Tuesday, August 29, 2023

BRICS Summit Ends With No Common Currency Agreement

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A BRICS Summit update from the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff.

Maybe they'll come closer to a common currency agreement next year. However, having also invited Egypt, Ethiopia, Iran, Saudi Arabia, UAE, and particularly monetary basket case du jour Argentina to join the bloc they may find it even more difficult to build consensus on a common reserve currency with more members. The Eurozone has for over a decade regretted admitting Greece along its original "more the merrier" strategy.

ps. If frontrunner candidate Javier Milei wins the Argentinian presidential election you can bet your bottom dollar Argentina will decline joining as he has already announced his intention to dump the peso and adopt the U.S. dollar as Argentina's domestic currency.

Read more at Yahoo's "The BRICS summit ended with no new currency and all 5 members issuing differing and contradictory commentary on de-dollarization."

Thursday, August 24, 2023

Robert Service on Trotsky's U.S. Lifestyle

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The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff is in the middle of historian Robert Service's biography of Leon Trotsky. Regarding Trotsky's first trip to America the Correspondent is struck by similarities between the Marxist revolutionary's lifestyle choices and those of present-day equality social justice leaders:

From Service:

"The Spanish steamship Montserrat left Barcelona on Christmas Day 1916. Trotsky claimed they travelled second class. This was one of his silly fibs since he was on record as having occupied a cabin of the first class..."

"...Trotsky thought it a superannuated hulk; but at least he and his family had decent berths, and they did not mingle with passengers from the lower decks. Despite being a revolutionary socialist and advocate of proletarian dictatorship, Trotsky felt no impulse to spend time talking to workers..."

"[In New York] some days the three of them [family] went for a spin in a car. A certain Dr. Mikhailovsky, presumably one of Trotsky's admirers or possibly a relative, supplied both the vehicle and the chauffeur. But Leva and Sergei, having been brought up to treat people on an equal basis, could not work out why Mikhailovsky's man never joined them in the restaurant. This was not the last occasion when Sergei was puzzled by his parents' enjoyment of a middle-class lifestyle. The apartment... ...was comfortable. It had the latest American furnishings with its fridge, gas cooker and telephone. This was an improvement on Paris and Vienna where the family had been unable to phone their friends."

Thursday, August 17, 2023

Government Spending: Social Security, Part 2

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5 MIN READ - The Cautious Optimism Correspondent for Economic Affairs (and Other Egghead Stuff) submits another entry on Social Security spending, this time regarding the question of whether or not “Congress already spent our Social Security money.”

It’s no secret that around the year 2034 Social Security’s payroll tax revenues—combined with “reserves” stored in the Social Security surplus fund—will be insufficient to pay full promised benefits to retirees.

Government bureaucrats usually blame the aging American population for the shortfall, and other apologists for the program’s management often argue “When Social Security was created they didn’t anticipate people living until age 78.”

Conservatives criticize the looming shortfall as the product of government incompetence, usually arguing that “Congress saw the trend back in the 1980’s and set up a trust fund as a reserve, and then they proceeded to spend all the money.”

Government bureaucrats and liberals then shoot back, arguing “the surplus *was* invested.”

So who’s right? We’ll try to explain.

THE 1980’S

Early in Ronald Reagan’s presidency the Social Security payroll tax rate was 5.35% (employee) + 5.35% (employer) = 10.70%. During this time America’s aging workforce plus swelling payments to family beneficiaries and disability claims were already straining the program—even with the huge advantage of baby boomers entering the workforce faster than seniors were retiring.

-Full time employees 1983-1990: 80.5M to 99.1M (+23.0%)

-SS retired workers and dependents 1983-1990: 24.9M to 28.3M (+13.6%)

(Source: BLS and Social Security Administration)

During the 1983 crisis the program was forecast to be ***only three months away*** from no longer being able to pay all promised benefits to retirees.

Further compounding problems was the long-term retirement prospects for the baby boomers.

In 1983 government analysts saw a huge generation of baby boomers entering or already in the workforce, but they knew beginning as early as 2008 the first baby boomers would start retiring and drawing pension payments. The further into the 2010’s, 2020’s, and 2030’s America got, the larger the pool of seniors would swell with insufficient replacement workers to pay for promised benefits.

So in 1983 a compromise was struck between Democrats and Republicans to not only keep Social Security going in the short term, but also to prepare for the upcoming explosion of baby boomer retirees.

For the first time ever Social Security benefits were deemed taxable. A schedule to gradually raise the retirement age was introduced. And the payroll tax was raised in 1984, again in 1988, and finally to 6.2% + 6.2% = 12.4% in 1990 where it remains today.

In 1990 withholding 12.4% of workers’ paychecks was significantly more than needed just to pay retirees in the 1990’s, but the strategy was to proactively accumulate a surplus to help pay for boomer retirements in the next century and avoid imposing higher taxes on the next generation of workers.

STILL NOT ENOUGH

But today government actuaries have calculated that payroll taxes plus the reserve—the Social Security trust fund—will still be insufficient to pay promised benefits starting in 2034.

So what happened to that precious surplus? Conservatives complain that there would be more than adequate money available if Congress hadn’t “stolen” the money and spent it.

Well, that accusation is mostly correct. Congress did take the surplus money out and spend it—right away.

The part that’s partially inaccurate, according to lawyer language at least, is the surplus funds were also invested… sort of. For the law did require surplus funds to be invested, but “invested” meaning in U.S. Treasury securities.

(Side note: The federal government has a long history of requiring private and public funds be diverted into Treasuries as it creates large and generous mandatory credit lines for Congress to tap into. For example, the Economics Correspondent wrote last year on National Banking Act regulations (1863-1913) that forced private banks to back their paper currency issuances 111% by U.S. Treasury securities. The Federal Reserve has also required member banks to maintain large stocks of Treasury securities if they want to acquire bank reserves in open market operations. None of these legal requirements have been enacted by accident.)

Which gets us to the heart of the problem. Whenever a single dollar is “invested” in a Treasury bond that dollar becomes immediately available to Congress to spend. And we know Congress isn’t going to sit back and let that dollar sit idle.

Hence during the 1980’s, 1990’s and 2000’s Congress spent all the trust fund surplus money, leaving IOU’s (Treasury securities) in its place—effectively a promise to replenish the trust fund plus interest at a later date. Congress’ plan was effectively “We’ll pay off those Treasuries plus interest using taxes collected decades from now.” (more on that problem in a minute).

Where conservative accusations remain accurate is this was a horrible way to manage an alleged surplus trust fund meant to prepare for a tidal wave of future pension payments. Not only are returns on Treasuries inferior to private sector investment returns—particularly during the last 20+ years—but Congress spent the money on all kinds of unproductive government programs that did far less for the economy than had it been invested in private industry.

If the trust fund had been even partially invested in corporate bonds or equities and allowed to earn superior returns—something George W. Bush proposed in 2005, and which was immediately shot down—Social Security wouldn’t be forecast to dip into the red within the next decade. Depending on the private rate of return the trust fund may have even been able to hold the program up until the last baby boomers passed away and the retiree “hump” was cleared.

But the worst part is by immediately spending the trust fund surplus, Congress defeated the whole purpose of building a surplus in the first place.

Remember, the idea was to have a large reserve to tap into so as not to impose higher taxes on future workers when the baby boomers retired.

But the reserve is now stuffed with trillions of dollars of debt that the Treasury must make good on. And the Treasury will do that by levying higher taxes than would otherwise have been needed had the surplus fund had not been touched—or at minimum had been handed over to private capital markets instead of profligate politicians.

So even as you read this article Americans are being taxed to the tune of trillions of additional dollars that the original payroll tax hike of the 1980’s was enacted to prevent. Effectively the American public is enduring two giant multi-decade rounds of higher taxes instead of one—all to compensate for Congress having spent the first round decades ago.

There’s only one technical difference between these two forms of taxation. Today Treasuries are being redeemed with general tax revenues that come from income taxes, corporate taxes, excise taxes, etc… basically anything except Social Security payroll taxes.

Had there been no trust fund surplus and Congress instead dealt with the problem in the 21st century—raising taxes as baby boomers retired in large numbers—then payroll taxes would have been raised instead.

So the net effect has been a transfer of liability from today’s workers (higher payroll taxes) to the taxpaying public in general which includes not only households but also small businesses and corporations.

Ironically (and sadly) wealthier retirees, who planned wisely during their working years and saved to draw supplemental retirement income from investments, are also stuck with higher income taxes than would otherwise have been the case. It’s a cruel turn of events that wealthier retired baby boomers were subjected to higher payroll taxes in the 1980’s and 1990’s and are now being stuck again with higher income taxes—effectively being forced to pay twice themselves—to pay off Treasuries in the surplus trust fund.

But then left-progressives would probably welcome this outcome since the end result is socking it to evil rich people—old, retired ones at least—assuming enough progressives even understand how Social Security's finances have played out since 1983.

Thursday, August 10, 2023

Government Spending: Social Security, Part 1

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7 MIN READ - Last month the Cautious Optimism Correspondent for Economic Affairs (and Other Egghead Stuff) posted several articles on military spending. Today we focus on some history and problems with the federal government’s single largest 2023 budget outlay at $1.35 trillion: Social Security.

First a little history.

Social Security was founded in 1935 as one of President Franklin Roosevelt’s many New Deal programs. At its inception a 1% tax was imposed on all worker paychecks with another 1% taken from the employer for a total of 2%.

Fully aware that the number of retirees would grow over time the Social Security payroll tax was scheduled to rise to 2% + 2% in the 1950’s and stay there for good.

It didn’t take long for the government to break that promise. The tax was raised to 2.25%+2.25% in 1957, to 2.5%+2.5% in 1959, and 3%+3% in 1960. And up and up it went over two more decades despite tens of millions of baby boomers entering the workforce.

For those who haven’t checked their paycheck stubs lately, the Social Security payroll tax has been 6.2% paid by workers and 6.2% by employers since 1990 (12.4%), yet the program has been running large deficits for years now and is expected to be unable to pay promised benefits as early as 2034.

VERY POOR RETURNS

The Economics Correspondent considers himself a halfway decent retirement planner and years ago, when he first noticed the Social Security Administration was taking 12.4% out of everyone’s paycheck (subject to a salary cap that is currently set at $160,200), his first thought was “Hmmm, 12.4% is considered a *very* healthy chunk to save for one’s retirement already. Just how well could a worker do on his or her own saving 12.4% instead of Social Security doing it for him?”

So if we open a spreadsheet and plug some numbers in, we get some interesting and sadly predictable results.

Starting with a minimum wage worker right out of high school at age 18, if the employee:

-Earns the federal minimum wage of $7.25 an hour
-Works 40 hours a week
-Is lazy and never works an hour of overtime
-Is unambitious and never gets promoted
-Is unambitious and never gets a raise… only the occasional bump in minimum wage to adjust for inflation
-We assume an average annual inflation rate of 2.5%
-We take the standard 12.4% from his paycheck
-We compound a modest stock market annual return of 9% over many decades (the S&P 500 has averaged 11% for the last 50 years)…

At age 72 our minimum wage worker with zero ambition has a nest egg worth of $3.18 million earning $23,843 a month in interest.

Of course by age 72, after years of inflation, $23,843 won’t be worth what it is today. So adjusting for inflation his monthly interest payments will be $6,291 a month in today’s dollars (about $75,500 a year) but our worker also has his $3.18 million nest egg to slowly tap into.

And in deep blue states where the minimum wage is over double the federal floor all these numbers more than double to greater than $6.36 million and inflation-adjusted annual payments of $150,000.

How does Social Security treat these minimum wage workers?

According to the Social Security Administration’s online calculator, the same worker can expect at age 72 to receive $6,961 per month in the future which, in today’s dollars, is $1,300 or $15,600 a year.

$75,500 a year vs $15,600 a year.

Oh, and the worker’s nest egg, which doesn’t really exist under Social Security anyway, goes to the government.

This all assumes Social Security can keep all its promises decades from now.

And of course we’re talking about an unambitious lifetime minimum wage worker. What about a middle-class worker averaging $60,000 a year over a lifetime, starting working at age 22 right out of college (with adjustments for inflation)?

Well investing his own money, by age 72 our middle-class worker is worth $8.9 million earning $66,500 a month.

Adjusting for inflation in 2023 dollars that’s a nest egg of $2.6 million earning $19,331 a month or $232,000 a year.

According to Social Security’s online calculator that same worker gets a monthly benefit of $2,785 or $33,420 a year: one-seventh as much.

And don’t forget there’s no nest egg to tap into. His $8.9 million disappears.

Which raises an interesting question: Why would anyone who works ever want Social Security? The program pays a negative inflation-adjusted return on investment and anyone who works can do better on their own.

PAY AS YOU GO

One of the fundamental problems behind Social Security’s lousy returns is that it was originally (and deliberately) set up as a “pay as you go” program instead of the alternative “fully funded” version.

In a “fully funded” retirement program, money is taken out of your paycheck and put in an individual investment account where it earns real returns. Once you reach retirement age your money has grown over decades and it’s waiting for you to tap into your own account. 

Self-funded retirement schemes, such as those in Singapore, Hong Kong, Chile, Poland, Sweden, Malaysia (and more) are like a mandatory IRA or 401k; the government is forcing you to save for retirement, but the money is yours and yours alone. It doesn’t get diverted to another retiree in return for only a promise to pay you later.

“Pay as you go” programs like Social Security don’t put worker proceeds into a retirement account to grow but rather instantly transfer the money to elderly retirees. Instead of investments that grow the worker’s retirement balance, today’s workers are told they will receive their pensions via direct transfers from another generation of workers 10, 25, or 50 years from now.

Hence one of the key problems with “pay as you go” programs is the payroll taxes aren’t invested in anything and don’t grow (exception, the late 1980’s/1990’s “surplus” which was spent by Congress). The only thing that grows is the size of the promises made to today’s workers regarding what they’ll get decades from now when they retire.

Also, unlike fully funded programs, worker contributions are diverted immediately for consumption spending instead of investment spending. Across the entire system there is no deferral of consumption which also trims long-term economic growth. 

Some people call this arrangement a Ponzi scheme, but is it? Well, one definition of Ponzi scheme the Correspondent found is:

“A fraudulent investment scheme in which an operator pays returns on investments from capital derived from new investors, rather than from legitimate investment profits… … Ponzi schemes generally fall apart when there is not enough new capital to pay the ever-growing pool of existing investors.”

In which case Social Security is technically not a Ponzi scheme. Because private investors can choose not to hand their money to a bankrupt Ponzi scheme whereas Social Security simply confiscates workers’ money by force.

So why did Congress and FDR set up Social Security as an inefficient pay as you go program? Two reasons mostly.

The first was to get votes *now* and *today*, not decades later. In 1935 FDR’s reelection was coming up in one year, and telling seniors that “sorry, the program isn’t going to give you much by Election Day because your contributions won’t have added up in one year” wasn’t going to get him the votes he wanted to win in 1936. Instead FDR told seniors they would start receiving large payments funded by workers ASAP, and many of them rewarded the incumbent president with their votes.

The other reason was more cynical. There is documented evidence that FDR or at minimum FDR’s New Dealer aides wanted Social Security to be a program that no one could ever get rid of.

According to liberal historian Arthur Schlesinger, FDR explained in 1941 that…

“We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.”

Today the Social Security Administration argues that these weren’t really FDR’s words but rather one of his top New Dealers, Luther Gulick.

Either way, it’s the program FDR approved and signed into law, and the vision turned out to be quite prescient. Like a hook in a fish, there’s now no easy way to transform Social Security into a fully funded program or wind it down.

If anyone tries to change Social Security to a fully funded program, payroll taxes taken from worker paychecks will go into the workers’ individual accounts instead of directly into retired seniors’ pockets—and seniors who were promised decades ago that they would get their regular Social Security payments at retirement will scream bloody murder (rightfully so) that they aren’t getting their money back as promised.

So if any politician tries to make Social Security more sustainable or fully funded, an entire generation of retirees will get stiffed and rise up in revolt, something FDR and his New Dealers foresaw.

The only ways the Economic Correspondent can see Social Security mathematically transforming into a fully funded program are:

1) Bankruptcy and restructuring (i.e. someone doesn’t get at least part of what they were promised).

2) Attempting to divert some contributions into higher yielding investments to plug the gap over many years. George W. Bush proposed this in his second term and was instantly excoriated by senior citizen lobbies who feared it would mean fewer payments—egged on by Democratic politicians who argued George W. Bush planned to bankrupt Social Security in the “Wall Street casino.”

3) Plugging the hole with a large one-time transfer from general tax revenues.

4) Going back to 1935 in a time machine and starting over.

The Economics Correspondent sees a combination of #2 and mostly #3 as the best option for making sure everyone gets what was promised to them while spreading the pain around as evenly as possible, but even #2 faces harsh political realities which will probably make it impossible.

Hence when Social Security is forecast to hit the wall in 2034 and no longer fully pay promised benefits the Correspondent suspects the federal government will either raise the payroll tax even higher, cut benefits for wealthier retirees (aka. “means testing” or reneging on promises to evil, comfortable retirees who committed the sin of being responsible during their working years), raise the retirement age by a few years to lower its overall payouts, or some combination of all three.

Wednesday, August 2, 2023

Where We Are in the Interest Rate Cycle

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An update on economic soft-landings from the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff.

The Economics Correspondent apologizes for his extended absence as he’s been travelling and has found less time for writing than he anticipated.

One of the many things that makes CO a super-cool party dude who knows things and does stuff is the freedom he gives his columnists and CO Nation as a whole to share differing ideas and disagree without employing the iron fist of New York Times, Facebook, or pre-Elon Twitter censorship.

So regarding economic soft-landings and the rallying stock market, the Economics Correspondent is going to go out on a limb and take the risky proposition of questioning the near-term (12-24 months) staying power of both the +2.4% GDP economy and the stock market… using data from the St. Louis Federal Reserve’s own charts.

Cautious Rockers can draw their own conclusions looking back at a straightforward graph of nearly four decades of business cycles and the temporal relationship between Fed interest rake hike campaigns and recessions (in vertical grey areas). Then readers can judge for themselves at what point temporally the United States economy lies within that process today—at the extreme right of the chart—assuming history likes to repeat itself.

ps. The Economics Correspondent remembers in 1999, early 2000, 2006, and 2007 countless Wall Street strategists and economists (some working for the government) declaring:

“The interest rate hikes are over and there’s no recession in sight. The Fed has achieved a soft landing and it’s all clear skies from here!” 

He even remembers in late 2007 the Dow and S&P hitting record highs among calls that:

“The Fed is now LOWERING interest rates and there’s been no recession.”

And…

“The bears and doom-and-gloomers have warned of recession for more than a year and it hasn’t happened. They’ve been proven wrong. With rates now going DOWN this is the best time to be an aggressive buyer of equities. Go all in!”