Friday, July 29, 2011

Rethinking Pension & Benefit Schemes- Part 2

In yesterday's post I discussed my views on the stupidity of every major nation's defined-benefit pension and/or healthcare schemes over the past 120 years, beginning with Germany under Bismarck.

Doug Dachille, a fixed-income maven and occasional guest on CNBC, has articulated several times that overly-indebted governments have a choice between whom they will disappoint/stiff.

They can default on their bonds, being legal debt obligations, in order to favor citizens who vote for members of the government. Or they can pay their bonds and enact combinations of more/higher taxes and benefits cuts for citizens.

A Wall Street Journal editorial in Wednesday's edition echoed Dachille by pointing out that there is no real need for a default, regardless of what happens by August 2nd or, potentially, the date on which Congress recesses for the summer, August 8th.

That is because there is more than sufficient tax revenue every month to pay the nation's debt interest.

Therefore, to Dachille's point, thanks to badly-designed and overly-optimistic social welfare programs passed by less-than-stellar intellects in Congress throughout the last eighty years, the more logical solution to America's spending and debt problems is to cut benefits in these programs.

Yesterday, on CNBC's noontime program, David Stockman was enlisted to push the network's liberal agenda. A perennial favorite of the network's due to his combination of serving in Reagan's administration, but actually being a big-tax-and-spend liberal, Stockman didn't fail his hosts. He immediately decried the current debt limit debate as really about deficits, which, of course, require new and higher taxes to close them.

He then bemoaned, several times, that Senate Democrats had regrettably and inexplicably thrown in the towel on demanding new taxes.

Apparently Stockman isn't familiar with Hauser's Law, or the fact that federal tax revenues as a percentage of US GDP average 18% over the long term, no matter what the composition of tax rates and bases.

Amazing as it may be, Stockman, too, confuses tax rates with tax revenues. He evidently continues to fail to understand that lower rates, which accommodate economic growth and higher GDPs, lead to higher total tax revenues on lower tax rates.

On Greta Van Sustern's Fox News program Wednesday night, GOP House Budget Chairman Paul Ryan discussed the current debt limit debate, noting, in answer to a question from the program's host, that various national debt estimates don't typically include the off-budget programs such as Social Security, Medicare and Medicaid. Further, he explained, those aren't like bonds which have been issued, and must be retired. The terms, conditions and costs of the entitlement programs can be changed and, thus, do not represent formal, fixed claims on the federal Treasury.

While some US states, such as Illinois, California, Michigan and New Jersey, pre-Christie, may flirt with defaults, exhibit government denial of their inability to tax their way out of their fiscal nightmares, and, ultimately, appeal to the federal government to bail them out, the US government has no ultimate guarantor.

It doesn't take a genius to see that fixed debt obligations in the form of bonds will have to be honored and serviced.

Given that tax receipts can't be expected to rise above about 18% of US GDP, the growth of which has been anemic due to recent newly-increased levels of federal spending and regulation, the only remaining variable in the equation to eventually shrink the US federal deficit has to be spending.

Quaint Washington games like automatic 7%-per-year baselines budget increases have to be ended. Eventually, Social Security, Medicare, Medicaid and all other off-budget programs should be brought on-budget, to reflect a consolidated balance sheet of federal liabilities.

Perhaps only then will most voters finally understand that they have allowed their elected federal officials, for some eight decades, to enact promised social benefit programs which will simply never be payable on a sustained basis.

One only has to revisit the Greek situation, with the many stories and jokes about the short working careers, easy work rules and lavish retirement benefits, to understand that much of the developed world's economies have the same tough challenge ahead- to shrink their once-promised federal-provided social benefits back to affordable levels. Probably involving, at some point, individual defined contribution accounts paid annually out of government receipts, so that there will never be generationally-shifted debts for the consumption of social welfare programs.

A chance remark in a recent Wall Street Journal editorial noted that, just now, as many governments need to borrow heavily to plug budget deficits, many of said governments are finding it convenient to excoriate debt rating agencies and dismiss requirements for using their ratings.

Regardless of how badly S&P, Moodys and Fitch mis-rated mortgage-back structured finance instruments earlier in this decade, or how badly they may err in rating sovereign debt, that chance comment caused me to speculate that global economic growth and debt may be about to reach a tipping point together.

Specifically, with so much borrowing occurring for so much deficit spending among so many nations, while growth among the developed economies has slowed, thanks to ill-advised taxation, spending and regulatory policies, we may well see a sustained period of lower global demand as a result.

The reason for this would be as follows. As governments realize that promised social benefits must be trimmed, they spark a realization among their citizens that savings must rise to offset diminished future government-provided retirement and healthcare subsidies. With government spending reduced, and private-sector spending among consumers reduced to save for future retirement and medical spending, we may well witness a global shrinkage of demand as the final consequence of the deleveraging which began with the financial crisis of 2008.

To me, it seems obvious that after nearly a century of unaffordable social benefit schemes, many governments are now having to rectify those unsustainable promises, cut them, and trigger heretofore unexpected and unseen changes in savings and consumption patterns among consumers across many developed economies. Such economic behavioral changes among consumers may last for decades, and result in permanent changes in savings and consumption rates and, for years, if not decades, slower national economic growth rates.

For, having realized that promised pension and healthcare benefits simply won't be forthcoming as promised by many governments over past decades, individuals will return to pre-mid-twentieth century habits of high savings rates and markedly lower consumption, to prepare for self-financed medical and retirement needs. I believe that will drive discontinuous changes in individual economic behavior not seen in the lifetimes of most economists currently engaged in modeling, estimating and forecasting such behaviors.

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