$2 Million Per Household Means Doom For Dollar
Daniel R. Amerman, CFA
In Part 1 (link) of this article, we explored the total cost of all United States retirement promises and expectations and found that they added up to a staggering $2 million per household, when we include all the retirement expenses, and look only at households "able" to pay. A promise that will be impossible to keep - so long as a dollar in the future is worth anything close to the value of a dollar today. In this Part II, we will explore just how far the dollar might have to drop to turn those impossible promises into real payments to retirees.
A Failure To Connect The Inflation Dots
To understand how the impossible becomes the possible (and by definition - it must), we have to remember something fundamental that too many economists have been leaving out of their long-term projections - the inflation rate is not independent of the dollar. Inflation rates don't exist in some independent, mathematical universe, where we can assume the recent past will endlessly repeat itself - rather, inflation is the rate of change in the exchange rate between symbols and reality, and inflation is therefore the mechanism through which symbols will be forced to converge with reality.
There are fundamental limits on reality, with reality being the amount of resources that a society is producing at any time. There are no limits (unfortunately) on symbols or promises, with the amount of dollars that can be created at any one time representing a decision about symbols, rather than resources. So, if the promised symbols get out of whack with the reality of actual resources - it is the symbols which must do the adjusting necessary to bridge the gap. Which brings us to the chart below:
I think we can all agree that $2 million per household is not reasonable. If we pick a long-term inflation rate of 3% as being reasonable because it roughly corresponds to the recent experience of one nation - then it still leads to an impossible outcome of over $1 million per household (which also brings us back to current dollars). Which then means that 3% is also an impossible inflation assumption. An outcome of $750 thousand per household looks impossibly high as well, meaning that a 5% inflation rate is impossibly low. (There is implicit index "management" in this chart, as discussed below.)
However, once we raise our inflation assumption to 8%, then we are down below the USA Today projection, with "only" $429,000 per "able" household. A feat we accomplish by dropping the value of the dollar to 21 cents within the next 20 years. Interestingly enough, we are now approximately in the recent historical range for US inflation, and we can see what kind of results that scenario can have on investment returns. In June of 1972 the DJIA stood at 929 and exactly ten years later, over a decade where inflation averaged 8.7%, the index was at a level of 812. Adjusting for the dollar losing 57% of its value over those 10 years, that means the index lost 62% of its value over a ten year period, in "real dollar" or purchasing power terms (exclusive of dividends).
Unfortunately, that scenario may turn out to be too optimistic for current circumstances, for $429,000 is still way too high. The average US household owes a total of about $112,000 in total debt. Let's say that it is reasonable that total payments per household over the decades ahead will be equal to roughly the value of their current debts. When we look that up on the chart - a 15% rate of inflation does indeed bring the total inflation-adjusted obligations per household down to $122,000. With a side effect of making the dollar worth 6 cents within the next 20 years. (The $112,000 used in the USA Today article isn't really comparable with the $122,000 figure, as the first is debt balance and the second is total "debt" payments. That said, when we remember that the $122,000 per household is on top of all current income taxes, Social Security and Medicare as well as mortgage, car, credit card and other debt payments, then it may be pushing the limits of what can be done.)
What Government Controls - And What It Doesn't
There is of course a problem with the perspective above - retirees are expecting real wealth in the form of goods and services, rather than just dollars. Meeting those expectations at the levels promised by the government will indeed be impossible, unless economic growth reaches all new levels. The government doesn't actually control economic growth, the private sector does. Therefore - absent an extraordinary long term surge in productivity growth rates - the promises will need to be broken in substance, and the government likely won't have much choice about that. However, it would highly inconvenient for all levels of government and the large corporations to legally break the retirement promises.
Therefore, there will be an overwhelming incentive for the government to meet the promises in form though not in substance, through using what it does control. Which is both the supply of dollars - and the indexes which are used to determine the fulfillment of inflation-indexed promises. Slash the value of the dollar and dollar denominated promises can be met. Slash the value of the official index versus the real value of the dollar, have the official rate of inflation be substantively less than the real rate, have the difference between the two rates compound over the years ahead, and the indexed promises are met. With meetings occurring in form through what the government does control, albeit not in substance with what the government does not. (With the side effect of drastically boosting tax revenues through inflation taxes as covered in the article "Seizing Your Assets To Cover Retirement Promises", available in the archives here or at the author's website.)
(The chart in the section above is an illustration which does implicitly show index "management" by the government, with differing real and official inflation rates. Our $2 million total comes from assuming a 3% official inflation rate. If real inflation is 3%, then we get real costs in current dollars, which is $1.1 million per household, in that simplified example. As we then increase our inflation assumptions by going down the chart, what we are doing then is increasing the differential between official and real inflation, which decreases the cost of meeting inflation-indexed promises.)
It all comes back to the very basics. We've promised more dollars than there are resources to back them up. Too many dollars chasing too few resources means inflation. The sum of our promises is an extraordinary $2 million or so (give or take half million) per household of working age and above the poverty line. Which means we will need an extraordinary amount of inflation to reconcile dollar promises and actual resources.
Economics Are Not Impersonal
There is one more factor that is routinely left of the long-term projections, that goes right back to Adam Smith and the very foundations of modern economics. People act in their own self interests. Let's say you are a younger worker, there are tens of millions of Boomers trying to collect money from you, and you are looking at the chart below:
The chart is of course identical to the previous one, other than the title. The change in title may, however, show the single greatest danger to Boomer retirement wealth expectations. If you are a younger worker, and you are in control of the economy - how much will you want to pay?
Two basic principles of economics come into play here. The first is that inflation generally redistributes wealth from creditors to debtors. A second and related basic principle, is that big bursts of inflation usually redistribute wealth from older people to younger people. The older portion of the population typically owns a disproportionate share of the money, as they have been saving and investing for many years. When the value of the dollar plummets, the value of all their previous savings and years of works plummets along with it. Worse, retirees or workers late in life won't typically have the years of income at new price levels needed to replace there losses - so they now face a future of impoverishment, their savings permanently destroyed.
This destruction of the value of the savings is a substantial benefit to many younger workers. They are more likely to have debts than substantial savings, so the inflation may improve their real net worth, as more debts are wiped out than assets. They rely on their current incomes to support their spending, and because their incomes rise with inflation, they do not take a hit in their ability to consume. Indeed, because they now have less competition for homes, cars, meals and other goods from the retirees (for the retirees have been impoverished), the current workers are able to enjoy more consumption than they could before the inflation occurred.
(If you are a Baby Boomer, then you may want to reread the two preceding paragraphs several times. What you have just read is what basic economics says is all too likely to be your future - unless you are prepared.)
When we add motivation and people acting their self-interests to the feature, then the case for the destruction of the dollar grows stronger still. Without a high rate of inflation - we have the largest attempted intergenerational resources grab in US history, as the Boomers attempt to collect exponentially compounded returns on their own work product over the previous decades, by using both their private dollars and the public promises they have made to themselves through current laws, to take huge bites out of the current goods and services that will be produced by the younger workers in the future.
The hole in the plan - is that the attempted grab is necessarily a claim on symbols, rather than directly on real goods and services. The workers who are producing the real wealth of the future will have an overwhelming incentive to slash the value of that symbol (the dollar) - because they don't have the assets to lose, but they have all the benefits to gain. From the perspective of the following generations, the question will not be how much they are capable of paying - but how little they can get away with paying. With inflation being a fundamental economic force that the following generations will use to fend off the Baby Boom's attempted resource grab.
If You Can't Beat Them - Join Them
The retirees of the future have expectations for symbolic wealth in retirement that likely greatly exceed actual resources that will be available. Too many people attempting to cash out too much paper wealth over a period of decades will have all too of predicable results on the value of the paper wealth, whether we call it dollars, stocks, bonds, or government retirement plans. The first and most obvious step then is to choose to invest in the reality of tangible assets rather than symbols. These tangible assets could be gold, silver, or real estate, to name some of the most prominent examples.
In combination with the tangible asset step, there is a second step to take as well, whether you are a Boomer, or older or younger - and that is to change your alliance. Instead of being part of a vast herd of Boomers marching in lockstep towards a future of broken retirement and investment promises - change your investment strategy so that you will be profiting from the upcoming promise breaking. If it is in the economic self-interest of the generations behind the Boomers to destroy the value of the symbols - then change your choice of allies, and align yourself with the self-interests of those who will be paying for the Boomer's retirement promises.
This will mean looking inflation straight in the eye and saying: "Inflation, you are likely to play a big role in my personal future, and instead of ignoring you or thoughtlessly flailing away at you - I will study you and your ways. I will learn the deeply unfair ways in which you redistribute wealth, and the counterintuitive lessons about how some investors will be destroyed by inflation and repeatedly pay taxes for the privilege, even while other investors are claiming real wealth on a tax-free basis. I will learn to position myself so that you redistribute wealth to me, and the worse the financial devastation you wreak - the more my personal real net worth grows. I will examine the official blindness to inflation within government tax policy that creates the Inflation Tax, and instead of raging or despairing, I will understand that a blind opponent is a weak opponent, and I will take advantage your blindness and use tax policy to multiply my real wealth."
It truly does boil down to common sense. The impossible is approaching fast, and we each have the choice of positioning ourselves so that our financial well-being depends on impossible promises being kept - or positioning ourselves so that we will profit from those impossible promises being broken. As you decide, do keep in mind that some of the most lucrative long-term and tax-advantaged opportunities to profit from inflation that have been available for decades can be found right now, but, by the time resurgent inflation dominates the headlines - the easy arbitrage opportunities will be long gone.
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