The Macro elephant in the room

Investment Analysis Clubs Macro Economic Trends and Risks
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Over the next three decades, the Social Security system is scheduled to pay benefits $21 trillion greater than its trust fund will collect in payroll taxes and related revenues. The Medicare system is projected to run a $48 trillion shortfall. These deficits are projected to, in turn, produce $47 trillion in interest payments to the national debt. That is a combined shortfall of $116 trillion, according to data from the Congressional Budget Office…

These unsustainable figures result from demographics, rising health care costs and program design. The ratio of workers supporting each retiree, which was about 5:1 back in 1960, will fall to just over 2:1 by the next decade. People who live until age 90, a fast-growing group, will spend one-third of their adult life collecting Social Security and Medicare benefits. Today’s typical retiring couple will receive Medicare benefits three times as large as their lifetime contributions to the system, and also will come out ahead on Social Security (adjusted into present value), according to the Urban Institute and the Brookings Institution…

The federal government might just try to borrow $116 trillion over three decades, on top of the current roughly $25 trillion in federal debt held by the public. But who will lend the government this much money? China and Japan are already paring back their roughly $2 trillion in American debt holdings. It seems unlikely that other countries would step up to take on much more. The Federal Reserve is trying to reduce its own more than $5 trillion in Treasury holdings that temporarily soared during the pandemic, and cannot monetize $100 trillion in debt without hyperinflation. That leaves America’s banks, corporations and investors, which almost surely lack both the capacity and willingness to lend $100 trillion to a government that cannot control its own finances…[end quote]

Social Security and Medicare are entitlements defined and guaranteed by law. Unless the laws are changed, the scale of borrowing would crowd out borrowing needed by businesses and individuals to run the productive economy.

Lenders demand higher interest rates when they see a risk that the value of their coupon payments will decline due to inflation. Interest rates rise when the demand for borrowed money exceeds the supply of money from lenders.

If the government’s debt is bought by fiat money created by the Federal Reserve hyperinflation will result. History has seen this many times. (cf. “This Time is Different” and “The Price of Time: The Real Story of Interest.”

The bond market is not paying the slightest attention to the Macro elephant in the room. The 30 year Treasury yield is lower than the 2 year Treasury yield.

Like global climate change, the crisis caused by unsupportable government debt will build up gradually. The bond and stock markets will be profoundly affected.

Politics is not allowed on METAR so let’s keep this to a discussion of how we, as investors and individuals, can protect ourselves from the coming fiscal crisis.

Wendy

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Not a big surprise. Generally, investors consider Treasury securities as all having essentially the same risk of default, namely, zero. Which leaves other factors as the reason for a price differential. Rationally, longer-term debt should have a higher interest rate due to unknown factors about inflation and so on. However, given the last 20 years of virtually zero interest rates (some say negative interest rates), it takes some time for investors (particularly consumers) to adjust to earning higher rates. As Treasuries are considered zero-risk investments, that security factor keeps the price of Treasury securities artificially low. That will likely change over time as inflation (particularly in the 4+% range) pushes people to evaluate the returns on ALL their investments.

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That presupposes a fiscal crisis is coming - that borrowing is the only way to meet these promises. But there are other options. Two obvious ones are to reduce the promises and/or increase taxes to raise the funds needed to meet these promises.

Without getting into the political side of those options, investors need to weigh the likelihood of each option (along with other possibilities I haven’t mentioned).

I believe the most likely option is some combination of the three - borrowing, reduced benefits, AND higher taxes. But there is no guarantee that all three will happen at the same time. Nor is there any guarantee changes will completely avoid some fiscal pain.

Again, skirting the political, I think it’s OK to note that there isn’t a lot of cooperation among the various political factions at the moment. But dealing with this issue will require some level of cooperation. Since nothing is likely to blow up in the next 5 years or so, I see little movement toward the cooperation that will be needed to deal with this issue during that time.

With uncertainty comes the need to diversify investments. If you are focused on bonds, add stocks. If you are focused on US companies, look for more international exposure - either through foreign stocks or through US companies with significant international business. It may not yet be time to make a significant move into those different investments, but it IS the time to start learning about them and maybe start dabbling in them so you become familiar with investments outside of your current comfort zone.

–Peter

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That presupposes a fiscal crisis is coming - that borrowing is the only way to meet these promises. But there are other options. Two obvious ones are to reduce the promises and/or increase taxes to raise the funds needed to meet these promises.

Peter,

There is a third way, and a likely one. That money will flow through labor. As more money flows through labor’s hands it will be taxed. As earned income is the most heavily taxed income, there is little that government has to do. It can make it easier for labor to organize, but even that is a function of labor itself, not current political elites.

The effect on stores of wealth will likely be the same, capital will flow out of the huge stores of wealth we currently observe, but the route will be more devious.

Also note, we are undergoing a massive sea change in energy use and creation. This is a once in a century change. This
change will drive a massive amount of wealth creation that at first will creat a large amount of labor.

New factories are typically not built with automation, and until the need for fossil fuels declines a lot, the need for labor to extract and refine fossil fuels will remain in parallel with the construction of renewables and the storage and distribution of those
renewables.

In the end the need for labor will drop at least for a while as batteries become commodities and new factories are not required.

Cheers
Qazulight

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Social Security and Medicare are funded through their own taxes. Not through normal income taxes, not through corporate taxes, not on investment income taxes. So labor taxes will help ONLY if labor wages go up, and thus they contribute more in FICA taxes (which is possible).

What we have here is a complete inability for Congress to listen to the math majors! Its not like this problem hasn’t been known for a long time and has not had solutions all along the way.

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I saw a piece on the wire, within the last two or three days, that the factions in Congress are trending toward agreement that SS and Medicare cuts are off the table. Reality says that goobers have parents too, and they don’t want to bear the cost of supporting their parents, after SS and Medicare are cut/eliminated, regardless of what “traditional family values” say.

So, the focus is shifting away from SS and Medicare, to the various aid programs for the poor. A few weeks ago, I posted an itemization of the money being paid out in food stamps, ADC, the Dept of Education, and several other programs. Adding it all up, came out to nearly $1T/year…meaning, cut all the federal subsidies for the poor and education, and the budget would be nearly balanced, thus easily able to fund SS and Medicare obligations with debt, long enough to get over the boomer hump.

And with all the aid for the poor gone, Plan Steve to let kids drop out of school after 8th grade, and work full time, would come in handy. Just give the kids and their parents lectures on “personal responsibility” and “the dignity of work”. :^)

Steve

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Not to mention that many other countries have the same exact problem … a low ratio of workers to retirees. That reduces the question to something along the lines of “if all countries are doing the same thing, will “hyperinflation” result for all of them?” and “if social security/medicare benefits are indexed to inflation, what does that mean anyway?”

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I agree that the debt in general and the funding of social security and medicare are issues that have to be addressed. I believe these will be in the next few years with the elimination of the payroll tax cap and increasing the retirement age. But we also shouldn’t exaggerate the problem.

Japan’s debt to GDP ratio 266%, much higher than the U.S. at 128%. Yet Japan remains a nice place to live with a high living standard. The UK has a debt/GDP ratio of about 85%, much better than the US, yet I think most economists are more optimistic about the future US economy than that of the UK.

In other words, the level of debt that is “unsupportable” is uncertain.

But where else will global money go? Countries have lost faith in Xi’s China, which faces contemporaneous debt, banking, and demographic crises that present greater hurdles than that faced by the U.S. The EU is aging faster than the US and has a debt crisis of its own.

Personally, I think this discussion has the wrong focus. The question should be whether the current and projected costs of social security/medicare is greater or less than economic consequences of not having these programs. Large reductions in these retirement programs will be to transfer even more of the economic burden of taking care of the elderly to their children. I suspect the negative consequences to the economy of such a transfer would be much greater than raising taxes to sustain current system.

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How exactly will that happen? Why will money flow through labor? Even more basic, what do you mean when you say “money will flow through labor”?

–Peter

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Labor is in short supply. This is now a world wide phenomenon. As labor is in short supply labor can demand a greater portion of the wealth generated by labor. Also, capital is mostly plentiful and it appears that it will remain plentiful. Both of these situations are a result of the same demographic forces that place such a strain on the social safety net programs.

In other words, labor rates will rise. Capital will become more efficient with labor but labor will be able to demand wage increases. Also working hours will remain high. These are the expected out
comes of capitalism.

This does not mean that it will work out that way in any particular country. But in the aggregate it will work out that way.

Please note: This is based on my observation that capitalism is not an economic theory or system. It is the natural outcome of our humanity. Thus no matter who are what type of government or “ism” is being practiced, capitalism will arise and it will address the imbalances in the economy.

Cheers
Qazulight

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Thank you. Now I understand.

I still don’t see how a world wide labor shortage (which I don’t entirely agree with, but that’s not important) would have anything more than a minor impact on US Social Security and Medicare benefits and taxation. This issue is fairly unique to the US economy and not the world economy.

–Peter

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It is. But I believe the thing is that we have a labor shortage here as well. That means a shortage in payroll FICA taxes. That hurts the social security and medicare ability to pay benefits.

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I guess I see it a bit differently. We don’t have a real labor shortage that’s impacting Social Security and Medicare. Instead, we have a glut of claimants on that system. We’ve known this glut was coming for decades, but haven’t had the will to deal with it - not in a significant way, anyway. Just tweaking around the edges to buy a couple years here and there.

And now we’re getting very close to the point where significant changes need to be made to these programs, or we run the risk of saddling our grandchildren and great-grandchildren with a lot of debt.

–Peter

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This is not new, the cap on the FICA payroll deduction has risen each year based on an index of national average wages. For 2023, that maximum is set at $160,200, an increase of $13,200 from last year. When the tax dedicated to Social Security was first implemented, it was capped by statute at the first $3,000 of earnings (which would be equivalent to about $56,000 in 2021 dollars).

Wages need to increase and keep up with the cost of living going forward better than they have for the past two decades and therefore the increase in the cap and the gross payroll FICA revenue.

The retirement age (full retirement for Social Security) at 67 is probably not going to increase beyond that current age

One proposal would apply the Social Security payroll tax to earnings over $400,000 in addition to earnings below the current maximum taxable amount.

Dramatically increasing the legal annual immigration population for working adults between the ages of 25 and 35 will extent the solvency of the Social Security system

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Snippet

The ratio of workers supporting each retiree, which was about 5:1 back in 1960, will fall to just over [2:1](https://www.ssa.gov/news/press/factsheets/basicfact-alt.pdf) by the next decade.

That is entirely impossible. The millennials and Zs are both bigger generations than the boomers. In 2030 the boomers born in 1946 would be 84. In other words six years of the boomers would be dying off quickly. The Xers would be retiring and that generation is the small generation.

There are a lot of studies making that claim. There is a ton of proof. It is a total fabrication. The reporters are worthless. Even the NYT is gullible.

The entire major premise of the article is invalid.

If this is coming from the CBO the agency is also entirely wrong.

From the SSA link
snippet

About 1 in 4 of today’s 20 year-olds will become disabled before reaching age 67

Note currently there are 7.6 million people on disability. Why would the assumption be that 25% of American workers would end up on disability?

There is more to it than that. Many people who work physically do end up on disability after their 60th birthday. But there life expectancy is not that much and either way they are off disability in a matter of a few years and on the regular SS.

The linked article from SSA is a forecast titled:

Fact Sheet
SOCIAL SECURITY

It is a forecast not a fact sheet. It is a hack job. Look over here we are going under!! What can we do to save you? Money fast!!!

Look this entire Biden exercise has made it so that the general public wants the cap lifted. Biden’s promise, the $400k, was to ensure he got elected during the early stages of public sentiment moving towards an industrial policy. He is letting the medicine go down smoothly.

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It might be possible … because it is “workers” to retirees, not “people” to retirees. For much of the boomers careers, at least 25 years of it (1985-2010), labor force participation was over 65%, today it is down to about 62% (this even despite average age rising!). Fewer people working lowers that ratio, and the millennial generation is only slightly larger than the boomer generation.

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We were in the throws of figuring out we do not want supply side econ.

Now the factories are coming back.

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Demographics are slow changing and are pretty much locked in decades in advance. It is quite unlikely that the projected numbers for the next decade are “impossible”.

DB2

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The numbers are only possible if we can dumb down the American public enough to buy into supply side economics again.

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Most of them can’t do basic math. So, anything is possible…

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