Market Reflections

Thoughts, ideas and musings on current state and evolution of financial markets

Social Security and Medicare Need Money to Replace Government IOU’s

The recession dented the financial health of Social Security and Medicare in the past year. According to trustees of these programs Social Security will start paying out more in benefits than it collects in taxes in 2016, one year sooner than projected last year, and the giant trust fund will be depleted completely by 2037, four years sooner.

The Medicare was in even worse shape. The trust fund for hospital expenses will pay out more in benefits than it collects this year and will be insolvent by 2017.

The problem
The trustees report is based on 2008 year-end status. Since then additional 2.7 million payroll jobs have been lost. Unemployment rate is at 25-year high of 8.9% and rising. Long-term unemployment rate, which includes marginally attached, discouraged, part-time for economic reasons workers, is already at 15.8%

Fewer people working means less being paid into the trust funds for Social Security and Medicare. For years, the Social Security trust fund has taken in more than it spent on benefits, resulting in a cushion of billions of dollars that the government could spend on other programs while giving the trust fund an IOU. Since Social Security and Medicare recipients are entitled to money, not IOU’s, the government will need to borrow more at a time when the federal deficit has already exploded to $1.8 trillion for this year, even by White House’s very conservative estimates. This is four times last year’s record deficit.

Medicare’s condition is much more precarious, reflecting the soaring health care costs while the tax collections shrink. This is all happening before the 78 million baby boomers will retire next few years. With recession the retirement is likely to occur earlier rather than later. Obama on Monday praised a pledge by the health care industry to achieve $2 trillion in savings on health care costs over the next decade. It is important to understand that this pledge was not to reduce the health care costs that have been soaring average 7% a year, but only to slow the further inflation to only 5.5%. Please note that all this has nothing to do with Obama’s promise to provide affordable health insurance at least to additional 50 million Americans currently without. Obamacare cost is extra.

Magnitude of the problem
By April 2009 government report there was 141 million people employed; 13.7 million unemployed and 80.5million “not in labor force”. The last category is not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey. At the end of April 2009 there were 51.6 million Social Security recipients. With additional 78 million of baby boomers joining next few years these programs will have about 130 million beneficiaries. For rough, back of the envelope calculation, we’ll assume that the unemployment rate will revert back to about where it is now as “new normal” in the future, when the economy will start chugging along again. That means only 141 million people will be paying into the Social Security program. Average benefit amount is currently about $1100 per month. This means Social Security outlays of $142,560,000,000 ($142 billion) each month in the future when all baby boomers are off the work force. It also means $1,710,720,000,000 ($1.8 trillion) burn-rate a year. To break even, each of the employed in average, has to pay into the fund $1010 per month just in Social Security taxes. Clearly, this is not sustainable unless we can assume average hourly earnings in private sector to increase from current $18.51 almost triple to $42.08 per hour during this recession. It probably is more realistic to assume that the average salary will stay stagnant for few years. That means $80 billion deficit in Social Security program burn rate each month and $1 trillion deficit yearly.

It is important to realize that both Social Security and Medicare are plain and simple Ponzi schemes predicated to perpetual increase of the number of employed workers. With substantial increase of productivity over past decades, erosion of goods producing economic activity and employment (only 19 million left as opposed to 23 million government employees at April 2009), heaviest tax burden of the world, decrease of birth rate in US and severe restrictions on immigration, it is unrealistic to expect increase of employed workers.

Means to fix it
Among other world renowned experts, Paul Krugman, Princeton University’s Nobel Prize-winning economist is of opinion that “Some of the measures that have been taken to deal with the crisis seem to be predicated on the belief that this is going to be a short, short recession,” Krugman said May 12. “Everything says that’s wrong, that this is going to be a sustained period of weakness. The market seems to be looking as if this is going to be an average recession, but it’s not.” Experts, not politicians are of suggesting that we may see some expansion last quarters of 2010 at best. Middle of the road estimates range from 3- 5 years of no growth before we will start seeing real “green shoots”, instead of “yellow weeds”. Conservative outlook sees same in 10 – 15 years instead.

The recession is will probably be long because the economy is down across the world, not only in US, because the foundation of the whole Anglo-Saxon economic system – the banking has failed rather than some isolated component of it. IMF recently revised down their estimate of world economic growth to 1.3% contraction. To spur recovery governments are funding economic stimulus and government spending by more debt. The twelve most industrialized of the world’s G20 countries will have to issue about $10 trillion worth of new bonds to cover the cost of the current crisis. However, Reinhart and Rogoff estimate the true cost at $15 trillion in the best case scenario and a whopping $33 trillion – 1/3 of total global savings – in the worst case. Issuing governments may have to inflate away their debt or pay drastically higher yields if deflation does not materialize. Note, that $33 trillion does not count the US benefit program funding needs. How much more low interest rate government debt can the market absorb? Put the other way, what interest rates will it take for the government to pay back the IOU’s in the Social Security and Medicare systems … with taxpayer’s money, of course.

Political solutions
There are no innovative solutions currently discussed on Capitol Hill. Substantially raising payroll taxes while unemployment is soaring, imposing the infamous carbon tax (about $3100 per family), etc. will only further suppress the business activity and consumer spending. More failed businesses, more bail-outs.
Probably the largest and longest run Ponzi schemes ever, but their fall is inevitable under the weight of 78 million new retirees.

It sure takes enormous courage from a politician to say to current and future retirees – too bad you paid into these programs, but that is what happens if you trust your money with crooks and swindlers running Ponzi schemes; unfortunately, there is no way to recover it. There is no politician on horizon courageous enough to say that, possibly has not born yet. Instead they will try everything to fix it. Earliest, they have to replace the IOU’s with real money. That means more borrowing, further increase in deficits and much larger public debt.

What does it mean to us?
A radical change is required to convert these Ponzi schemes into sustainable programs. There is no political will apparent to embark on that path at this time. The limited arsenal of methods to patch it up and leave the problem for the next one elected will lead to ever growing deficit, ever growing debt, higher borrowing cost, suppression of growth and recovery, less money in your pocket. On that background economics 101 tells us to expect fall of dollar value, much higher energy costs, steep inflation, subdued economic activity and stagnant markets for a long time. It is not going to be “business as usual” for long time, but it is not the end of the world yet if that scenario plays out. Could get much worse if the public sector becomes a controlling shareholder of industry after industry and the totalitarian aspects of socialist environment will creep in. Let’s hope that will not happen.

Few things are obvious. Any means you have get most out of these programs as soon as you can while they still have something to distribute. Find and use all legal means to avoid paying more of your money into these programs. In case you cannot, don’t expect these programs to be there in the form they are today when you need them. Develop alternatives for yourself and your loved ones. Employment in goods producing sectors will erode further until the employment costs equalize with emerging countries. As an example, GM is moving its production to China as part of its reorganization effort. GM is also considering moving its headquarters out of Detroit to a less expensive location in effort to cut costs. Due to imminent Medicare insolvency inefficiencies in health care industry will be in government short-term focus. Adjustments, potentially painful and dumb to the folks employed there are likely. I have yet to discover at least one occasion where the government meddling in any business has produced positive results. I have a prize for you should you bring one to my attention. Yet, health care providers, be aware, government will be interfering.

About The Author

Raymond has been active on financial markets since 1989 mostly trading commodity and currency futures and options. Trading systems and strategies, statistical and empirical modeling of markets have been his focus almost two decades now. Few projects are listed on his website. Raymond believes that every person could and should take responsibility and protect his/her finances. At least to be able to identify scams and fraud before giving life savings to a crook. It is not enough to rely on government because way too often officials (elected or other) are part of the scam themselves. Whether their reasons are campaign contributions, cushy job or lack of knowledge to understand the consequences of their actions none will help the victim. Recent succession of governments each trying to bankrupt the country faster than the previous it may very well happen that the world largest Ponzi schemes Social Security and Medicare will go down with the country. Without prudent financial decisions now one may sorely miss every penny of his/her savings lost to scam artists and “professionals”. To help out Raymond is sharing with users his analysis and views on variety of economic, financial market and trading issues.


One Response to “Social Security and Medicare Need Money to Replace Government IOU’s”

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