On Borrowed Time

In the vast majority of posts I publish here and at When Giants Fall, I highlight news reports or commentaries written by others. Oftentimes, I include material that I don’t necessarily agree with in its entirety, or that details solutions, for example, that I personally find lacking. For the most part, I assume that people know where I’m coming from and understand that its the essence of the material that matters, rather than the finer details.

In many ways, the first of the following three articles, “Is America About to Go Broke?” by Scott Burns at MSN Money, serves as a good example. On the one hand, I’ve written about and agree with its premise that unfunded retirement and other social safety net obligations are an accident-waiting-to-happen with seriously negative consequences down the road.

On the other hand, I don’t necessarily think that Treasury inflation-protected securities, for instance, are the best way to protect yourself against this particular menace. Among other things, I believe that Washington will have every incentive to change the rules when inflation starts spiraling higher so that TIPS holders won’t have the hedge against rising prices that they thought they had.

Anyway, here is the column:

Government obligations for Social Security and Medicare may soon exceed the combined net worth of every household and nonprofit organization in the country.

Prices dropped last year. But we still need to invest to protect ourselves from inflation. That’s why our retirement-plan investing needs an inflation “tilt.” You’ll understand why in a few paragraphs.

How bad will future inflation be? I don’t know. Neither does anyone else. It could be a normal inflation of 3% to 4% a year. It could also be a banana-republic 10% a month.

What we know is that all governments make promises they can’t fulfill. Our government certainly has. Under both political parties, it has taken promise making to a high art. This is not hyperbole. The figures can be found in regularly published government reports.

Much worse than you probably think

The figures exist, but they are ignored. News reports regularly inform us of the growing federal deficit, projected at a stunning $1.75 trillion for fiscal 2009 and $1.17 trillion for 2010. But regularly reported, less visible government obligations have been growing much faster.

In the nearly five years from January 2003 to December 2007, the Medicare trustees reported that the unfunded liabilities of Social Security and Medicare grew by a stunning $10.4 trillion. The average annual growth topped $2 trillion.

That exceeds the expected formal deficit of $1.75 trillion this year.

In the 2008 trustees’ report (.pdf file), the unfunded liabilities of Social Security and Medicare — promises of future retirement and health care benefits — total $42.9 trillion. In a few days, we should be able to read the 2009 report. It’s a good bet that the unfunded liabilities will show an increase in the new report.

Ironically, payroll tax payments are still large enough that the Social Security and Medicare programs don’t need every dime. The extra money goes into the program trust funds as Treasury debt. The actual cash is spent elsewhere. Basically, the employment tax has been subsidizing other federal spending. This has been going on since the 1983 “reform” of Social Security, a disaster chaired by Alan Greenspan, later the Federal Reserve chairman.

Today’s deficits? That’s nothing

Last year’s Social Security trustee report estimates that OASDI (Social Security retirement and disability) and HI (hospital insurance), excluding book entry interest for the trust funds, will have more revenue than expenses until 2015. If higher cost assumptions prevail, however, the last year of positive flow will be 2010.

That’s next year.

I am not making this up. It is public record. You can see for yourself by examining table VI.F9 on page 191 of the 2008 trustees’ report.

When Social Security and Medicare costs exceed their revenues, the Treasury will have to borrow money to cover the shortfalls. When that happens, today’s stunning deficits will look small.

That’s why our future contains inflation, not deflation.

The upside-down nation

There is another way to see how serious our situation is: Compare the unfunded liabilities of Social Security and Medicare with the net worth of every household in America.

According to the Federal Reserve flow-of-funds figures for year-end 2007, our collective net worth as consumers was $62.7 trillion. By the end of 2008, the same figure had fallen to $51.5 trillion. Another year of growth for Social Security and Medicare liabilities would bring total unfunded government promises to about $46 trillion. That’s nearly 90% of our net worth.

If consumer net worth fell an additional $5 trillion — the same amount it fell in the last three months of 2008 — we’d be broke.

Yes, you read that right.

Government obligations for basic programs would exceed the net worth of every household and nonprofit organization in America.

We’d be the upside-down nation.

Below: This table compares the unfunded liabilities of Social Security and Medicare over the next 75 years, which is the standard measure, with the net worth of all households in America.

Program	Jan. 2004	Jan. 2008	Change	Projected Jan. 2009
Social Security and Disability: OASDI	$ 3.7 trillion	$ 6.6 trillion	$2.9 trillion	NA*
Hospital insurance: HI	$ 8.5 trillion	$12.7 trillion	$4.2 trillion	NA
Supplemental medical insurance: SMI Part B, doctors expenses, etc.	$11.4 trillion	$15.7 trillion	$4.3 trillion	NA
Supplemental medical insurance: SMI Part D, prescription drugs	$ 8.1 trillion	$ 7.9 trillion	($0.2 trillion)	NA
Total unfunded liabilities	$31.7 trillion	$42.9 trillion	$11.2 trillion	$46.0 trillion (estimate)
Consumer net worth	$51.9 trillion	$62.7 trillion	$10.8 trillion	$51.5 trillion
Unfunded liabilities as % of consumer net worth	61.1%	68.4%	NA	89.3%

*Not available / Sources: Social Security and Medicare trustees’ reports, Federal Reserve, author estimate

The only way out of this is to print more money, inflating the value of assets relative to the amount of debt.

Cutting the expense of investing through index funds alone wouldn’t solve the inflation problem. In addition to cutting expenses, we would have to invest a portion of our money in assets that give us a hedge against inflation: Treasury inflation-protected securities, real-estate investment trusts and energy companies.

Would this be perfect protection? No way. But it would give our savings a fighting chance.

Of course, not all of our nation’s financial woes stem from obligations that are somewhere down the road. Right now, Washington is doing its best to turn a silk purses into sow’s ears, so to speak, as EconomPic notes in “We’re All Euro Now: Government Spending at 45% of GDP.”

Chuck Dietrick with the details:

One of the more disconcerting statistics is government spending as a percentage of GDP. In 1903, the figure was 6.8% for the U.S. In 2009, it’s projected to be 44.72%-a greater than 8% increase over the average of the previous 5 years-not particularly encouraging. Less encouraging are the comparisons with major Western European countries. In 2007, France was at 61.1%, Sweden and Denmark 58.1%, Italy 55.3%, the UK 50%, and Germany 48.8%. Yep, we’re on the march to be the equal of those paragons of economic stagnation.

The below chart details this run up since the early 1900’s (Federal, State, and Local as a percent of GDP); government spending is now projected to be at the highest level as compared to GDP since WWII.

Source: US Government Spending

And just in case anyone thought all this government largesse was somehow being offset with efficiencies in other areas, the following post from CBS News’ EconWatch blog, “It’s A Good Time To Work For Uncle Sam,” should go some way towards dispelling that notion:

President Obama’s call last year for “shared sacrifice” doesn’t extend to federal employees, at least based on the details of his administration’s 2010 budget released this week.

At a time when the official unemployment rate is nearing double digits, and 6.35 million people are receiving unemployment benefits, the U.S. government is on a hiring binge.

Executive branch employment - 1.98 million in 2009, excluding the Postal Service and the Defense Department - is set to increase by 15.6 percent for the 2010 fiscal year. Most of that is thanks to the Census Bureau hiring 102,000 temporary workers, but not counting them still yields a net increase of 2 percent in one year.

There’s little belt-tightening in evidence in Washington, D.C.: Counting benefits, the average pay per federal worker will leap from $72,800 in 2008 to $75,419 next year.

Meanwhile, according to Forbes’ layoff tracker, there have been 558,087 layoffs since November 2008 at large public companies; even local school districts aren’t immune. That’s just a sliver of the total unemployed, which government data estimate to be 8.6 percent of the workforce, or an alternate method of reckoning that counts discouraged workers puts at 20 percent.

Some of the Feds’ hiring increases have been stunning. If you look at the four-year period from 2006 to 2010, the number of Homeland Security employees has grown by 22 percent, the Justice Department has increased by 15 percent, and the Nuclear Regulatory Commission can claim 25 percent more employees. (These figures assume that Congress adopts Mr. Obama’s 2010 budget without significant changes.)

A 39-page “dimensions” document accompanying the White House’s 1,380-page appendix offers justifications for each new hire. Homeland Security says its new employees will “increase border security.” The Agency for International Development wants to improve “the management and stewardship of foreign assistance programs.” The Smithsonian Institution wants “additional security guards.” And so on.

The final evidence that it’s a good time to have a .gov e-mail address? Civilian government employees are set to enjoy a 2 percent raise. Not only are private sector workers are struggling to keep their jobs, but their earnings are stagnating and pay cuts are no longer uncommon.

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