflation risk for the funded period will be nil.
Showing posts with label retirement. Show all posts
Showing posts with label retirement. Show all posts
Tuesday, April 19, 2011
Wednesday, March 24, 2010
Stock Market Will Be Flat over Next Ten Years--Boomers Will Work 'til They Drop
The Great Depression lasted nearly ten years. The reason for depressions is that the Federal Reserve Bank creates excessive liquidity. The liquidity is used to stimulate the economy, but the stimulation is in the wrong place. For example, there may be no demand for an additional shoe store at 6% interest, but if interest rates are brought down to 4% then a new shoe store becomes viable. But the new shoe store will be sustainable only at 4% rates. If rates are kept that low, the amount of money created will exceed the value to the economy that the shoe store adds. The result is inflation. The public starts to realize that it is subsidizing businesses that cannot be reasonably justified. Everyone is paying out money through inflation so that the shoe store can stay in business. Better to make the shoemaker welfare payments and not waste so much money. The public starts to protest. The Fed then contracts the money supply, raising interest rates back to 6% or even 7%. The shoe store closes. In 1980 the prime rate was in the twenties. The higher interest rates throw more businesses out of business than were started due to the initial stimulus. A depression occurs.
What has forestalled the inflation is overseas sovereign investors' subsidization. Never before in history have other countries been willing to make themselves poorer by purchasing the additional liquidity that a country creates to keep interest rates low. This phenomenon will not last forever. It could last for 10 years, though.
Because there has been inflation in line with the past 20 years (eg., in the 3-4% range, and recently none due to credit contraction) there has been little impetus to raise interest rates. In fact they have been reduced in order to limit the effects of the bank credit contraction, which occurred for the very same reason as inflation. The Fed created excessive reserves, and mismanaged banks lent money via credit cards and mortgages that were unlikely to be repaid. When this pattern of lending had to change, there was a market collapse.
Because of these policies the country has been becoming poorer but not through inflation. Rather, the credit collapse caused people to lose jobs even though interest rates have not been raised.
Interest rates are now almost as low as they can be. If rates are raised significantly, additional businesses will be closed. If rates continue this low for long, the foreign subsidies to our economy will eventually end. The Fed has created an unsustainable system.
The period of time that this will take to clear up will be longer than the Great Depression. If you count the market decline of 2001 as part of this cycle, it already has been as long as the Great Depression. It may not be cleared up in the Boomers' lifetime.
That leads to the question of what Boomers are to do about retirement. The savings rate has been low, and few boomers have the assets to retire. A rising stock market such as existed up until 2000, ten years ago, would have subsidized the Boomers and allowed them to retire. As well, Social Security has been curtailed since their parents' day (the retirement age will be 67 or likely older), and anyway, Social Security is insufficient for retirement for all except the poor.
But the Boomers may be forced into retirement because of job losses due to the Federal Reserve Bank's being forced to raise rates. If the economy had been allowed to progress naturally there would have been better businesses, more innovation, less overseas plant transfers and a more dynamic economy. The misallocations due to the Fed would have been smaller.
If there were no Fed there would have been no problem.
In inflation-adjusted terms the stock market will not be able to advance until the misallocation of credit has been cleared up; the real estate market is stable and advancing; firms can be subsidized with additional Federal Reserve monetary creation; and inflation is stable. That is, for the stock market to begin advancing the basis for a new bubble will need to be created. This is what Jimmy Carter and Ronald Reagan did in 1979-1982 by allowing Paul Volcker to contract the amount of money and raise interest rates to very high real levels.
True reform of the American economy so that innovation is spurred in the way it was in the late 19th century will require major economic upheaval and abolition of the Federal Reserve Bank.
I doubt that either party has the courage to do this now. Hence, the stock market will not in the long term advance in real terms, although it might advance in nominal (not inflation adjusted) terms if the Fed continues to subsidize it through monetary expansion. In that case hyper-inflation with non-asset holders getting squeezed as real wages are further diminished is a real possibility.
What has forestalled the inflation is overseas sovereign investors' subsidization. Never before in history have other countries been willing to make themselves poorer by purchasing the additional liquidity that a country creates to keep interest rates low. This phenomenon will not last forever. It could last for 10 years, though.
Because there has been inflation in line with the past 20 years (eg., in the 3-4% range, and recently none due to credit contraction) there has been little impetus to raise interest rates. In fact they have been reduced in order to limit the effects of the bank credit contraction, which occurred for the very same reason as inflation. The Fed created excessive reserves, and mismanaged banks lent money via credit cards and mortgages that were unlikely to be repaid. When this pattern of lending had to change, there was a market collapse.
Because of these policies the country has been becoming poorer but not through inflation. Rather, the credit collapse caused people to lose jobs even though interest rates have not been raised.
Interest rates are now almost as low as they can be. If rates are raised significantly, additional businesses will be closed. If rates continue this low for long, the foreign subsidies to our economy will eventually end. The Fed has created an unsustainable system.
The period of time that this will take to clear up will be longer than the Great Depression. If you count the market decline of 2001 as part of this cycle, it already has been as long as the Great Depression. It may not be cleared up in the Boomers' lifetime.
That leads to the question of what Boomers are to do about retirement. The savings rate has been low, and few boomers have the assets to retire. A rising stock market such as existed up until 2000, ten years ago, would have subsidized the Boomers and allowed them to retire. As well, Social Security has been curtailed since their parents' day (the retirement age will be 67 or likely older), and anyway, Social Security is insufficient for retirement for all except the poor.
But the Boomers may be forced into retirement because of job losses due to the Federal Reserve Bank's being forced to raise rates. If the economy had been allowed to progress naturally there would have been better businesses, more innovation, less overseas plant transfers and a more dynamic economy. The misallocations due to the Fed would have been smaller.
If there were no Fed there would have been no problem.
In inflation-adjusted terms the stock market will not be able to advance until the misallocation of credit has been cleared up; the real estate market is stable and advancing; firms can be subsidized with additional Federal Reserve monetary creation; and inflation is stable. That is, for the stock market to begin advancing the basis for a new bubble will need to be created. This is what Jimmy Carter and Ronald Reagan did in 1979-1982 by allowing Paul Volcker to contract the amount of money and raise interest rates to very high real levels.
True reform of the American economy so that innovation is spurred in the way it was in the late 19th century will require major economic upheaval and abolition of the Federal Reserve Bank.
I doubt that either party has the courage to do this now. Hence, the stock market will not in the long term advance in real terms, although it might advance in nominal (not inflation adjusted) terms if the Fed continues to subsidize it through monetary expansion. In that case hyper-inflation with non-asset holders getting squeezed as real wages are further diminished is a real possibility.
Tuesday, February 2, 2010
Prepare Now to Escape Obama's Retirement Trap
Jim Crum and Chris Johansen both forwarded an e-mail containing Ron Holland's article "Prepare Now to Escape Obama's Retirement Trap." Holland offers a nightmare scenario for the private employee benefit system. While I don't think it will happen, it very well could. I was interested that Theresa Ghilarducci and Alicia Munnell, two pension researchers from academia, figure in this scenario.
My reaction to this scenario is that while it is certainly possible, there are three stumbling blocks: the political power of plan sponsors, the lack of value added to the government of confiscation of plan assets in the event of a crash (there will be little to confiscate) and the potential aggravation of middle class voters.
First, the political power of corporate America and labor unions combined, both of which interests have heavy investments in the current employee benefit system, will likely forestall attacks on the system as now constituted. Nothing has ever been done to the US pension system that was completely unpalatable to either of these two interests. Note that the recent health care proposal met with some labor union resistance. If health reform ever passes, the limits on rich union health plans will be deleted. Perhaps more so for pensions, which have advocates on Wall Street and in the banking and insurance industries as well as big labor and corporate America generally. While politicians are greedy fools, they respond quickly to their corporate bosses.
Munnell and Ghilarducci can devise plenty of benefit schemes, but when big business calls and calls heavily, Congress listens carefully.
Holland notes that the dollar's days are numbered because of federal debt. He writes that the US government is thrashing about, looking for additional revenue. All true. Holland argues that "wealth confiscation" is a realistic likelihood, that there is $15 trillion in retirement assets, and Congress might well tax or otherwise confiscate this money. Holland states that Alicia Munnell proposed a mandatory federal retirement system that would be financed by taxing existing pension assets.
Teresa Ghilarducci, another pension researcher now at the New School, advocates putting $600 up to $12,000 plus 5% of your compensation above $12,000 into a "Guaranteed Retirement Account". This would be accompanied by a cap of $5,000 on contributions to 401(k) plans and a tax on retirement plans' income. Also, there would be a prohibition on international investments (I'll bet commodities too, but that's just a guess).
Holland suggests that a "crisis" such as a downgrade of US treasuries or a run on the dollar could trigger a move like this. He notes:
"At some time during the next decade, a global run on treasury debt and the dollar will also likely take the American stock market down past lows not seen since the financial meltdown crisis in 2008 and 2009. The 50% to 75% stock market pullback during the actual bankruptcy of the Washington debt and paper dollar will send shock waves through retirees and current plan participants as their private retirement plan balances plummet." Upon the stock market crash, argues Holland, the American public will be bamboozled into switching to Ghilarducci's retirement concept, a new federal plan.
I agree that the stock market is capable of falling by 75%. However, confiscation of the $15 trillion in retirement assets is unlikely to be very helpful. To retire Baby Boomers in an acceptable way will cost $15 trillion. Let's say there are 50 million boomers earning an average of $40,000. If each retires at age 67 and receives an annuity of $30,000, the cost will be (not really but an order of this magnitude): $30,000 x 10 x 50 million = $15,000,000,000,000, $15 trillion. So I'm not sure what the Federal government would gain by taking the $15 trillion from the retirement funds and putting it into a government plan. It's a wash.
Of course, the current allocation of the 15 trillion on deposit is skewed heavily toward the higher income earners. But do you believe that this massive number of potential higher-income retirees, with tremendous voting power (much more than the people who don't have assets) will quietly watch the government take its assets, even given an emotional crash? And if the stock market falls so that the pension assets are worth half that, how would the government benefit?
This scenario assumes that the chief goal of the US government is to impoverish the affluent. While I do believe that the government is in the process of impoverishing us, rich and moderate income, I do not believe that they will do this in a heavy handed way. They can destroy the nation simply through the Fed and inflation.
Thus, I think the more realistic scenario is inflation. Inflation was invented to limit tax revolts. It slams people on pensions the hardest, and Americans have docilely accepted bankers' propaganda via university academics and media sources that inflation helps them. Since Americans have behaved like drooling idiots about inflation since World War II, it seems a safe bet that they will continue to do so.
It is the duty of the Federal Reserve Bank to extract wealth from the hard working and give it to the non-working, both as welfare for the poor and mostly welfare for the rich, especially stock holders and derivatives investors. Why bother with directly confiscating pension money when all the Fed needs to do is print money, hand it to commercial banks, who in turn lend it to government, hedge funds and investment bankers, who then repay the loans in depreciated dollars as everyone else in the country sees their savings and wages decimated? I think something like that is more likely than confiscation of pension assets. Confiscation is too messy and too controversial. Inflation is a good way to get the suckers to thank you for stealing from them.
Nothing beats a nice healthy inflation to feed government and Wall Street snakes.
My reaction to this scenario is that while it is certainly possible, there are three stumbling blocks: the political power of plan sponsors, the lack of value added to the government of confiscation of plan assets in the event of a crash (there will be little to confiscate) and the potential aggravation of middle class voters.
First, the political power of corporate America and labor unions combined, both of which interests have heavy investments in the current employee benefit system, will likely forestall attacks on the system as now constituted. Nothing has ever been done to the US pension system that was completely unpalatable to either of these two interests. Note that the recent health care proposal met with some labor union resistance. If health reform ever passes, the limits on rich union health plans will be deleted. Perhaps more so for pensions, which have advocates on Wall Street and in the banking and insurance industries as well as big labor and corporate America generally. While politicians are greedy fools, they respond quickly to their corporate bosses.
Munnell and Ghilarducci can devise plenty of benefit schemes, but when big business calls and calls heavily, Congress listens carefully.
Holland notes that the dollar's days are numbered because of federal debt. He writes that the US government is thrashing about, looking for additional revenue. All true. Holland argues that "wealth confiscation" is a realistic likelihood, that there is $15 trillion in retirement assets, and Congress might well tax or otherwise confiscate this money. Holland states that Alicia Munnell proposed a mandatory federal retirement system that would be financed by taxing existing pension assets.
Teresa Ghilarducci, another pension researcher now at the New School, advocates putting $600 up to $12,000 plus 5% of your compensation above $12,000 into a "Guaranteed Retirement Account". This would be accompanied by a cap of $5,000 on contributions to 401(k) plans and a tax on retirement plans' income. Also, there would be a prohibition on international investments (I'll bet commodities too, but that's just a guess).
Holland suggests that a "crisis" such as a downgrade of US treasuries or a run on the dollar could trigger a move like this. He notes:
"At some time during the next decade, a global run on treasury debt and the dollar will also likely take the American stock market down past lows not seen since the financial meltdown crisis in 2008 and 2009. The 50% to 75% stock market pullback during the actual bankruptcy of the Washington debt and paper dollar will send shock waves through retirees and current plan participants as their private retirement plan balances plummet." Upon the stock market crash, argues Holland, the American public will be bamboozled into switching to Ghilarducci's retirement concept, a new federal plan.
I agree that the stock market is capable of falling by 75%. However, confiscation of the $15 trillion in retirement assets is unlikely to be very helpful. To retire Baby Boomers in an acceptable way will cost $15 trillion. Let's say there are 50 million boomers earning an average of $40,000. If each retires at age 67 and receives an annuity of $30,000, the cost will be (not really but an order of this magnitude): $30,000 x 10 x 50 million = $15,000,000,000,000, $15 trillion. So I'm not sure what the Federal government would gain by taking the $15 trillion from the retirement funds and putting it into a government plan. It's a wash.
Of course, the current allocation of the 15 trillion on deposit is skewed heavily toward the higher income earners. But do you believe that this massive number of potential higher-income retirees, with tremendous voting power (much more than the people who don't have assets) will quietly watch the government take its assets, even given an emotional crash? And if the stock market falls so that the pension assets are worth half that, how would the government benefit?
This scenario assumes that the chief goal of the US government is to impoverish the affluent. While I do believe that the government is in the process of impoverishing us, rich and moderate income, I do not believe that they will do this in a heavy handed way. They can destroy the nation simply through the Fed and inflation.
Thus, I think the more realistic scenario is inflation. Inflation was invented to limit tax revolts. It slams people on pensions the hardest, and Americans have docilely accepted bankers' propaganda via university academics and media sources that inflation helps them. Since Americans have behaved like drooling idiots about inflation since World War II, it seems a safe bet that they will continue to do so.
It is the duty of the Federal Reserve Bank to extract wealth from the hard working and give it to the non-working, both as welfare for the poor and mostly welfare for the rich, especially stock holders and derivatives investors. Why bother with directly confiscating pension money when all the Fed needs to do is print money, hand it to commercial banks, who in turn lend it to government, hedge funds and investment bankers, who then repay the loans in depreciated dollars as everyone else in the country sees their savings and wages decimated? I think something like that is more likely than confiscation of pension assets. Confiscation is too messy and too controversial. Inflation is a good way to get the suckers to thank you for stealing from them.
Nothing beats a nice healthy inflation to feed government and Wall Street snakes.
Tuesday, February 3, 2009
If You Are a Boomer, You Can Retire—Here’s How
The 202 million Americans born between 1940 and 1994 look forward to retirement, but to retire they will need financial stability. The assets required for retirement amount to roughly $540,000 for a middle-class professional who wishes to retire at age 67 on $70,000 per year including social security benefits. Unfortunately, though, 401-k, pension plans, annuities and other financial arrangements fail to protect retirees from a trio of financial risks—inflation, stock market volatility and deflation. These risks reduce Americans’ prospects for a comfortable retirement.
The steps that the Federal Reserve Bank has taken recently to eliminate deflation and depression may prove to weaken the dollar and cause inflation. In the 1970s, stagflation, the combination of unemployment and inflation, saw inflation rates of 13.3% in 1979 and 12.5% in 1980. That could happen again—and worse.
This past year, according to the Federal Reserve Bank, M1, currency and demand deposits, increased at a seasonally adjusted rate of 37.6% in the three months from August to November 2008. M2, which includes savings deposits, increased 13.9%. In comparison, in the five years that preceded the 1979-80 inflation, from November 1973to December 1978, M1 increased about 37%. In other words, since last summer the Fed has increased the money supply by an amount equivalent to the amount it increased the money supply during several years preceding the 1979-1980 inflation. More ominously, according to the St. Louis Fed, the monetary base grew from $873.8 billion on September 10 to $1,671 billion on December 17, an increase of better than 90%. These fluctuations suggest inflation risk.
Moreover, the recent panic in the financial markets reminds us that 40 or 50 percent fluctuations in stock market prices are to be expected over any twenty year period. No matter what, retirees face the risk of stock market declines.
Those facing retirement also face a third risk: fluctuating commodity and house prices. For instance, oil has descended from $145 to $37 and now back to the $40s per barrel over the past few months. Someone who purchased a year’s worth of heating oil last July suffered losses. Dollar depreciation, stock price depreciation and commodity price depreciation all threaten retirees, but of the three, the least threatening risk is depreciating commodity and house prices. Many retirees would benefit from deflation because deflation would stretch their consumption budgets. But the federal government has made prevention of deflation a key objective. Monetary policy is at loggerheads with retirement policy. Yet, none of the interest groups associated with retirees has emphasized this crucial issue.
Potential retirees thus face three risks. First, they face the risk of inflation, which would significantly erode the value of dollars that they hold and so devalue traditional annuity, savings and money market accounts. Second, they face the risk of stock market fluctuation. Third, they face the risk of price depreciation in commodities and real estate.
Dollar-Based Retirement
Much has been written about retirement in financial terms. Many experts argue that an annuity that replaces 60 to 80 percent of final average income is necessary to retire. In private industry, the old fashioned defined benefit pension plan used to accrue benefits of one to two percent of final average salary per year of service. That would mean that an employee with 35 years of service would get about 50% of pay, often partially reduced for primary social security benefits upon normal retirement age. When social security was added to the pension the result was about 70% of pay. With respect to today’s more popular 401(k) plans, an employee who earns $100,000 and aims to retire at 67 with 70% of pay including social security would need roughly $540,000. But what if the $540,000 is eroded to $400,000, $300,000 or less in real dollar terms over a 2-3 year period? In the late 1970s there were accounts of retirees forced to sell their homes or eat pet food in order to make ends meet because of governmentally-induced inflation.
Commodity-Based Retirement
It is time to rethink dollar-based retirement. Retirees need to pay for a stream of goods and services whose dollar value fluctuates. The most important risk that they face is diminution of the stream of goods and services, not their fluctuating dollar value. A steady dollar income in an inflationary environment poses a greater risk to retirees’ well being than a stream of commodities that meets retirees’ needs in a deflationary environment, even if the dollar value of the commodities is declining.
Retirees need to consider the commodity value of retirement income rather than its dollar value. That is, retirees need to compute their budgets, translate the budgets into commodity equivalents, and then annuitize a stream of commodity consumption into a flow of forward commodity futures contracts. Then, they need to fund the stream. Today, this can be conveniently done with exchange traded funds. Excess assets over and above the required commodity stream could be invested in traditional financial instruments, CD’s, precious metals or other hedges.
The reason this is necessary is the Federal Reserve Bank’s risky, potentially inflationary monetary policy.
In 2003, the average white retiree’s budget was $26,341. Social security, which is indexed for inflation, covered roughly half of this amount. The average retiree spent 15 to 17% of this budget on food, eight to 13% on utilities, 17% on transportation, 2.6% on gasoline 30-35% on rent, and 9-10% on healthcare.* Were inflation to escalate, the average retiree would face risk over and above social security. Commodity contracts could insure this risk.
But if a retiree earns twice the average wage, or about $80,000, and wants to retire at age 67 with an annuity of $56,000, then at today’s low interest rates he needs a pool of goods and services (net of social security) of at least $360,000 upon retirement. At a median October home price of $218,000, home ownership would account for 60% of this fund unless house prices continue to fall. If the retiree wishes to avoid a reverse mortgage or borrowing to fund his retirement (which would create yet an additional risk), he would need the full $360,000.
The $360,000 would need to be allocated as something like $56,000 for food (agricultural futures), $56,000 for energy (energy futures), about $50,000 in materials for home repair and new car costs (materials futures), with the remaining amount in cash, precious metals or other hedges against deflation and inflation to purchase a range of other items. It would be easy to develop more refined budgets that could be annuitized with forward commodities futures using exchange traded funds.
Retirees should not have to fear deprivation. However, for millions of Baby Boomers, the Federal Reserve Bank is creating that very risk. In order to sidestep the financial system’s uncertainties, Boomers need to stop thinking in dollar terms and start thinking in consumption terms. They need to re-conceptualize their retirement planning in terms of a commodity rather than a dollar stream. There is no reason why insurance companies and pension funds cannot furnish such arrangements.
Theoretically, money provides a store of value as well as a unit of account and medium of exchange. Our monetary system’s inability to do so deserves re-consideration. In 1913, when the Federal Reserve Bank was founded, life expectancy was only 52 years for males and females combined and planning for retirement was not an important issue for the average American. To this day retirement planning is not one of the Federal Reserve Bank's priorities. Americans continue to hope for retirement, but recent events suggest that Fed policy and the monetary system may encumber rather than facilitate their goals. Today’s economic theories were developed at a point in time when erosion of fixed incomes affected the wealthy and helped debtors. Today, inflation primarily harms the middle class and poor elderly.
*Pierre Bahtzi, “Retirement Expenditures for Whites, Blacks and Persons of Hispanic Origin. Monthly Labor Review, June 2003, pp. 20-22.
The steps that the Federal Reserve Bank has taken recently to eliminate deflation and depression may prove to weaken the dollar and cause inflation. In the 1970s, stagflation, the combination of unemployment and inflation, saw inflation rates of 13.3% in 1979 and 12.5% in 1980. That could happen again—and worse.
This past year, according to the Federal Reserve Bank, M1, currency and demand deposits, increased at a seasonally adjusted rate of 37.6% in the three months from August to November 2008. M2, which includes savings deposits, increased 13.9%. In comparison, in the five years that preceded the 1979-80 inflation, from November 1973to December 1978, M1 increased about 37%. In other words, since last summer the Fed has increased the money supply by an amount equivalent to the amount it increased the money supply during several years preceding the 1979-1980 inflation. More ominously, according to the St. Louis Fed, the monetary base grew from $873.8 billion on September 10 to $1,671 billion on December 17, an increase of better than 90%. These fluctuations suggest inflation risk.
Moreover, the recent panic in the financial markets reminds us that 40 or 50 percent fluctuations in stock market prices are to be expected over any twenty year period. No matter what, retirees face the risk of stock market declines.
Those facing retirement also face a third risk: fluctuating commodity and house prices. For instance, oil has descended from $145 to $37 and now back to the $40s per barrel over the past few months. Someone who purchased a year’s worth of heating oil last July suffered losses. Dollar depreciation, stock price depreciation and commodity price depreciation all threaten retirees, but of the three, the least threatening risk is depreciating commodity and house prices. Many retirees would benefit from deflation because deflation would stretch their consumption budgets. But the federal government has made prevention of deflation a key objective. Monetary policy is at loggerheads with retirement policy. Yet, none of the interest groups associated with retirees has emphasized this crucial issue.
Potential retirees thus face three risks. First, they face the risk of inflation, which would significantly erode the value of dollars that they hold and so devalue traditional annuity, savings and money market accounts. Second, they face the risk of stock market fluctuation. Third, they face the risk of price depreciation in commodities and real estate.
Dollar-Based Retirement
Much has been written about retirement in financial terms. Many experts argue that an annuity that replaces 60 to 80 percent of final average income is necessary to retire. In private industry, the old fashioned defined benefit pension plan used to accrue benefits of one to two percent of final average salary per year of service. That would mean that an employee with 35 years of service would get about 50% of pay, often partially reduced for primary social security benefits upon normal retirement age. When social security was added to the pension the result was about 70% of pay. With respect to today’s more popular 401(k) plans, an employee who earns $100,000 and aims to retire at 67 with 70% of pay including social security would need roughly $540,000. But what if the $540,000 is eroded to $400,000, $300,000 or less in real dollar terms over a 2-3 year period? In the late 1970s there were accounts of retirees forced to sell their homes or eat pet food in order to make ends meet because of governmentally-induced inflation.
Commodity-Based Retirement
It is time to rethink dollar-based retirement. Retirees need to pay for a stream of goods and services whose dollar value fluctuates. The most important risk that they face is diminution of the stream of goods and services, not their fluctuating dollar value. A steady dollar income in an inflationary environment poses a greater risk to retirees’ well being than a stream of commodities that meets retirees’ needs in a deflationary environment, even if the dollar value of the commodities is declining.
Retirees need to consider the commodity value of retirement income rather than its dollar value. That is, retirees need to compute their budgets, translate the budgets into commodity equivalents, and then annuitize a stream of commodity consumption into a flow of forward commodity futures contracts. Then, they need to fund the stream. Today, this can be conveniently done with exchange traded funds. Excess assets over and above the required commodity stream could be invested in traditional financial instruments, CD’s, precious metals or other hedges.
The reason this is necessary is the Federal Reserve Bank’s risky, potentially inflationary monetary policy.
In 2003, the average white retiree’s budget was $26,341. Social security, which is indexed for inflation, covered roughly half of this amount. The average retiree spent 15 to 17% of this budget on food, eight to 13% on utilities, 17% on transportation, 2.6% on gasoline 30-35% on rent, and 9-10% on healthcare.* Were inflation to escalate, the average retiree would face risk over and above social security. Commodity contracts could insure this risk.
But if a retiree earns twice the average wage, or about $80,000, and wants to retire at age 67 with an annuity of $56,000, then at today’s low interest rates he needs a pool of goods and services (net of social security) of at least $360,000 upon retirement. At a median October home price of $218,000, home ownership would account for 60% of this fund unless house prices continue to fall. If the retiree wishes to avoid a reverse mortgage or borrowing to fund his retirement (which would create yet an additional risk), he would need the full $360,000.
The $360,000 would need to be allocated as something like $56,000 for food (agricultural futures), $56,000 for energy (energy futures), about $50,000 in materials for home repair and new car costs (materials futures), with the remaining amount in cash, precious metals or other hedges against deflation and inflation to purchase a range of other items. It would be easy to develop more refined budgets that could be annuitized with forward commodities futures using exchange traded funds.
Retirees should not have to fear deprivation. However, for millions of Baby Boomers, the Federal Reserve Bank is creating that very risk. In order to sidestep the financial system’s uncertainties, Boomers need to stop thinking in dollar terms and start thinking in consumption terms. They need to re-conceptualize their retirement planning in terms of a commodity rather than a dollar stream. There is no reason why insurance companies and pension funds cannot furnish such arrangements.
Theoretically, money provides a store of value as well as a unit of account and medium of exchange. Our monetary system’s inability to do so deserves re-consideration. In 1913, when the Federal Reserve Bank was founded, life expectancy was only 52 years for males and females combined and planning for retirement was not an important issue for the average American. To this day retirement planning is not one of the Federal Reserve Bank's priorities. Americans continue to hope for retirement, but recent events suggest that Fed policy and the monetary system may encumber rather than facilitate their goals. Today’s economic theories were developed at a point in time when erosion of fixed incomes affected the wealthy and helped debtors. Today, inflation primarily harms the middle class and poor elderly.
*Pierre Bahtzi, “Retirement Expenditures for Whites, Blacks and Persons of Hispanic Origin. Monthly Labor Review, June 2003, pp. 20-22.
Friday, October 12, 2007
Hillary Clinton Shines Shoes
In 2005 President Bush proposed the establishment of 401-k type stock investment accounts for Social Security. The idea came under attack from the Democrats and was stopped. At the time, the stock market was coming off its 2002 lows. Now, the stock market is reaching new highs. It is therefore curious that the Democrats, notably Hillary Clinton, would choose to propose the very same idea during this presidential primary season. I wonder if there is some kind of financial manipulation lurking behind Clinton's proposal.
In an October 11 editorial, the New York Sun points out that Hillary Clinton opposed establishing Social Security investment accounts two years ago but now she is proposing "private accounts" (separate from Social Security) for all Americans. The Sun editorializes
"Given, this isn't giving workers back the money the government is taking in Social Security taxes as President Bush (and most of the Republican candidates for president) would do, but the accounts — even as add-ons to Social Security — are a huge victory in principle for the Bush view."
I find the Clinton proposal odd for several reasons. First, since 1982 I have been putting previously $2,000, now $5,000 (I believe $4,500 if you're under 50) into Individual Retirement Accounts. The idea was created in 1974 as part of the Employee Retirement Income Security Act of 1974. Paul J. Yakoboski of the Employee Benefit Research Institute notes that:
"The Economic Recovery Tax Act of 1981 (ERTA) extended the availability of IRAs to all workers, including those with pension coverage. The Tax Reform Act of 1986 (TRA '86) retained tax-deductible IRAs for those who did not participate in an employment-based retirement plan (and if married, whose spouse did not participate in such a plan), but restricted the tax deduction among those with a retirement plan to individuals with incomes below specified levels. In addition, TRA '86 added two new categories of IRA contributions: nondeductible contributions, which accumulate tax free until distributed, and partially deductible contributions, which are deductible up to a maximum amount less than the $2,000 maximum otherwise allowable."
Hence, there is absolutely nothing new about retirement accounts for anyone. They are currently available to anyone and everyone, and if you don't have a 401(k) or pension plan, they are tax deductible. It is true that the $4,500 limit is a low percentage of income for anyone earning over $65,000. But there also is such a thing as a SERP, self-employed retirement plan, which serves high earners. As the financially savvy know, Roth IRAs also are available to those who earn less than $150,000. It's not clear to me that the Clinton proposal is more than vacuous, which makes me suspicious. Hillary has to know that IRAs exist, so why would she make this proposal now?
Perhaps Hillary aims to improve benefits for those earning over $65,000 (this is not clear from the Sun article) and doesn't want to say so, but any extensions of the IRA concept will probably have next to no effect on private savings, so this idea would also be vacuous. USA Weekend Magazine pointed out in 2004 when the IRA limits were raised:
>"Even though retirement planning tops the list of Americans' money concerns, astonishingly few people contribute to individual retirement accounts -- a mere 6% of eligible Americans, according to a recent study by the Congressional Budget Office."
Given the small interest in IRAs, what help would extending the IRA concept be? High earners likely save anyway and, more so, typically have access to either a 401(k) (with limits that might bother those earning over $100,000) or a SERP. SERPs have high limits.
An intriguing question that comes to mind is why Hillary would make a proposal which may be a first step toward permitting private accounts in social security at this point in time.
Quoteland.com attributes the following quote to Bernard Baruch, the Wall Street tycoon, in 1929:
"When beggars and shoeshine boys, barbers and beauticians can tell you how to get rich it is time to remind yourself that there is no more dangerous illusion than the belief that one can get something for nothing"
Incidentally, Quoteland also attributes Baruch with the statement "Bears don't live on Park Avenue" (which may explain why I live in West Shokan).
In 2005 the stock market was coming off its 2002 lows. In 2007 the market is at or nearing all-time highs, especially if you have been investing in gold stocks as I have (Randgold (GOLD) courtesy of Howard S. Katz has had a tremendous run and I am breaking out my cigars and champagne.)
The question to ponder is why Hillary would begin to speak about expanding stock market accounts just when the market is reaching all time highs; the dollar is reaching all time lows; inflation is going from very warm to hot; the Chinese are beginning to sell dollars, portending increased inflation; and public awareness of monetary expansion, which has been going on since the 1980s, will result in political pressure to limit monetary expansion aka Fed counterfeiting aka raising the Fed Funds interest rate. That is, inflation will stimulate a declining stock market (the stock market goes up and down because of Fed interest rate policy, i.e., whether the Fed is counterfeiting many new dollars or just a few) because inflation causes public pressure to stop the Fed's counterfeiting; the Fed will then raise interest rates; and the stock market will then decline. Since 1981 the Fed has been counterfeiting many new dollars, which it calls "lowering the Federal Funds rate", and which Howard S. Katz calls "counterfeiting". With increasing inflation, now that the Chinese are tiring of giving billionaire hedge fund managers in the U.S. large welfare subsidies, the risk of a stock market collapse is increasing.
All this makes me wonder why Hillary would begin to think about encouraging small investor interest in the stock market at this point in time.
Several bloggers such as Captain's Quarter's , Cao's blog as well as talk radio have been discussing a nexus between Hillary and speculator George Soros. Whether Soros or others on Wall Street have an interest in seeing an exogenous shock to stimulate stock prices just as the fundamentals are working toward a weakening stock market is a question that deserves some scrutiny.
Another question is what will be the effects, both in terms of actual economic redistribution and in terms of psychology, of the Bush/Clinton proposals to expand stock ownership. The Fed does one thing, increase the money supply. This in turn has two effects: (1)make the rich richer by boosting the stock market because of lower interest rates and (2) make the poor poorer by causing inflation. There is probably some tipping point at which effect (1) becomes outweighed by effect (2) in fact. There is also probably a different tipping point at which effect (1) becomes outweighed by effect (2) in peoples' minds. The two are likely different. If someone has a $100,000 stock account they may be worse off from the net effect of lower interest rates and the higher price of grapefruit, but the higher stock account may be more salient or apparent to them, and they may see themselves as better off. It would not be a far stretch to imagine that Hillary's proposal is linked to the idea of encouraging this kind of wealth illusion, which would have the effect of moderating but not fundamentally changing the effects of Fed policy.
In an October 11 editorial, the New York Sun points out that Hillary Clinton opposed establishing Social Security investment accounts two years ago but now she is proposing "private accounts" (separate from Social Security) for all Americans. The Sun editorializes
"Given, this isn't giving workers back the money the government is taking in Social Security taxes as President Bush (and most of the Republican candidates for president) would do, but the accounts — even as add-ons to Social Security — are a huge victory in principle for the Bush view."
I find the Clinton proposal odd for several reasons. First, since 1982 I have been putting previously $2,000, now $5,000 (I believe $4,500 if you're under 50) into Individual Retirement Accounts. The idea was created in 1974 as part of the Employee Retirement Income Security Act of 1974. Paul J. Yakoboski of the Employee Benefit Research Institute notes that:
"The Economic Recovery Tax Act of 1981 (ERTA) extended the availability of IRAs to all workers, including those with pension coverage. The Tax Reform Act of 1986 (TRA '86) retained tax-deductible IRAs for those who did not participate in an employment-based retirement plan (and if married, whose spouse did not participate in such a plan), but restricted the tax deduction among those with a retirement plan to individuals with incomes below specified levels. In addition, TRA '86 added two new categories of IRA contributions: nondeductible contributions, which accumulate tax free until distributed, and partially deductible contributions, which are deductible up to a maximum amount less than the $2,000 maximum otherwise allowable."
Hence, there is absolutely nothing new about retirement accounts for anyone. They are currently available to anyone and everyone, and if you don't have a 401(k) or pension plan, they are tax deductible. It is true that the $4,500 limit is a low percentage of income for anyone earning over $65,000. But there also is such a thing as a SERP, self-employed retirement plan, which serves high earners. As the financially savvy know, Roth IRAs also are available to those who earn less than $150,000. It's not clear to me that the Clinton proposal is more than vacuous, which makes me suspicious. Hillary has to know that IRAs exist, so why would she make this proposal now?
Perhaps Hillary aims to improve benefits for those earning over $65,000 (this is not clear from the Sun article) and doesn't want to say so, but any extensions of the IRA concept will probably have next to no effect on private savings, so this idea would also be vacuous. USA Weekend Magazine pointed out in 2004 when the IRA limits were raised:
>"Even though retirement planning tops the list of Americans' money concerns, astonishingly few people contribute to individual retirement accounts -- a mere 6% of eligible Americans, according to a recent study by the Congressional Budget Office."
Given the small interest in IRAs, what help would extending the IRA concept be? High earners likely save anyway and, more so, typically have access to either a 401(k) (with limits that might bother those earning over $100,000) or a SERP. SERPs have high limits.
An intriguing question that comes to mind is why Hillary would make a proposal which may be a first step toward permitting private accounts in social security at this point in time.
Quoteland.com attributes the following quote to Bernard Baruch, the Wall Street tycoon, in 1929:
"When beggars and shoeshine boys, barbers and beauticians can tell you how to get rich it is time to remind yourself that there is no more dangerous illusion than the belief that one can get something for nothing"
Incidentally, Quoteland also attributes Baruch with the statement "Bears don't live on Park Avenue" (which may explain why I live in West Shokan).
In 2005 the stock market was coming off its 2002 lows. In 2007 the market is at or nearing all-time highs, especially if you have been investing in gold stocks as I have (Randgold (GOLD) courtesy of Howard S. Katz has had a tremendous run and I am breaking out my cigars and champagne.)
The question to ponder is why Hillary would begin to speak about expanding stock market accounts just when the market is reaching all time highs; the dollar is reaching all time lows; inflation is going from very warm to hot; the Chinese are beginning to sell dollars, portending increased inflation; and public awareness of monetary expansion, which has been going on since the 1980s, will result in political pressure to limit monetary expansion aka Fed counterfeiting aka raising the Fed Funds interest rate. That is, inflation will stimulate a declining stock market (the stock market goes up and down because of Fed interest rate policy, i.e., whether the Fed is counterfeiting many new dollars or just a few) because inflation causes public pressure to stop the Fed's counterfeiting; the Fed will then raise interest rates; and the stock market will then decline. Since 1981 the Fed has been counterfeiting many new dollars, which it calls "lowering the Federal Funds rate", and which Howard S. Katz calls "counterfeiting". With increasing inflation, now that the Chinese are tiring of giving billionaire hedge fund managers in the U.S. large welfare subsidies, the risk of a stock market collapse is increasing.
All this makes me wonder why Hillary would begin to think about encouraging small investor interest in the stock market at this point in time.
Several bloggers such as Captain's Quarter's , Cao's blog as well as talk radio have been discussing a nexus between Hillary and speculator George Soros. Whether Soros or others on Wall Street have an interest in seeing an exogenous shock to stimulate stock prices just as the fundamentals are working toward a weakening stock market is a question that deserves some scrutiny.
Another question is what will be the effects, both in terms of actual economic redistribution and in terms of psychology, of the Bush/Clinton proposals to expand stock ownership. The Fed does one thing, increase the money supply. This in turn has two effects: (1)make the rich richer by boosting the stock market because of lower interest rates and (2) make the poor poorer by causing inflation. There is probably some tipping point at which effect (1) becomes outweighed by effect (2) in fact. There is also probably a different tipping point at which effect (1) becomes outweighed by effect (2) in peoples' minds. The two are likely different. If someone has a $100,000 stock account they may be worse off from the net effect of lower interest rates and the higher price of grapefruit, but the higher stock account may be more salient or apparent to them, and they may see themselves as better off. It would not be a far stretch to imagine that Hillary's proposal is linked to the idea of encouraging this kind of wealth illusion, which would have the effect of moderating but not fundamentally changing the effects of Fed policy.
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