Social Security isn’t very secure right now

Social Security was back in the news again with the release of a series of recommendations from the President’s Commission on Deficit Reduction. You see, Social Security isn’t very secure right now. Any competent actuary would tell you that the way we fund Social Security is nowhere near sufficient to pay the benefits that are promised. That is why a goodly proportion of younger workers deride the idea of ever getting anything from Social Security for themselves. That is probably a little overstated, but none the less a good starting point for discussions.


You see, there is a major misunderstanding of what Social Security is. Most people in the public and many in politics see Social Security as a retirement program for workers. You pay in and later you get paid back. Essentially, between the 7.65% of wages (up to a point) that workers pay in FICA taxes and the matching chunk that the employer pays, each worker puts 15.3% of their stated wages into Social Security. Then, when you retire there is an account with your name on it that says how much you paid in and the earnings on that account and you get that. Wrong! Very, very wrong.


Social Security is a transfer payment, like welfare. When a proud American worker, after 40 years down at the plant or in the office or whatever retires and begins to collect Social Security, she is essentially going on welfare. It doesn’t sound as nice as collecting Social Security, does it? But, it is essentially the same thing. When one group of people (in this case workers) pays taxes to the government and then the government writes checks to another group of people (in this case retired workers) that is a transfer payment. Money is transferred from one group to the other. That is how welfare works. In this country, we have cultivated this differentiation between welfare and Social Security that makes it a lot less stigmatizing to collect Social Security than to go on welfare.


Recently, the Social Security system has been on better financial footing, thanks largely to the fixes implemented during the Reagan years. Those fixes are about to break down. The number of baby boomers who are reaching retirement age over the next 15 years or so are going to break the system without another fix. When we say fix, we mean tax increase, benefit cuts, means testing or delay in receiving full benefits. That is what the Deficit Commission recommended, sort of.


So Social Security is back in the news. Expect a whole bunch of questions from people about what this means to them. Tell them whatever you think is right, but it means increased safety for those on Social Security now or soon and more taxes and less benefits for those who have a long way to go. On the plus side, these young workers will more likely get something from Social Security when their time comes.


Issue of the Week

The Group of 20 Nations was meeting in Seoul, South Korea last week. The G-20, a list of countries too long to type-out, is the G-7 plus most of the larger developing nations, the BRICs and others. Between the G-7, essentially the US, Canada, Western Europe and Japan, you see maybe 60% of world GDP, today. The other 13 nations in the G-20 will be 60% of world GDP pretty soon as most of the growth in the world these days is happening there.

Most of the G-20 runs trade surpluses with the US and they like it that way. We might say all of them do, but just to be careful we’ll opt for most. So for most of the G-20 a weaker US dollar is a bad thing, at least on the surface. Running on the theory that a weaker US dollar will make our exports more competitive and their exports less attractive to us, the idea of a weaker US dollar is to reduce that trade surplus most of them run with us. As we have mentioned before that probably won’t do a lot of good, but that is the theory most of these folks are operating under.


Some of our brothers and sisters in the G-20 are miffed at us for complaining about their currency shenanigans while at the same time plotting QE2 (the latest round of quantitative easing from the Fed, see the last several missives for a further discussion of QE and its impacts), which will likely have the effect of weakening our dollar. The Treasury Secretary can argue with a straight face that QE2 has nothing to do with the dollar because the Fed is doing this all on their own. You see the Treasury is responsible for international monetary affairs for the US including fussing with the dollar or helping our buddies fuss with their currencies. It is the Treasury who periodically steps-in and buys a whole bunch of Euros for example to thwart a run on the Euro. So, if the Fed does it, and the Fed is an independent arm of the government from the Treasury, it isn’t the US government who is playing with the currency. Yeah, as Chico Marx used to say “who you gonna believe, me or your own eyes?”


Well, our brothers in the G-20 aren’t going to accept that at face value. When their central banks buy or sell a huge volume of their currency, it is manipulation. When the Fed does it, it is wholly innocent, domestic monetary policy. Yes, and we’ve got some great land we can show you once the tide goes out.


The Fed can get away with a lot due to its crucial position near the hub of the world’s financial system. But, in an age where every nation is trying to get rich by selling stuff to the US, there is only so much the Fed can do to mitigate that. Already, during the latest recession our imports were cut about in half, some of that was from lower demand for energy products due to the recession, some was due to improvements in efficiency. We may make more strides in energy conservation/efficiency in the future. All those wind farms may make a difference someday.


But, for the present, the world needs us to be a bigger consumer while we need the rest of the world to look at their domestic markets and get them to spend more. We want a world in which developing nations save less and spend more, while we want to spend less and save more. If only it were that easy.


Economic News

The US trade deficit shrank in September to a mere $44.0 billion from $46.5 billion in August according to the Commerce Department. Expanding exports explain much of the improvement. The weaker dollar could explain some of the bounce in exports, but so might growing foreign economies and a willingness to deal with trade partners on a more aggressive basis. This year, the trade deficit will be bigger than last year, since we have already eclipsed last year’s deficit with two months yet to go.


Consumer Sentiment edged up in November. The Reuters/University of Michigan survey rose from 67.7 in October to 69.3 in November. This is yet another modest improvement in an economic series now that the election is over.


Weekly Stuff

Remember the week before last? That ‘best of all possible worlds’ where everything or nearly everything went up in price? Well, that didn’t last long. It took only one week do absolutely reverse most of that. Last week was the antithesis of the benign week before, nothing worked. Stocks were down almost across the globe. Bonds were down in almost all locales and in almost all qualities. Real estate was down, commodities were down. What was up? The dollar.


Probably the most important cross-trade in the world right now is the dollar/euro with the dollar/renminbi (China’s external currency for world trade) running a close second. When the dollar gains against the euro and the renminbi, everything else turns down. When the dollar falls against these two, the world is a beautiful place (see the prior week’s idyll on the markets). The dollar carry trade is the problem here. Too many people with too many investments funded by too cheap money provided in dollars with hardly any interest rate attached and every reason to go down in value. Why wouldn’t you borrow a currency whose government is trying to destroy it? If you keep the loans on for a few years, you can almost assure yourself that the cost of paying it back will be less than nothing. This is at the heart of the “risk on – risk off” trades we have seen over the last eighteen months or so. When the dollar strengthens, for whatever reason, the loans get paid-off pronto and whatever was purchased with the dollars gets sold. (The order was backward there, but you get the point.)


The reason it takes the name risk on – risk off is that whenever risk rears its ugly head, the dollar gains, the euro drops, the renminbi drops and everything goes to heck.


Stocks lost roughly 2% in the US last week no matter what part of the market you were in. The funny thing was we started the week by setting new recovery highs and then started slipping and by the end of the week we were falling. The angst surrounding QE2 is part of the problem, with more voices calling for the Fed to rethink this policy. The contumely heaped on the US at the G-20 was a start and then the academic/investment complex chimed in. Now, we don’t know if the market would be better off if the Fed stands firm on QE or whether we’d be better off if they bent to the newest wind.


There were other markets that took notice of this brouhaha. Most European markets were down for the week. Japan was up but most of Asia was down as well. China’s Shanghai exchange scared everyone with a pretty dramatic drop last Friday. The fall of 5.5% reversed what would otherwise have been a very non-dramatic week. After the Chinese and their ‘managed trade’ buddies won at the Seoul G-20 Summit, their market decided that the coast was clear for Chinese monetary authorities to further tighten their policies in the on-going effort to slow the growth of the Chinese market. No one really knows if the Chinese central bank will indeed tighten credit, but the risk of that is enough to get the traders to start heading for the exits. This sort of reaction to monetary and economic numbers is not new in China. The volume of ‘hot money’ in the Chinese market is enough to sway that bourse in the short run. Remember that the entire Chinese market is still only a fraction of the size of most European markets, and of course an even smaller fraction of the US market.


But, all of the QE news was bigger news for bonds than for stocks. Most bond markets were down on the week. It didn’t matter what side of that trade they were on, or what currency they traded in. Our guess is that the world sees an inflationary spiral starting that Bernanke and Company don’t see, but time will tell. The damage was a little worse in Treasuries than in most other areas of the market. Corporate bonds suffered more if they were high grade, less if they were high yield. Muni’s especially got whacked for some reason, maybe they had come too far recently.


Most foreign bond markets were down and with the dollar move were doubly down. The currency markets are racing to see who can get lower faster and that ought to confound the dollar’s attempt to get cheap. As the tension builds around this wholesale race to the bottom, the dollar’s historic role as the safe haven will thwart the desire to make the dollar cheaper.


Real estate markets were lower, following stocks generally and financials specifically. Losses of 5% or more in US REITs were common. Foreign real estate securities handled things a little better with losses of 4% after the negative currency impact.


Commodities had a bloodbath. The only commodities we saw that didn’t fall were cows and pigs (feeder cattle and live hogs). Industrial metals fell, ag commodities generally fell, precious metals fell, energy fell, softs fell, nearly everything fell. The main reason was the aforementioned dollar carry trade that borrows vast amounts of falling dollars and buys ever-rising commodities. Oops!


We just finished with the half-hearted celebration of Veteran’s Day across the US. You’d think with a new generation of Americans exposed to combat overseas that we’d take this holiday more seriously. It began as Armistice Day in 1919, to remember the fallen from World War I. The Armistice between France, the United Kingdom, and the US and Germany was signed on November 11, 1918 to end fighting on the western front in World War I. After World War II in America the holiday was renamed Veteran’s Day and commemorates those who have served in all the wars the US has fought in over the years. (This is a different mandate from Memorial Day, which was started after the Civil War and commemorates the fallen in all our wars.)


Europe had not known a major land war in almost 40 years prior to World War I. The massive victory of the Prussians over France in the Franco/Prussian War of 1870-71 was a distant memory by August 1914. The technological advancement in warfare over those years came as a big surprise to the old generals who lead the armies in the early part of the war. Dedicated railroad cars and rapidly transportable munitions made the destructive force of the armies unprecedented and on a greater scale than ever before. The death toll was enormous on all sides in the war. Hardly a family in Europe totally escaped the pain of the war.


It also marked the emergence of the US as a global player. Our entry on the side of the western allies made the war unwinnable for the Germans and their allies. It was a matter of time before the fresh new army on one side would tip the scales in their favor. The Germans agreed to withdraw beyond the pre-war borders, cede territory to France, pay reparations to the victors and reduce their military. The German Kaiser was forced into exile.


All in all, November 11, 1918 was a big day in world history. Think about that for a moment. The armistice was the end of the German Empire that had been a century in the making. It also led for the demise of the Austro-Hungarian Empire which was the last vestige of the Holy Roman Empire that Charlemagne had built. The Ottoman Empire collapsed and modern Turkey was born. It was the culmination of Slavic self-determination (though that word hadn’t been coined yet) with the rebirth of Poland, the birth of Czech, Bulgarian, Romanian, Hungarian nation states and a huge expansion of Serbia into Yugoslavia. Many peoples in the Middle East had new states created for them, Syria, Iraq, Jordan, Palestine. The map of Europe was redrawn as were the maps of Africa and Southwest Asia.


The severity of the armistice would cause problems for the new German democracy and lead to the destruction of the Weimar Republic, which lead to the political and social turmoil that allowed a Hitler to come to power. The victorious Western Allies were no better off with depression to follow in Britain and France in the 20’s and the US in the 30’s. The ‘war to end all wars’ and the toothless League of Nations didn’t stop World War II a generation later. Think about that a moment.


Have a great week


Karl Schroeder, RFC, CSA

Investment Advisor Representative

Schroeder Financial Services, Inc.