Tuesday, March 20, 2012

Government Doesn't Have The Money To Pay Retirement Promises ... And The Household Sector Isn't Setting Enough Aside

There is at least an implicit myth about government and money. The myth is that government has money.

There is a related myth about government's ability to meet its financial obligations. The myth is that government can meet its obligations.

Government promises are only as good as the willingness of future taxpayers to make good on those promises. Since that's in the future, we can only guess what will happen. And guessing is not an appropriate substitute for proper planning.

{Of course, a future government can always print more money, but that doesn't represent real purchasing power. Today we're using the word money to represent something of value.}

On a related note, city governments often are granted money from their state governments, which are provided money by the national government. But none of these governments has any money of its own. It first must take that money from its citizens or borrow it from others. If it borrows, its citizens are required to repay the loans. Hence, it's always on the taxpayers, regardless of which government spends the money or where it gets the money which it spends.

To make the point crystal clear, all governments simply are the collectors and spenders of taxpayer generated money. Hence, all claims, aka debts, on the government are the ultimate responsibility of citizen taxpayers.

So how good a credit risk are these various governments? Well, to be blunt, they're as good as, and only as good as, their future taxpayers' financial capability and willingness to pay. It's as simple as that.

Accordingly, taxpayers have a right as well as a need to know what the various and cumulative future obligations of government represent.

Taxpayers have that right and need to know, because the taxpayers will get the bill for payment.

Thus, if government has acted or currently acts irresponsibly, both current and future taxpayers are on the hook. And the bigger the obligations, the greater the likelihood that the bill will go to future taxpayers instead of the current ones.

Will future taxpayers accept the bill when it's presented? Well, that's up to them.

After noting that most businesses within the private sector have cleaned up their financial situation in recent years, Rearview Stress Tests asks the relevant question, "When do taxpayers get to stress-test the government?" Here's some of what it says:

"With the exception of housing, which is still subject to political attempts to prop up prices, the rest of the private economy is also doing well. Corporate balance sheets are as healthy as they've been in many years. The bond market and private hiring are coming back. Even consumers have shed much of their debt and are doing better, save for the raid on their real incomes from rising food and energy prices. Absent stupid policy, the next economic or financial crisis isn't likely to start with banks or another business bubble."

Then it moves to the federal government:

"The balance sheet to worry about belongs to the U.S. government, which in the name of trying to restore growth threw the party of the century. The Treasury is still rolling out $1.3 trillion deficits, three years into a recovery, and the Federal Reserve is still holding interest rates at near-zero and has tripled its own balance sheet.

Neither institution—much less the White House or Congress—seems to have an exit strategy worth the name. The White House says a big tax increase next year will solve any fiscal woes, and Fed Chairman Ben Bernanke says, well, trust him. . . .

What we don't know, but would like to, is what would happen to the Fed's balance sheet if interest rates rose rapidly, say, to their historic modern norm of about 5%? What really needs a stress test is the government."

Discussion and Analysis

To the above suggested government stress test, I would add the unfunded entitlements, including those of the various cities and states. We'd find that most governments are broke and have made promises that simply can't be kept without a wholesale change in taxes and across the board government spending reductions. We have far too many indebted governments with no current plan or known capability to make good on the future promises they have made on the taxpayers' behalf.

But it's even worse than that. We aren't even articulating a serious intent to get our financial house in order. If you doubt this, just listen to the politicians running for office this year. Who has a plan?

And unfortunately, most taxpayers and households have made no credible plans of their own either.

It's a reasonable estimate that more than $100 trillion in unfunded retirement promises have been made.

And it's also known that individuals and households aren't saving anywhere close to enough to provide for their retirement needs, leaving aside what we will need to set aside to backstop the unfunded government promises.

Summing Up

Of course, nobody knows for certain what will happen with respect to future investment returns. However, we do know that promises have been made to future retirees for which insufficient money has been set aside.

We also know that most pension plans are assuming that future returns will approximate historical results.

And we know that households continue to rely far too much on Social Security promises.

Meanwhile, we know that interest rates are low, debts are high and worldwide economic growth is likely to be subdued for many years.

And what are the politicians saying about all this? Not much.

Meanwhile, We the People close our eyes and hold out hope that the money will be there as promised.

And that brings us--where else--to the workers of tomorrow. Future generations.

My prediction is straightforward; there's a likely train wreck ahead. But when is the question, and that remains to be seen.

That's about all any of us can say with a high level of confidence. Isn't that a shame?

Thanks. Bob.

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