Crash Course Chapter 13: A National Failure To Save
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If you’ve just seen the previous chapter on debt, then you might be wondering if either our savings or our assets are of sufficient quantity to make those levels of debt perfectly manageable. In the next chapter I’ll deal with assets. In this chapter I will present evidence that the United States has failed to save money at virtually every level of society and make the claim that the United States government is insolvent. I use that term precisely. Whereas bankruptcy is a legal process that begins once cash flows can no longer meet current obligations, insolvency happens when one’s liabilities exceed one’s assets and is the first step on the road towards bankruptcy.
The purpose of the Crash Course is to give you the context and data you need to be able to accurately assess the likelihoods and risks that our economy faces over the next few years. My position is that the next twenty years are going to be completely unlike the last twenty years, and to support this statement I am going to take you through six key areas of data. Debt, Savings, Assets, Demographics, Peak Oil, and Climate Change. Any one of these could prove economically challenging, but the combination of two or more simultaneously, well,.I’ll leave that for you to assess.
This is a chart of the personal savings rate stretching back to 1959. The personal savings rate is the difference between income and expenditures for all US citizens expressed as a percentage. So a number like “10%” indicates that for every dollar earned, 10 cents was saved, not spent. Note that the long-term historical average for US citizens between 1959 and 1985 was 9.2%. For comparison, in Europe that number is around 10%, and in China, a stunning 30% of income is saved.
Savings are important to us individually, because they form the cash cushion that gets us through economic difficulties, and at the national level, because savings are essential to the formation of investment capital (that is, the property, plan, and equipment that create actual future wealth).
You may have read or heard recently that the personal savings rate has plunged to historic lows to levels last associated with the Great Depression. In fact, the personal savings rate has steadily declined from 1985 to present, indicating that those headlines we just saw were not some very recent blip on the radar, but rather the culmination of a 23-year erosion of savings as a cultural attribute of US citizens.
However, we are not a nation of averages, and this chart somewhat obscures the fact that the extremely wealthy are saving incredible amounts of money, while at the lower ends the savings rate is deeply negative.
Why is this important? Because as the Greek philosopher Plutarch once stated, “An imbalance between rich and poor is the oldest and most fatal ailment of all republics.”.
What else can we note about this chart? For starters, persistently declining savings tells us that there is an implicit assumption by the majority that credit will be available in the future, and that we have largely substituted a “save and spend” mentality with a “buy it now” mentality. As we look at this chart, we might also note that the savings rate began its decline right around 1985.
Hmmmm…wait a minute…didn’t we see that same time frame in the last section on debt? Yes. Yes, we did. While this chart is showing ALL debt across all sectors, and the prior chart was of personal savings only, we can note that our national tolerance of debt shifted drastically upwards beginning in 1985, right as our national approach to savings was beginning its long decline towards zero.
In order to believe that the future is going to be bigger, shinier, and brighter than the present, you have to believe that low savings and high debts are a path to prosperity. I am skeptical, to say the least, because this just doesn’t make sense to me – it violates several laws of nature.
Another category of saving is in pensions and retirement funds. At the state and municipal levels, we can observe that they, too, have failed to save, and pensions are underfunded to the tune of $1 trillion. What this means is that, as money was taken in through taxes, states and municipalities actively chose to spend that money elsewhere, in preference to putting it into pension funds. The idea there, we can guess, was to spend today and let someone else figure out how to pay for it in the future. Well, for many states, the future has arrived.
What does it mean when we say that the state and municipal pensions are underfunded by a trillion dollars? How is that calculated? The trillion dollar shortfall is what is called a Net Present Value, or NPV, amount.
A Net Present Value calculation adds up all the cash inflows (in this hypothetical example, $1000 per year for six years) and offsets, or NETS, those inflows against all the future cash outflows. Since a dollar today is worth more than a dollar in the future, the future cash flows have to be discounted and brought back to the PRESENT. We NET all the cash inflows and costs, discount them back to the PRESENT to determine if the thing we are measuring has a positive or negative VALUE. NET. PRESENT. VALUE.
This is the methodology used to calculate the status of state and municipal pension funds. Growth in the value of the pension fund assets, plus future taxes, are offset against cash outlays to pensioners, and brought back to the present, to indicate that in order for the pension funds to simply have zero value, $1 trillion would, today, have to be placed in those funds.
An important realization about NPV calculations is that the future has already been largely taken into account, so waiting and hoping for a different future result to emerge pretty much never works. If we have to place $1 trillion in the funds today, but don’t do this, next year the number will be larger. The only way it could be smaller is if fewer people are collecting benefits or the fund’s assets outperform the assumed rate of growth that fed the NPV calculation.
Moving right along, corporations are coming off the highest levels of profitability in decades but they too opted to underfund their pensions, to the tune of $1.5 trillion Net Present Value dollars, in preference for, uh, other uses for that cash.
Because pensions typically invest in bonds and stocks in a roughly 60/40 split, any recessions or market declines will only add to the shortfall. In part, the pension shortfalls are a direct function of the extremely low interest rates currently available – thanks, Greenspan and Bernanke! – and also because the main stock market index is pretty much at the same level it was nine years ago. And that’s only if we DON’T inflation-adjust the results. If we did, then we’d have to go back a bit further. Since most pension funds assume an eight-to-ten-percent yearly return, and since the stock market has had a zero gain for nine years, the pension shortfalls are understandable.
But when we get to the Federal government, that’s when scary numbers emerge. David Walker, the recently retired Comptroller of the US and a personal hero of mine for valiantly and tirelessly working to raise awareness of the looming US government shortfalls, said of the US government:
- Its financial position is worse than advertised
- It has a broken business model
- It faces "...deficits in its budget, its balance of payments, its savings — and its leadership."
In my assessment, he’s absolutely right. And here’s some data to support that. This is a table taken right from the US government annual report found on the Treasury Department website. Again we are going to be looking at NPV numbers. The first is a nearly $9 trillion dollar shortfall, representing the total US government net position without including Social Security and Medicare.
Again, this means that ALL US government cash inflows PLUS the value of all government assets have been offset against known outlays to determine that, today, the US government would have to somehow obtain $8.9 trillion to balance its liabilities and assets.
But that’s not even a fifth of it. Once we add in Social Security and Medicare, the shortfall suddenly balloons to $53 trillion by the Treasury Department’s own calculations.
Whoa! Stop right there! That’s more than four times GDP!! This means the US government is insolvent. Full stop. Why is this not topic #1 on the presidential campaign trial? A country this far in hock has some real future issues and is potentially on its way to bankruptcy.
In case you are harboring the notion that there’s some money socked away in a special US government account, like a “lock box,” this picture shows George Bush standing next to the entire Social Security “Trust Fund.” There it is…the entire trust fund is a three ring binder with slips of paper in it saying that the US government has spent all the money and replaced it with special Treasury bonds.
Hold on there…aren’t Treasury bonds an obligation of the US government? How can the government owe itself money? It can’t. All government revenue either comes from taxpayers or borrowing, so when the time comes to pay off those special bonds, that money will either come from taxpayers or additional borrowing. If it were possible to owe money to yourself and pay interest to boot, then we could all become fabulously wealthy by writing ourselves checks. But of course, this is a foolish, easily-dispelled notion.
At any rate, depending on which government agency’s numbers you use, the Federal shortfall is anywhere from $53 trillion to $85 trillion. This number is so large that it even scares small monkeys. And, proving the point that you cannot grow your way out of an NPV shortfall, this number has grown by nearly $40 trillion over the past 10 years, advancing during both strong and weak economic times.
And finally, saving is related to investing, and according to the American Society of Civil Engineers, we’ve fallen short there as well. In 2005, they assessed the condition of 12 categories of infrastructure, including bridges, roadways, drinking water systems, and wastewater treatment plants. They gave the US an overall grade of “D,” and calculated that $1.6 trillion would be needed over the next five years to bring us back up to first world standards. Since that was in 2005, and inflation for things made out of metal and asphalt has advanced enormously since then, let’s just round this up to an even $2 trillion.
And putting it all together, we find that a personal failure to save is reflected by a state and local failure to save, which are mirrored by a corporate failure to save, all dwarfed by a failure to save at the federal government level. And capping it all off is a profound failure to invest. All of these deficits lie before us and lead me to conclude that the next twenty years are going to be completely unlike the last twenty years.
This is our legacy – the economic and physical world that we are choosing to leave to those who follow us – and most of these bills will come due, in a big way, in the twenty-teens. Is that too far away to worry about? Not in the least, once you consider the full scope of the deficits.
How did we get here? How did this happen? As a former consultant to Fortune 500 companies, I saw an explanation for this, and it all begins at the top. If the leadership of a company was financially reckless or had a moral disregard for its workers, then this same behavior could be found reflected throughout all the layers of the company.
Our government has pursued a reckless policy of debt accumulation while neglecting saving and investing, and so have states, municipalities, corporations, and private citizens.
David Walker was exactly right in the earlier quote: “The US government faces deficits in…its leadership.” The top sets the tone. This topic should be front and center in our 2008 political debates, but it is nowhere to be found. We are laboring under a profound deficit of leadership.
Next we move onto assets, and see how they stack up against our debts and our national failure to save.