23 October 2012

The True Burden

We have a rapidly growing problem in America that is far larger than the public debt.

Whatever the Federal, state or local governments might owe, that’s their problem.  The source of their funds to satisfy their debts relies almost entirely on the wealth of the household that they tax (be it household income or assets).  Therefore, the ultimate review of our nation’s viability must be about how healthy the household is.  In my view, the survival of everything else rests on the survival of the household.

So I look at it as a sort of end-game process, if you will.  When we are younger, we work.  That subsidizes being alive in that time.  But ultimately, the wealth we accumulate along that way must be adequate to fund that end-game – the years that we no longer work.  So the following is my methodology for how I look at that (it's a little dense, but if you can get through the next couple-few paragraphs, you'll do fine).

I look at the US household’s true burden as a function of how much A) net financial wealth we have as a multiple of B) an expected adjusted disposable income stream it must ultimately subsidize.

A – Net financial wealth. Total financial assets, less total liabilities.  Total financial assets are all deposits, money market instruments; credit market instruments (e.g. treasury securities, savings bonds, municipals, corporates, mortgage notes, agencies, etc.); stocks and mutual fund shares; life insurance and pension fund reserves; and equity in noncorporate businesses (e.g. the net worth of the shop mom and pop own).  It’s basically everything a household owns, other than the house, the car, your comic book collection… assets that can be readily liquidated.  Total liabilities for the household are mostly the mortgage.  [All of this data can be found in the Federal Reserve’s Flow of Funds report, table L.100.]

B – Expected adjusted disposable income.  Our quality of life during our retirement years is going to be financially dependent on whether it can maintain the income we had grown accustomed to during our working years.  So I start with disposable income (what's left after the government takes its share).  From that, I subtract Social Security disbursements.  Why?  Because we are trying to come up with a number that must be covered, that social subsidies do not.  Remember, this is now the income that is no longer there, because you aren't working anymore.  [My present shortcoming here is, I haven’t figured out how to think about Medicare payments yet, especially as health care costs are demonstrably different vis-a-vis age.  This data is from the Bureau of Economic Analysis and Treasury budget statements.]

So as I said, my barometer of the true household burden is basically A as a multiple of B.  But let me expound a bit more on B… B is the total cumulative expected shortfall in income, net of Social Security payments, during the entire period of our retirement.  [And another shortcoming here is that, I just use a flat 65, for retirement age, when clearly it is ~65-67, but I haven’t figured out how to feather that in yet.  That won't change the analysis much though.]

In 1950, there were 12 million people, or 8% of population, over the age of 65.  Today there are 41 million, or 13%, and that is expected to max out at around 20% in about 20 years from now (per a Congressional study I read).

In 1950, people died on average at age 68.  Now they die on average at age 78.  In 20 years, that will be more like ~80-81 (per that same study).

In other words, all the household wealth in existence in 1950 only had to cover three years of retirement, and for only 8% of us.  Today, our wealth now must cover 13 years of retirement, and for 13% of us.  So just because people live longer and more (baby boomers) are now retiring, that burden has increased to an effective ~7 times that of 1950.  Extrapolating out to 2030, that burden is then estimated to have become ~13 times that of 1950.

This unsustainable burden is a simple function of improved health and thus longevity.  If we want to continue social subsidies as billed, we need to raise taxes.  Otherwise we must cut subsidies, lengthen the retirement age (same thing), or just give old people a hunting knife and a sleeping bag and send them off into the woods to fend for themselves at some point.

Neither option endorsed gets anyone elected, does it?  Thus why we continue to not have that conversation.

So I think the graph (below, through Q2 2012) says it all.  In 1950, household wealth after all liabilities was enough to cover 12 years’ worth of disposable income, net of Social Security, for retirees that only lived three years past retirement.  Today, our wealth now covers only three years for retirees that live ~13 years or so past retirement.

Am I being unfair, because I only use net financial wealth?  OK, sell the house, have a yard sale.  It’s the same disturbing trend.  Total net wealth in 1950 covered ~20 of only three required years then, and only five of 13 required years now... 

[As a quick aside... notice in the charts how little the massive bubbles in the stock markets of the late 1990s and the housing markets of the mid 2000s did anything to wealth appreciation relative to this growing retirement burden.  Scary, huh?]

And here’s the worst kicker of all that… most of that wealth is owned by just a small group of people.  The top 1% population owns one-third of all our wealth.  The top 20% owns four-fifths of it.  So unless they all suddenly become lavishly charitable, redistribution will become a growing theme whether we like it or not.

Either way you slice it, we are completely upside down.  This is the real dilemma, not Federal debt rising in abruptly in recent years to $16 trillion.  The total subsidy (Social Security, Medicare, et al.) is a potential ~$40-50 trillion problem going forward.  And that’s just the subsidy that’s supposed to support our retirement years.  Which I hope you get, this entire analysis is just about the part that those effectively bankrupt systems don’t subsidize.

Basically, population and age inflation just outstripped net asset price inflation.  There simply isn’t enough pie around for everyone anymore, given a maturing population and rate of output, no matter how you cut it.  So unless we figure out a way to get back to consistent ~4-5%+  GDP growth going forward, our standard of living must decline.  Or our population.  Or our longevity.  Or all of the above.  And regardless of what redistribution we engineer.

Which means that, unless we reinvent another industrial boom (which isn’t out of the picture), this nation is headed toward some serious societal conflict in the decades to come.

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