There are quite a few people who I am likely to offend or put off in the course of this article so let me start with the most offensive statement and see if I can save some of you folks some of your own time.
Social Security and Medicare are failed Ponzi schemes!
If your head hasn’t exploded yet, good. I will now set out to explain my conclusion.
A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from profit earned by the individual or organization running the operation. Perpetuation of the returns requires an ever-increasing flow of money from new investors to keep the scheme going.
Source: Ponzi scheme by Wikipedia (http://en.wikipedia.org/wiki/Ponzi_scheme)
As I explained in my previous article, Living on Borrowed Time (Part 2), the way that Social Security was built was based on the credible, at the time, assumption that most people who paid into Social Security wouldn’t live long enough to collect it. It didn’t start out as a Ponzi Scheme. It started as the inverse of Term Life Insurance.
If you’re not familiar with Term Life Insurance, you select a policy amount that the insurance company will pay in the event that you die within the term of your policy (usually 10 or 20 years). You make regular payments over the life of that policy and if you live through the term of that policy, the insurance company keeps all the money you have paid and your life insurance coverage ends. You bet that you will die within the term of the policy, which would mean your beneficiaries would collect the full amount of your policy. They (Insurance Company/Underwriters) bet that you won’t. It is worth noting that while you may be making a blind bet, they are not. Before you qualify for life insurance you must go through health screenings, have a background check done, your family’s medical history is probed. When they have all of that information, they turn to mathematical wizards, known as Actuarial Scientists, who calculate the probability that you will die in the term of your contract. I’m serious, these people exist and they make a lot of money calculating when you will die. The probabilities they come up with make the Insurance companies a ton of money. Frankly, if the actuary tells the insurance company that you are a bad bet to live out your term, they won’t insure you.
Social Security is the inverse of that. They (the government in the 1930s) bet that you (the taxpayer and potential recipient of Social Security retirement benefits) wouldn’t live long enough to collect. Given historical data, social norms (here and abroad), and the best actuarial science could calculate at the time, it was a safe bet. To hedge the bet, there were enough other cultural norms in place that would make the long-term viability not a serious concern. In the decades that followed, every premise of the cultural norms that secured the Social Security fabric was picked apart.
- More payees than recipients
- US dollar was stable and backed by gold
- Large corporations offered pensions
- We exported more goods around the world than we imported
- There was enough gold in the Treasury to handle a substantial amount of debt
- Saving money was embedded into the nation’s cultural fabric after the Great Depression
- Families typically lived in close communities
I started with Social Security because it predates Medicare, but it was built on the same premises (funded the same way) and grew out of control for much the same reasons. Of the support structures I list above, I will only go into the breaking of three of them to explain how that has led us to where we are.
- More payees than recipients
- US dollar was stable and backed by gold
- Large corporations offered pensions
Baby Boomers had fewer children
The Baby Boom, a period from 1946-1964, resulted in the largest surge of babies born in the U.S. As a result of the Great Depression and then World War II, the birth rate dropped sharply. When World War II was won and the soldiers came back, there was an economic boom and a baby boom unlike any seen in this country. From an average of just over 2 children per family, the national average climbed to nearly 3.5 children per family. This combination created a glut of children and later, a glut of workers in the American marketplace. The result was that the combined income from the workforce from 1964 through the early 1980s was more than enough to cover the recipients of Social Security and Medicare (at that time).
Where things changed was that college became more of a standard, industries moved families all over the country, women hit the job market in never before seen numbers and…baby boomers had fewer children than their predecessors. Whereas the child rate was around 3.5 when the baby boomers were born, that rate plummeted to fewer than 2 until the baby boomers, themselves, began having children through the 1970s and 1980s. Even once the baby boomers started to have children, they didn’t have nearly so many children as their predecessors. The child per family rate has steadily climbed ever since the 1970s but we have only recently crossed above the 2 children per family mark.
This has flipped the balance of payers and recipients completely. When Social Security and Medicare began, seniors made up 13% of the US population. Currently they are closer to 20% of the US population and there is a large swell of people approaching seniority (40-59) behind them. The future workforce (aged < 40) make up 55% of the total population and they too are having relatively few kids. So at the time that recipients of Social Security and Medicare need their largest source of income, the workforce (relative to the recipients) is at it’s smallest. A fundamental tenent of the Ponzi scheme is broken (more payees than payers equals bankruptcy).
The Old Greenback She Ain’t What She Used To Be
From the founding of this country, the U.S. dollar was a currency. A currency, for those who are unfamiliar, is something that represents something of value (labor, property, precious metals, etc.). Historically the U.S. Dollar represented (or was backed up) by Gold. Every U.S. dollar was equivalent to a fixed amount of gold. That value didn’t waver and only changed if Congress decided to change it. The result of that backing was a steady growth in the value of the U.S. dollar in international trade. After World War II, it became the standard International currency by which trade was calculated (and later converted into local currency).
All of that changed in 1972. In 1972, President Richard Nixon took the United States off of the Gold Standard. At that point the dollar stopped being a currency and just became fiat money. (If you don’t understand the distinction, please read up on it here). Congress and the Treasury were no longer the sole deciders on how many dollars were printed and what the value of those dollars were. It would now be valued much like a publicly-traded stock. The more shares of stock that become available, the less valuable (relative to the whole) your shares of stock become. This is what happened with the U.S. dollar. When the printing and backing of the U.S. Dollar became the sole discretion of the Federal Reserve, instead of the U.S. Government (and no, they are not the same thing), we created more dollars at a faster pace which steadily erodes the value of a dollar. This is the reason why products cost more every year. This is a big part of why housing, food, education, energy, and healthcare prices have ballooned since the 1990’s. The creation of floods of fiat money, which represent national debt to the US, is draining the value out of the U.S. dollar.
Then there is the individual killer. Since the early 1980’s there has been a growing menace that has managed to get inside our culture…credit cards. Credit, in general, is nothing new to banking, economics, or US culture but the rise of credit cards, unsecured loans, and extended financing has “economically shackled” American citizens unlike anything since before the American Revolution. The credit involved in credits cards is also a form of fiat money. The more of it that is created, the less valuable the money becomes. The result of this one-two punch is that a dollar (in 2012 value) is worth roughly 11% of it’s value in 1935 (Social Security) and 4% of it’s value in 1965 (Medicare). This result means that funds collected from 1965 to current are worth progressively less every year. For all the money that has been paid to Social Security and Medicare, it’s value doesn’t compare to the present day costs because their money lost value (and is continuing to do so) while the cost of living increased (and is continuing to do so).
The Company Won’t Take Care Of You Now
In 1978, Congress passed a provision that allowed for a tax-deferred account that would allow people to take portions of that salaries and put them toward their retirement. The original intent was that the funds would be used to invest in federal and municipal bonds (which fund the government) but it also allows for use of those funds toward publicly-traded stocks. In 1980, an industrious benefits consultant named Ted Banna, was looking for a way to streamline his client’s profit-sharing plan. The method he came up with is a 401(k) / 403(b) account, named after the provisions that Congress passed in 1978.
What the 401(k) did for employers was allow them to share their profits, usually by some form of matching their employees’ contributions, and discontinue pensions (which had been the corporate standard since the 1940s). Pensions are expensive and once the value of the dollar began to fluctuate, pensions became a very complicated system to manage. A 401(k) plan is decidedly cheaper for a company to provide and are often managed by a third-party financial firm.
What the 401(k) did for the finance industry was create explosive growth. For the first time ever, average citizens were readily involved in the stock market. As the 401(k) plans caught on with employers, the total value of publicly traded companies reached heights never before seen. Financial investment firms had exponential growth selling funds that the funds from 401(k) accounts could be tied to. The gradual adoption 401(k) retirement plans and growth in stock market activity would lead to the economic boom of the 1990s and is a large part of the success we enjoy today.
What the 401(k) does for the average citizen is a mixed bag. The 401(k) is an investment vehicle that can be wildly profitable (if invested well and in the right conditions) or it can be a devastating failure. It takes a savvy investor to best utilize what a 401(k) account can do. Realizing this, many financial firms have built an industry around “steering” customers toward “sound investment strategies”. Many of these strategies are less about you building value in your account and more about products (particular stocks or mutual funds) that they can sell you. The typical citizen today is more savvy about the stock market than we were in the 1980s, but we’re still a long way from being knowledgable enough to make a steady profit from that type of investment.
When the economy is climbing, a well-invested 401(k) account can experience massive growth in a very short amount of time. Any accounts that were invested in Technology-growth stocks through the 1990s experienced unprecedented growth through that time. Returns of 2000% – 5000% were absolutely attainable. The profitability of growth like that tempted many to put more and more into their accounts to profit from it. Unfortunately, many of these same people were not savvy investors of the stock market. When the market eventually came back down, as all markets do, many people lost incredible amounts of money (70-90%) of their account value. If this was simply an investment account formed out of a person’s expendable income, that wouldn’t be as tragic. Unfortunately the losses sustained were the retirement savings of many people. Those loses have not been returned. The money that was put into those accounts went toward stocks that will likely never approach those levels of relative value again. To a savvy investor, a 401(k) is an investment vehicle with tax benefits. To everyone else, it is gambling with your retirement.
The above factors, as well as other less significant ones, have combined to wipe out the stability of and increase people’s dependence on Social Security and Medicare. A combination of bad government decisions, profiteering corporate decisions, and unfortunate decisions made by many Americans leads us to where we are today. We are a physically healthy country in the early stages of a terminal economic condition. As I discussed in my earlier posts about Borrowed Time, it has to come from somewhere. In order for the older generations to live longer, the funds for them have to come from somewhere. The same can be said for Borrowed Money. Scarily, the funds are coming from sources who are self-serving and do not have our best interests at heart.
Note from the Author:
I did not write this piece to unnecessarily scare anyone. I wrote this piece to deliberately, but appropriately, scare and inform people about the economic realities, and historical reasons for them, in this country. In our current political climate, it is far too easy to blame the current government (Legislative or Executive), a particular political party, or some other scapegoat. The problems we face now were developed over decades and their solutions may take just as long, if solutions can be found. It is time we, as a country, stopped the finger-pointing and got to the business of building our country’s economic future because the time is not far off that we may not have one.
- 6 Important Historical Moments in Our Nation’s Debt (abcnews.com)
- Living on Borrowed Time, Part 1 (carpebootium.com)
- Living on Borrowed Time, Part 2 (carpebootium.com)