What happens to retirement portfolios when the government can’t pay for Social Security and Medicare, the real economy has moved to China, and tax rates are rising fast? Financial expert Daniel Amerman, CFA, introduces a different perspective on long term financial security.

Link:  Looting Social Security by Paul Craig Roberts

Hank Paulson, the Gold Sacks bankster/US Treasury Secretary, who deregulated the financial system, caused a world crisis that wrecked the prospects of foreign banks and governments, caused millions of Americans to lose retirement savings, homes, and jobs, and left taxpayers burdened with multi-trillions of dollars of new US debt, is still not in jail. He is writing in the New York Times urging that the mess he caused be fixed by taking away from working Americans the Social Security and Medicare for which they have paid in earmarked taxes all their working lives.

Wall Street’s approach to the poor has always been to drive them deeper into the ground.

As there is no money to be made from the poor, Wall Street fleeces them by yanking away their entitlements. It has always been thus. During the Reagan administration, Wall Street decided to boost the values of its bond and stock portfolios by using Social Security revenues to lower budget deficits. Wall Street figured that lower deficits would mean lower interest rates and higher bond and stock prices.

Two Wall Street henchmen, Alan Greenspan and David Stockman, set up the Social Security raid in this way: The Carter administration had put Social Security in the black for the foreseeable future by establishing a schedule for future Social Security payroll tax increases. Greenspan and Stockman conspired to phase in the payroll tax increases earlier than was needed in order to gain surplus Social Security revenues that could be used to finance other government spending, thus reducing the budget deficit. They sold it to President Reagan as “putting Social Security on a sound basis.”

Along the way Americans were told that the surplus revenues were going into a special Social Security trust fund at the U.S. Treasury. But what is in the fund is Treasury IOUs for the spent revenues. When the “trust funds” are needed to pay Social Security benefits, the Treasury will have to sell more debt in order to redeem the IOUs.

Social Security was mugged again during the Clinton administration when the Boskin Commission jimmied the Consumer Price Index in order to reduce the inflation adjustments that Social Security recipients receive, thus diverting money from Social Security retirees to other uses.

We constantly hear from Wall Street gangsters and from Republicans and an occasional Democrat that Social Security and Medicare are a form of welfare that we can’t afford, an “unfunded liability.” This is a lie. Social Security is funded with an earmarked tax. People pay for Social Security and Medicare all their working lives. It is a pay-as-you-go system in which the taxes paid by those working fund those who are retired.

Currently these systems are not in deficit. The problem is that government is using earmarked revenues for other purposes. Indeed, since the 1980s Social Security revenues have been used to fund general government. Today Social Security revenues are being used to fund trillion dollar bailouts for Wall Street and to fund the Bush/Obama wars of aggression against Muslims.

Having diverted Social Security revenues to war and Wall Street, Paulson says there is no alternative but to take the promised benefits away from those who have paid for them.

Republicans have extraordinary animosity toward the poor. In an effort to talk retirees out of their support systems, Republicans frequently describe Social Security as a Ponzi scheme and “unsustainable.” They ought to know. The phony trust fund, which they set up to hide the fact that Wall Street and the Pentagon are running off with Social Security revenues, is a Ponzi scheme. Social Security itself has been with us since the 1930s and has yet to wreck our lives and budget. But it only took Hank Paulson’s derivative Ponzi scheme and its bailout a few years to inflict irreparable damage on our lives and budget.

Years ago with stagflation defeated and a rising stock market, I favored privatizing Social Security as a way of creating a funded retirement system and producing greater savings and larger incomes for retirees. At that time Wall Street was interested, not for my reasons, but in order to collect the fees from managing the funds.

Had Social Security been privatized, I doubt that Wall Street would have been permitted to deregulate the financial system. Too much would have been at stake.

After the latest crisis brought on by Wall Street’s dishonesty and greed, trusting Wall Street to manage anyone’s old age pension requires a leap of faith that no intelligent person can make.

Wall Street has got away with its raid on the public treasury. Now, pockets full, it wants to pay for the heist by curtailing Social Security and Medicare. Having deprived the working population of homes, jobs, and health care, Wall Street is now after the elderly’s old age security.

Social Security, formerly an untouchable “third rail of politics,” is now “unsustainable,” while the real unsustainables–a pre-1929 unregulated financial system and open-ended multi-trillion dollar Global War Against Terror–are the new untouchables. This transformation signals the complete capture of American democracy by an oligarchy of special interests.

Paul Craig Roberts was an editor of the Wall Street Journal and an Assistant Secretary of the U.S. Treasury.

Link: “Surviving The Cure For Asset Deflation” by Daniel R. Amerman, FSU Editorial 12/03/2009

Many people would say that the true lesson of the early 2000s in the United States is the demonstration what an extraordinarily loose credit policy can do in terms of asset prices. Low cost and easily obtainable mortgages led to a real estate bubble, even as easy and loose corporate bond markets led to a booming private equity market, with leveraged buyouts being an important factor in maintaining an overvalued stock market.

The problem is that Wall Street, the government, and much of America has effectively bet everything they have on these asset bubbles not only staying inflated, but continuing to expand. Pensions long ago became “the tail that wags the dog”, for state governments, local governments and most major corporations. Almost every state and local government in the US that has full time employees has entered into promises for future benefits, which it anticipates being unable to cover from ongoing tax revenues. Some of these promises are unfunded, others are fully “funded” (meaning they have adequate current portfolios given the investment return assumptions), but the mechanism all comes down to the same thing. Via the mechanism of the markets, vast sums of money and resources will flow from the outside economy into the local economies for all the states and cities, and will pay for the legally binding promises that would otherwise be unaffordable from current revenues. In other words – the asset bubbles have to not only be maintained, but must continue to inflate, or else the pension obligations bankrupt every level of state and local government.

Governments aren’t the only ones relying on asset bubbles, so are most of the major corporations. Oh, the defined benefit plans are disappearing fast in terms of the ability of workers today to participate, but there are still tens of millions of workers covered, and many trillions of dollars of pension and health care benefits that will have to be paid. Future benefits that would destroy corporate profitability, and drive many corporations into bankruptcy.

The government doesn’t control the value of assets, but it does control the value of the dollar. It can do something that actually fools almost all of the people almost all of the time. The government can devalue the dollar. It can create inflation. What the government can do is it can take that hundred thousand dollar asset, that wants to fall to $20,000 in real terms, and let it fall, but still make it worth $200,000 in nominal terms simply by devaluing what each of those dollars are worth. Which means the homeowners are no longer underwater, and the banks are no longer insolvent.

… so long as the purchasing power of money is destroyed faster than the purchasing power of assets, an illusion of asset inflation is created.

An illusion that is potentially deadly for your investments and standard of living for the next several decades – but which is impossible to see through if you take the most common approach to looking at inflation or deflation, which is that it must be one or the other.

…consider the dilemma of the pension funds. It could be the State of California, or your local city government, or just about any major corporation that has been around for several decades. Legally binding promises have been made based on the belief that markets always rise and reliably compound wealth. (I wrote my first book pointing out what an exceptionally bad and historically unsupported idea that was, back in 1993.) So for example’s sake, if the market value of a portfolio doesn’t rise from $35 billion to $50 billion, then the pension sponsor is in serious trouble. Enter asset deflation, and the portfolio goes down to $25 billion, and refuses to go back up. An event that leads to systemic bankruptcy of every level of state and local government and corporation in the United States with major pension obligations.

Unless, as illustrated above, a dollar becomes worth 50 cents. Asset deflation is entirely covered by monetary inflation. Rephrased, the destruction of half of the value of the pension fund (and your) assets is entirely hidden by the destruction of half of the value of your money. Everybody is legally solvent again.

…if you are unwilling to be fooled again, and you are willing to roll up your sleeves and learn, then an unfair world transforms into a world of opportunity. Because here is the real essence of inflation and deflation: they are both REDISTRIBUTIONS of wealth. In each case, and particularly when the two occur together as illustrated in this article – there is a fundamental redistribution of wealth within society. With some people doing much better and others doing much worse.

This fundamental redistribution is more dangerous for some than others. Generally speaking, the higher the degree of monetary inflation and asset deflation, the more the older segment of the population is disproportionately devastated. For the reason that older savers have the savings & portfolios to lose, but lack the decades of peak personal career earnings needed to replace the assets. Which is deeply, totally unfair, but it is the way of the world.

With knowledge, the redistributions can flow to you, rather than away from you. The greater the degree of inflation – the more wealth that fundamental economic forces will redistribute to you. Understand how the redistributions work – and a potentially catastrophic degree of inflation can become the single most financially lucrative event of your lifetime.

But for this to happen, two uncommon steps have to be taken, which will separate you from most of your peers. You have to fully accept personal responsibility for your own future, and say “I won’t be fooled again”. Then you have to make the choice to learn how to turn societal deceptions into personal opportunity.

For the United States, John Mauldin says that we must open the borders to allow more people to immigrate. Unfortunately, the policy conflict between opening the borders and maintaining a war against terrorism is glaringly obvious.

More immigration can create more revenue for Social Security and Medicare. Obviously, the U.S. Government is allowing immigrants to enter the U.S.  However, it seems a deceptive way to make amends for the unsustainable promises made by our leaders.

Link: A Conversation with John – Thoughts from the Frontline Weekly Newsletter – John Mauldin

Demographic changes are predictable: we know how many people are going to be here in forty years because they’re already born. We know how many forty-year-olds we’ll have in forty years because they’re already born. So, we can see these changes coming at us.

If you’re Japan, you’re walking into a demographic nightmare. Russia is a demographic train wreck. And it’s not going to be but a few decades, in the grand scheme of things, until Iran will have more people than Russia. That’s got to be fit into your equations. You’ve got to look at these large, broad changes that are happening.

In the US, we’re going to be running into the freight train of Medicare and Social Security. There’s just not any way to get around it. We’re going to have to make tough generational decisions about how to handle that. And how we handle it is going to have enormous implications for our economy. If we handle it the way it’s likely to be handled – which is by raising taxes – then we have said we’re making a decision, conscious or not, that we’re going to become Europe. That means high residual unemployment and difficult, slower growth of individual opportunities.

There are other large changes when you talk about the demographic issues. Europe would have to take massive numbers of immigrants in order to support their system. They’re just not prepared for that. Neither is Japan. The US is blessed with a world population that wants to come here and are not very culturally different from us – especially the Hispanic populations. We’re going to need those immigrants. I think that one of the most economically suicidal things we’re doing today is trying to figure out how to close the borders. We need to be doing the opposite. We need to figure out how to open the borders. It needs to be a more rational policy than we have now. Again, you have to put those things into the financial equations.

Link: Half of Americans at risk for not having enough in retirement, survey says – Boston.com

That’s the case even if they work until 65 – two years beyond the current average retirement age – and take a reverse mortgage on their home and use all their assets, including the mortgage proceeds, to buy an inflation-adjusted lifetime annuity to maximize their income.

In 2004, about 43 percent of households were considered at risk, based on the center’s analysis of a triennial Federal Reserve survey of consumer finances. In 2007, the number rose to 44 percent, the center now estimates, based on that year’s Fed survey. Without waiting for 2010 survey, the center’s researchers decided to update the index in response to the recent recession and economic crisis.

The index needed updating because the 2007 survey “reflects a world that no longer exists,’’ the center’s report says, with the Dow Jones Industrial Average near 14,000 and housing prices only slightly off their peak.

Admittedly, the new 51 percent figure is based not on actual Fed survey results but on the center’s projections of what they would have been in the second quarter of 2009. Since then, financial conditions have improved. The index does not factor in possible income from work in retirement.

Still, while stocks are bouncing back, home prices are unlikely to shoot up again. With people living longer, the Social Security full-retirement age increasing gradually to 67, and low interest rates keeping annuity payouts low, the analysis “clearly indicates that this nation needs more retirement savings,’’ the center’s report says.

“We are clearly facing a retirement crisis – one that will continue to grow as younger workers age,’’ said Alicia Munnell, director of the center. “To overcome today’s retirement challenges, people need help understanding financial topics so they can make reasonable financial choices throughout their lives.’’

Many Americans are reacting to the economic downturn not by resolving to save more but by no longer actively planning for retirement. A survey by Nationwide Insurance, which underwrites the retirement risk index, found the number of such “disengaged’’ Americans increasing by more than a third. “That’s exactly the opposite of what they should be doing,’’ said Paul Ballew, senior vice president at Nationwide.

Also, the percentage of Americans in employment-based retirement plans decreased from 41.5 percent to 40.4 percent in 2008, according to the Employment Benefit Research Institute.

On that note, anyone concerned about retirement income should think about the future in terms of purchasing power. If inflation jumps up to 10% (it reached 19% in 1981), money in savings accounts will be devastated. Inflation transfers wealth from retirees to workers.

Link: $300,000 of Gold, in the Palm of My Hand

The longer the Fed keeps interest rates at zero, the more worthless paper money becomes. That creates the impression that gold is more valuable — in fact, this week it hit all-time highs at almost $1,100 per ounce as the Fed announced the indefinite continuation of its zero-rate policy. But that’s not gold becoming more valuable. That’s the paper money in which the price of gold is denominated becoming less valuable.

In other words, gold is the constant. Its value doesn’t change. Its dollar price changes, but not its value. So when investors come to me and ask me how they can hedge against the falling value of the dollar, I always tell them to buy gold.

You can’t escape the falling dollar by buying other currencies like the euro or the yen. They’re just paper, too. Lately they’ve looked strong versus the dollar. But in the end, they’re just paper.

And you can’t escape with stocks. Fine, stocks are up something like 60% since the March bottom. But that’s only if you price stocks in dollars. Try pricing stocks in gold — in other words, how many ounces of gold will one unit of the S&P 500 or the Dow Jones Industrial Average buy? If you think about it that way, with gold now at all-time highs, then stocks are really only up about 34%.

OK, 34% is great. But think of the risk you took to get it. And remember that in terms of real purchasing power — the ability to buy an ounce of gold, to acquire real value — stocks only went up about half as much as it seems on the surface. The other half is just the value of the dollar collapsing.

It’s going to get worse. The Fed is going to keep rates at zero just about forever. The government isn’t going to stop spending. As I wrote here a couple of weeks ago, Treasury Secretary Tim Geithner is going to try to make the dollar even cheaper by getting exporting nations like China to raise the value of their currencies.

So it’s like I’ve been saying here for a couple years now. Buy gold. It’s that simple.

Link: Invest in Silver Over Gold – Seeking Alpha

As we get closer to the day inflation kicks into full force, it is worth noting some common gold:silver ratios. History has more or less showed us that the historical ratio has averaged between 20:1 – 25:1 (depending on the measured time horizon). I personally like to break it down using different ratios for periods of low to moderate inflation and high and double digit rates of inflation. As a rule of thumb for times of low to moderate rates of inflation (below 5 or 6%), I use a ratio between 45:1- 55:1. During times of high to double digit inflation (late 70′s style) I revert back to the historical ratios between 15:1-30:1. Given the current low level of “headline inflation” (which is nonsense anyway), which has to inevitably rise over the coming decade, silver is very attractive on the gold:silver ratio, currently at 64.36. Though inflation is said to be “very low” (according to the governments convoluted measure), my expectation for it rise sharply over the coming years, makes silver an absolute bargain.

Take a conservative estimate of the future gold price when inflation is in full force, say $1300/oz, silver using a ratio between 25:1 to 40:1, would give you a price somewhere between $32.5 and $52.5. It need not even be take that far to see the price appreciation potential. Assume the price of gold remains at $1060/oz throughout the time when inflation plagues consumer prices, silver should still be between $26.5-$42, which is a substantial rise on a percentage basis.

The Supply-Demand dynamics favor silver by a mile for one simple reason but important reason, discussed in detail in my previous article Silver Unmasked. The past decade of research has uncovered the vast array of applications from medical to technological uses, many of which will become the “gold standard” in various fields. The article briefly discussed the lack of reserves near the earth’s surface and the implications to future price of this metal. So in other words, while gold may be the ideal inflationary hedge, silver is a close second but also has a long term catalyst (increasing industrial uses) to make silver a likely outperformer. Gold lacks industrial demand almost altogether, and is often recycled. Silver has and will have increasing industrial uses from such products as the silver-oxide battery, which will take substantial market share from the much inferior batteries “lithium Ion” currently used.

Though the first two measures have been successfully used by many investors (especially gold and silver bugs), I would just like to add a recent regression analysis I ran using 6 years of weekly gold and silver prices (Jan 2002 – Feb 2008), proved very statistically significant (the time period was chosen as it was a time of low to moderate inflation). Of the nearly 300 observations, the regression output using the equation Y= -2.7571 + .022929(X) (Silver = -2.757 + .022929 * the market price of gold), had an extremely high systematic relationship of 96.9%. In other words, only 3.1% of the equation mentioned above was unrelated to the price of gold. I also did random sampling, taking the weekly gold price in February over the six years measure, which forecasted what the price of silver SHOULD be given the prevailing gold price. The mean difference was 3.4%, which is much higher than I would have expected. It is not to say that I buy into this analysis, but it is just another tool in the toolbox now. According to the derived equation, silver should be trading at $22/oz.

Conclusion: Using 3 basic methods in an attempt to figure out the relatively undervalued metal, silver is sharply undervalued given the current spot price of $1060/oz for gold. The closest estimate of what silver should be relative to gold, means silver is 30% undervalued (at minimum).

Individuals whose employer pension is based on a defined benefit plan may want to plan to supplement their retirement income from other sources. The choice of how to save and invest is more complex than ever. These are challenging times for investors and future retirees.

Link: Steep Losses Pose Crisis for Pensions – Washington Post

The financial crisis has blown a hole in the rosy forecasts of pension funds that cover teachers, police officers and other government employees, casting into doubt as never before whether these public systems will be able to keep their promises to future generations of retirees.

The upheaval on Wall Street has deluged public pension systems with losses that government officials and consultants increasingly say are insurmountable unless pension managers fundamentally rethink how they pay out benefits or make money or both.

Within 15 years, public systems on average will have less half the money they need to pay pension benefits, according to an analysis by Pricewaterhouse Coopers. Other analysts say funding levels could hit that low within a decade.

After losing about $1 trillion in the markets, state and local governments are facing a devil’s choice: Either slash retirement benefits or pursue high-return investments that come with high risk.

The urgent need for outsize returns by these vast public pension funds, which must hit high investment targets year after year to keep pace with rising retirement costs, is in turn fueling a renewed appetite for risk on Wall Street.

Before the crisis, many public pension funds had experimented with risky trading techniques or committed more of their money to hedge funds and other nontraditional firms, which in turn invested some of it in complex mortgage securities. When these melted down, pension funds got burned.

Now, facing an even bigger funding gap, some systems are investing in the same securities, betting that a rebound in their value will generate huge returns.

“The amount that needs to be made up is enormous,” said Peter Austin, executive director of BNY Mellon Pension Services. “Frankly, they are forced to continue their allocation in these high-return asset classes because that’s their only hope.”

Some pension experts say the funding gap has become so great that no investment strategy can close it and that taxpayers will have to cover the massive bill.

The problem isn’t limited to public pension funds; many corporate pension funds have lost so much ground that they are also pursuing riskier investments. And they, too, could end up a taxpayer burden if they cannot meet their obligations and are taken over by the federal Pension Benefit Guarantee Corp.

Public systems still have enough to meet their current obligations. If governments take no action, retirees could keep drawing full benefits for the foreseeable future even under the most pessimistic projections.

But already, some funds are seeking to trim benefits to conserve money. Some governments have also proposed increasing the amount of public money paid each year into the funds. In practice, however, some political leaders have begun doing the opposite — cutting annual contributions to pension funds — as a way of balancing state and local budgets buffeted in the recession by falling tax revenue and rising costs.

More Risk or Lower Returns

This is the dilemma confounding pension funds as they emerge from the wreckage of the financial crisis: If they shy away from riskier investments, they would be settling for lower returns that leave future shortfalls unaddressed. But by aggressively pursuing the higher rates of return they need, pension funds increase the chances they will be burned again by investment bets gone bad.

“State pension fund directors face enormous pressure trying to recover their investment losses. It will be tempting for them to consider investments that promise a high rate of return,” said Sue Urahn, managing director of the Pew Center on the States, which plans to release a report on pension losses within weeks.

Traditional investment strategies, which rely on stocks, haven’t fared well in recent years. To meet their obligations to retirees, pension funds tend to assume they will earn an eight percent return on investments each year. The stock market, as measured by the Standard & Poor’s 500-stock index, is actually down 32 percent this decade.

If your employer contributes to a defined benefit plan for your retirement, you may not get what you expect. You might need to consider an alternate plan for saving for retirement.

Link: U.S. Employers Face Huge Pension Funding Tabs Without Relief, Watson Wyatt Analysis Finds

Despite recent increases in asset values and regulatory relief from the Internal Revenue Service (IRS), U.S. employers will be required to contribute $89 billion into their defined benefit (DB) plans in 2010 and more than $146 billion in 2011 unless they receive funding relief from the federal government, according to an analysis by Watson Wyatt, a leading global consulting firm.

“The combination of a deep recession and new pension law has landed employers in extraordinary circumstances, and they need temporary funding relief to lessen the enormous pension contributions required in the next few years,” said Mark Warshawsky, director of retirement research at Watson Wyatt, who testified on these points at an October 1 House Ways and Means Committee hearing.

Watson Wyatt analyzed the projected required contributions for single-employer DB plans under various scenarios: the existing law (including the September 25 IRS guidance) and three legislative proposals currently under consideration.

The analysis found that past relief granted by legislation and regulations had lowered required contributions for corporate pension plans to $32 billion in 2009 from $38 billion in 2008. But without further action, employers’ contributions would explode to more than $146 billion in 2011. Under the three legislative proposals, employers’ contributions would be somewhat lower, by $10 billion to $25 billion annually with different time paths, but required contributions would still be very large.

Without additional funding relief, the average regulatory funded status would decline slightly from 96.4 percent in 2008 to 93.8 percent in 2009, and then fall to 83.8 percent in 2010 and to 76.8 percent in 2011, the analysis found.

…

“A crucial decision lies ahead for lawmakers,” said Gene Wickes, global director of benefits consulting at Watson Wyatt. “Congressional and administration support for funding relief would help ensure that DB plans remain viable for employers and a vital element in the retirement security for workers. It could also save employers from making the difficult choice between large, required pension contributions or jobs, wages and capital investment.”

For the funding analysis, please visit: http://www.watsonwyatt.com/us/pubs/insider/showarticle.asp?ArticleID=22407

For the testimony, please visit: http://waysandmeans.house.gov/hearings.asp?formmode=view&id=8071.

via Michael Panzner at Financial Armageddon

Link: The Archdruid Report: The Metastasis of Money.

If economists took a wider view of the history of their discipline than they generally do, they might have noticed that what most of them consider a fundamental feature of all economies worth studying – the centrality of money – is actually a unique feature of an economic era defined by cheap abundant energy. Since the fossil fuels that made that era possible are being extracted at a pace many times the rate at which new supplies are being discovered, current assumptions about the role of money in society may be in for a series of unexpected revisions.

In an ironic way, this process of revision may be fostered by the antics of the world’s industrial nations as they try to forestall the Great Recession by spending money they don’t have. The economic crisis that gripped the world in 2008 was primarily driven by a drastic mismatch between money and wealth. When the price of a rundown suburban house zoomed from $75,000 to $575,000, for example, the change marked a distortion in the yardstick rather than any actual increase in the wealth being measured. That distortion caused every economic decision based on it – for example, a buyer’s willingness to go over his head into debt to buy the house, or a bank’s willingness to lend money on the basis of imaginary equity – to suffer similar distortions. Now that the yardsticks have snapped back to something like their proper length, the results of the distortion have to be cleared out of the economy if the amount of money in the system is once again to reflect the actual amount of wealth.

Yet this is exactly what governments and businesses are doing their level best to forestall. Governments are scrambling to prop up economic activity at a pace the real wealth of their societies can no longer support; banks and businesses are doing everything in their power to divert attention from the fact that a great many of the financial assets propping up their balance sheets were never worth anything in the first place and now, if possible, are worth even less. Both are doing so by the simple expedient of spending money they don’t have. As government deficits worldwide spin out of control and the total notional value of the world’s derivatives market climbs steadily above one quadrillion dollars, the decoupling of money from wealth is even more extreme than it was at the height of the real estate bubble.