CREF Stock, 5 years ending 31May2005
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1. "Trust fund". There ain't no such animal. If any article or proposal describes how the "trust fund" will kick in and help pay Social Security benefits after about 2017, when current benefits being paid will exceed Social Security taxes being collected, it isn't worth the paper it's printed on. Consign it to the circular file. The ancillary expression, "lockbox", usually mentioned by politicians wanting to preserve the present flawed scheme, identifies the speaker as out of touch with reality and somebody you definitely should not pay any attention to.
Social Security is a welfare program for seniors (full disclosure: I am now receiving these welfare payments). GW Bush himself described it pretty well, in a quote I carried in last month's issue: Now, ....some of you may think there's what they call a Social Security trust: The government collects the money for you, we hold it for you, and when you retire, we pay it to you. But that's not how it works. You pay your payroll tax; we pay for the people who have retired, and if there's any money left over, we spend it on government. That's how it works. And what's left is an empty IOU, a piece of paper.
2. "Social Security surplus". Another mythical creature. Currently, about $130 billion per year more is collected in Social Security taxes than is needed for benefits payments; this will be the case to about 2008, then the so-called "surplus" will gradually decline until the break-even point is reached in about 2017. The illusion is that this "surplus" could be used to fund alternate financing schemes, such as private retirement accounts, without otherwise impacting government or the economy. Fuggetaboutit. Re-read previous GW Bush quote - the "surplus" is spent on government. Diverting it to private retirement accounts would immediately raise the annual Federal budget deficit from about $470 billion to about $600 billion.
3. "Cost-of-living benefits calculation". The Social Security payments "awarded" to you when you retire are currently based on your "contributions" (taxes) adjusted by the wage base, a true measure of the cost-of-living increases that the Feds can't fudge. The move afoot to replace this index with the CPI, which the Feds regularly lie about to understate the true rise in the cost of living, is a cut in benefits by any other name, perhaps by as much as 40% for people just entering the workforce today. (This change alone would probably bring the Social Security system into balance again, but at great loss of popular support, so it probably won't happen.)
4. "Progressive indexation". OK, it may not be a tax increase, but this latest proposal to make proposed changes to Social Security more palatable is certainly a benefits decrease. The way it works: If your income is high enough during your working years that you can afford to set aside your own money for retirement, then your Social Security payments will be a smaller percentage of your working lifetime income than under current formulae. The two problems with this approach are (1) that Social Security retains its political popularity largely because what you collect when you retire (if you live that long) bears some reasonable relationship to what you paid in taxes while you were working, and (2) the projected "rate of return" on Social Security taxes to be paid by workers entering the job market today, under the current system, inflation-adjusted, is a hair above 1%, but if the "indexation" is implemented the rate of return will be strongly negative for upper-middle-class (and higher) wage-earners.
In the "Debt Overhang" booklet that was mailed with the January 1993 issue of The Contrarian's View, I wrote: Because the Social Security system is a political "sacred cow", you can be sure the politicians won't do much until the country is at the brink of a crisis so plain to see that even they cannot ignore it. But given the choice between bankrupting the government and triggering a depression too horrible to imagine, or breaking its retirement "promise", I have no doubt that it's the promise that will go. Isn't this unfair, when you've been planning your life around a promise that will no longer be kept? Sure it is, but politicians are always making and breaking promises.... they even break them with retroactive legislation.... so it's completely in character for them. And even though it will be grossly unfair and it will be a bitter pill to swallow, we will swallow it, because the alternatives are worse: We can accept having the government steal part of our retirement away in taxes, or have all of our savings wiped out in a hyperinflation or the value of our assets demolished in a vicious deflation. All choices make us poorer; which is the least painful? Once the government's retirement promise is broken, the Social Security system will lose its middle-class support and will revert to its original function as a welfare system.
This is the process we're beginning to see now. "Progressive indexation" is the breaking of the politicians' promise that Social Security benefits will be there for you. They will be there for "poor" (lower-income) people who don't have enough money after taxes to save for retirement. As for you, make sure that you don't have a successful career followed by a sudden reversal of fortune just as you reach retirement age, because your Social Security income will be based on your successful years, and you'll be screwed.
This brings me to the one most positive aspect of the current discussions on Social Security, which is ownership. Under the current system, you own nothing. If you live long enough, you collect, and you collect only as long as you live. A few years ago a good friend died at age 62 of pancreatic cancer, while still working as an accountant and before collecting any Social Security benefits. The total benefit? Her widower husband received a $255 death payment. His income, while both were working, was higher than hers, so he was ineligible for any additional Social Security benefit based on her income. Thousands of dollars she paid into "the system", and $255 was all that came out of it on her account.
My favorite quote on the sometimes cruelly unfair nature of the present welfare scheme is from Star Parker: If Social Security did not exist, and we attempted to enact today a system like we currently have, would it pass? The answer is unquestionably no. There is no way that any working American would agree to turn over to the government 12.4 percent of his or her paycheck in exchange for a benefit that has no guarantee, on which ownership has been relinquished and that is less than what could be obtained by buying risk-free government bonds. No way. Zero chance.
The politicos' push toward tax-funded personal retirement accounts is because they know that young people entering the workforce today know that Social Security as constituted today, and with the cuts in benefits that will certainly be needed to bring the system into balance in the 2020s and beyond, is a really bad deal for them. They all look at the stock market returns over the past 50 years and assume (hope?) that the positive return on the private accounts will compensate for the negative inflation-adjusted return of the welfare part of the system. But will it?
There isn't yet any solidifying consensus on what shape the personal retirement accounts will take, so as a reasonable guess let me take one of the proposals set forth by the 2001 bipartisan Final Report of the President's Commission to Strengthen Social Security. In one of their models taxpayers divert 2% of their FICA deductions to a personal retirement account in exchange for accepting an adjustment to the value of their traditional benefit which is equal to their account contributions annually adjusted to (inflation +3.5%). OK, that's a mouthful; in translation, it means that, if the retirement account had a real (inflation-adjusted) rate of return of 4.5%, today's 39-year-old medium-wage worker would retire with about a one-third greater retirement benefit than under present law ($19K annually instead of $14K in 2005 dollars).
So, is that 4.5% real rate of return realistic? Stocks traditionally return 9% to 11% annually, or 5% to 8% after inflation. But history shows that when stocks are bought at historically-high prices the long-term return is close to zero, and actually negative after adjusting for inflation. So if the effect of having people divert part of their Social Security taxes into (primarily) the stock market is to keep stock prices "artificially" high for a long period of time, then the expected return might not materialize, and people might be better off with "traditional" Social Security.... if benefit cuts could be avoided, which they can't.
But even if the assumed personal retirement account returns don't materialize, those accounts would still be a better deal than the current scheme, because of ownership. And it's not necessary that the funds be invested in stocks; the accounts could be restricted to, say, inflation-indexed Treasury bonds (which would have the practical effect of transferring the "trust fund" into marketable securities and into Treasury-obligation debt held by the public), and it still would be a better deal than currently.
It's unlikely any politico would want to adopt the "Nick Chase fix", which is to continually adjust the full-benefit retirement benefits age according to the amount of money currently being paid (and projected to be paid) into the system by workers. Under current demographics that would put the retirement age for a 30-year-old worker at about 75, leaving people to wonder how they're going to get by for the twenty years between the time corporations throw them away in their mid-50s, and the time they start getting their welfare checks.
My other proposal for retirement affluence, ideal for lower-income people, I call "Megabucks Retirement". (The primary Massachusetts lottery, now called "Mass Millions", started out as "Megabucks".) It's not uncommon for ordinary workers to spend $20 per week on state lottery scratch tickets and such. The states pay out about 60% in winnings, and keep the other 40%.
Under my scheme, the states would, instead of keeping that 40%, credit it to the individual retirement account of the gambler. Even if the real rate of return over the years was only 3%, my trusty calculator shows that the lottery-ticket-buyer who began funding his retirement at age 18, at $420 per year in 2005 dollars, would at age 65 have a retirement kitty worth about $43,430 (in 2005 dollars). The $50-per-week gambler would have almost $110,000. Not that I recommend people gamble their meager earnings away, but I know that many do, and it would be far kinder to return part of their money to them, with interest, at retirement than to just suck it up into general tax revenue where it can be misspent. For low-income workers who have only Social Security payments (whatever they turn out to be) when they retire, this could be a welcome supplement. But my idea is too clever and too sensible, so it will never be implemented.
You may think that (some) politicians deserve credit for tackling the Social Security imbalance now, rather than in the next decade when it becomes a really big problem. Not so.... the crisis is immediate; that is, within the next three years, as in 2008 the first of the Baby Boomers retire, and the decreasing Social Security tax revenue (per retiree) from then on enlarges the annual budget deficits
Repairing Social Security is not really an actuarial
problem. There are a number of sound proposals
being floated that would restore it to balance, mostly
using private retirement accounts. But it is certainly a
highly political problem, as many people, perhaps a
majority, are unwilling to exchange a political
promise, which almost certainly can't be kept, for a
partially-private system with investment risk which
most likely would be a better deal, but might not.
Look, we don't have to get into the theory of why deflation can or cannot occur. I go by what I see in the markets and in chart action. The fact is that the stock market has been deflating all year. Now the stock market has been joined by oil, commodity prices, copper, steel, aluminum, gold, Goldman Sachs Natural Resources Index, materials in general.... All debt must be paid off, some debt paid off in a hurry and some paid off over time. But you pay off debt with dollars, and if there's too much debt outstanding and there's pressure to pay off that debt - that's going to create a demand for dollars. The greater the debt, the greater the potential demand for dollars to pay off that debt. - Richard Russell
Greenspan is trapped. He needs to "normalize" rates to encourage saving and investing, otherwise the economy cannot really grow in the future. But he needs to lower them too; otherwise the economy might collapse now. - Bill Bonner
Mark Finn of Vantage Consulting has spent years analyzing trading systems. He is a consultant to large pension funds and Fortune 500 companies. He is one of the more astute analysts of trading systems, managers, and funds that I know. He's put more start-up managers in the business than perhaps anyone in the fund management world. He has a gift for finding new talent and deciding if their ideas have investment merit. He has a team of certifiable mathematical geniuses working for him. They have access to the best pattern recognition software available. They have run price data through every conceivable program and come away with this conclusion: Past performance is not indicative of future results. - John Mauldin
Federal Reserve chairman Alan Greenspan has called the persistence of low yields on long-term Treasury securities even though short-term rates have risen significantly a "conundrum." The chairman's view is not surprising since he and the Fed believe that, despite some wobbles in the first half of this year, the U.S economy is on track for 4-percent growth and stable inflation around 2 percent for the second-half of the year and well into 2006. If markets believed that rosy picture, we would expect yields on ten-year notes to be between 5.5 and 6 percent and stocks to be at higher levels than they were at the start of the year. Instead, yields on ten-year notes are approaching 4 percent and, adjusted for inflation, are close to 1.6 percent--a level consistent with recession. - John H. Makin
The big question now is whether the rosy assessment of the U.S. economy is right or wrong. In our view, it is dead wrong, for two main reasons: First, contrary to perception, the flow of economic data since the beginning of the year suggests the exact opposite; and second, and more important, the U.S. economy's recovery from its recession in 2001 has a precarious foundation in the unsustainable housing bubble and exploding consumer debts, while employment and income growth are calamitously lagging. While scrutinizing the economic data, we first noted a sharp slowdown in consumer spending. Inflation adjusted, it declined slightly in January, by 0.1%. An increase of 0.3% followed in February. Meanwhile, sluggish retail trade figures for March suggest little more than stagnation. With these weak numbers before our eyes, we have been following the public discussion and the Fed's statements about the strong economy with amazement. - Kurt Richebächer
The median family income has risen only 11% after adjusting for inflation since 1990. At the same time, median household spending has jumped 30% and outstanding household debt has jumped 80%. - Jim Puplava
I regret that we ever used stock options. - Bill Gates
The present era has no comparable reference in the past history of capitalism.We have a higher percentage of the intelligentsia engaged in buying and selling pieces of paper and promoting trading activity than in any past era. A lot of what I see now reminds me of Sodom and Gomorrah. - Charlie Munger
The market value of real estate is close to 200% of disposable income now. That ratio's previous high was in the late '80s, when it climbed close to 160%. A ratio close to 200% cannot last more than a few months. It is the equivalent of Nasdaq trading over 5000.... When the history books get written, the corporate crooks of the '90s will have a certain lasting notoriety, and deservedly so. But the villain of our era will most certainly be the man who created and then sustained the biggest bubble the U.S. economy has ever had to deal with: Fed Chairman Alan Greenspan. - Peter Eavis
The growth of home mortgages exploded from an annual rate of $368.3 billion in 2000 to an annual rate of $884.9 billion in 2004, compared with a simultaneous increase in residential building from $446.9 billion to $662.3 billion. Altogether, the United States experienced a credit expansion of close to $10 trillion during these four years. This equates with simultaneous nominal GDP growth of $1.9 trillion. America's financial system is really one gigantic credit-and-debt bubble. - Kurt Richebächer
The Federal Reserve Board has been unable to find any credible purpose for the huge balance sheets built by Fannie and Freddie other than the creation of profit through the exploitation of the market-granted subsidy.... Without the needed restrictions on the size of the GSE [government-sponsored enterprise] balance sheets, we put at risk our ability to preserve safe and sound financial markets in the United States, a key ingredient of support for housing. - Alan Greenspan
The death tax penalizes virtue and rewards vice. For those who save and create wealth so they can leave money to their children, the IRS robs them at death. For those who spend down their wealth on a lavish and ostentatious lifestyle, there is no tax. The best way to avoid the death tax is to die broke and leave nothing for posterity! - Stephen Moore
One of the many conceits of politicians and economists are that they are somehow out of ordinary. They are godlike, or so they pretend, having no other ambition but to make the world a better place. Neither drink, nor meat, nor false witness cross their lips. They sweat for no material gain...and know no lust - save for the betterment of all mankind. They pass laws...they enact codes and regulations...they jiggle this lever and turn another - as if they were the masters of the whole human race, rather than mere parts of it themselves. Since they float above it all, they are not subject to the normal temptations. The rest of us spend our whole lives like animals - craving profits, mates, status, pride, love, and money like a raccoon searching for a garbage pail without a lid. Unless we are kept in tight cages, who knows what we will do? - Bill Bonner
Literally tens of millions of seniors and would-be seniors are totally dependent on the pensions to which they
have regularly contributed. They trust their company and the pension managers to perform to their best
interests...in dollars, anyway.... The dollar is a shrinking measurement. It is shrinking in value, purchasing
power, and faith. This is a situation which is merely history repeating itself, and nothing that I can see, can
correct this situation. The only way the dollar could gain value, purchasing power and faith, is for their
numbers to shrink, and for a responsible government to cease printing them to pay its bills. Pigs will fly first.
Some pension plans have an "inflation," or "cpi", provision in them, which increases the amount paid, as the
Consumer Price Index (cpi) rises, or inflation increases. This is not total security however, as the same
government which prints the money in which the pension plans are denominated, lies about those figures...for
its own benefit. Naturally, or does this shock you? - Don Stott
This snapshot begins almost three months after the popping of the 2000 tech bubble, and stocks at the end of May 2000 were already on the downslope.... I'm not measuring from the bubble top. For stocks, the return is still negative, as you can see below:
CREF Stock, 5 years ending 31May2005
CREF Equity-Index, 5 years ending 31May2005
And here's where the success stories lie: Bonds (still doing well, if they're not junk) and (for the time being) real estate:
CREF Bond, 5 years ending 31May2005
CREF I-I Bond, 5 years ending 31May2005
TIAA Real Estate, 5 years ending 31May2005
Bonds are telling us the future is deflationary. The behavior of the economy (worldwide, not just the U.S.) following the weak recovery of 2002-2004, spells recession ahead. The stock market is saying, "What? Me worry?"
My feeling is that stocks are being propped up by hedge-fund activity and, when needed, government intervention. This "conundrum" (as Alan Greenspan might say) will not last. The stock rally is about over. After a choppy summer, where the stock markets essentially mark time, I expect the message being sent by bonds to win out and stocks will plummet to the extent that intervention fails.... below Dow 9000 for sure, perhaps much lower, in the fall (September - November).
The risk of systemic failure remains at about 15%. In
late June and early July it will rise to about 20% as
hedge funds unwind their "carry trades" due to
incipient interest-rate inversion (short-term rates
catch up to long-term rates). Then my estimate of the
risk of systemic failure reverts to 15% until stocks
go bananas in the fall, when I'll take another look at
it.
A. "Professors' Investment Group (PIG)" - investment club portfolio.
SUMMARY - "PIG":
Original cost: $10,699.00
Present value: $17,109.51
Increase: $ 6,410.51 [+59.92%]
COMMENT on "PIG": There is no change from the last issue.
TIAA/CREF 403(b) retirement plan; I switch between indexed stock/bond/money funds:
(No transactions since June 30, 2004 due to my retired status. Update soon, I hope!)
Values, 31May2005: stock, 189.955; equity-index, 77.50; MM, 22.23; bond, 76.09; inflation-indexed bond, 46.27; real estate, 219.28; TIAA current yield
in SRA, about 5.2%. Current money-market yield is 2.73%.
Gain, 1988: 18.91%; 1989: 14.48%; 1990: 8.28%; 1991: 27.93%; 1992: 10.20%; 1993:
3.08%; 1994: 4.07%; 1995: 4.80%; 1996: 5.28%; 1997: 5.38%; 1998: 5.72%; 1999: 5.12%;
2000: 9.99%; 2001: 1.11%
Gain, January 1 through March 31, 2002: 0.97% (3.86% annual rate of return)
Total gain since January 1, 1988 (14.25 years): 223.43%
Compound annual rate of return: 8.59%
Gain shown excludes the impact of additional monthly cash contributions.
(Please note that I have not had the time to calculate my rate of return beyond March 2002, and
may not get the time until 2005)
Buying CREF stock on January 1, 1988 and holding it gained 422.38%, for a compound annual rate of
return of 11.46%.
COMMENT on NYSE "Timer's Trend": We are currently on a BUY signal of May 17, 2005 (whipsawing!).
COMMENT on NASDAQ "Timer's Trend": We're still on a SELL signal given February 17, 2005.
NEXT ISSUE - will appear near the end of June.