As I write this in late January, the United States government has a serious deficit spending problem. According to the U.S. Government Accountability Office, the total federal debt held as a percentage of gross national product sits at about 60 percent – the highest level we’ve seen since we were paying off debt from WWII. We passed that level on the way down around 1950.
Looked at another way, Congress is sending the nation deeper into hock each year by about 4 thousand to 5 thousand dollars per year for every man, woman and child in the country, as of the last couple of years.
When the federal government spends money it does not collect in taxes, of course, it must issue bonds for the difference. And the taxpayer must eventually repay that borrowed money, plus interest.
In the short run, this is not a huge problem for the United States, political posturing notwithstanding. Trillions in capital has come to the United States in recent years, despite all our problems, because other places have bigger problems than we do. Currently, the 10 year treasury yields about 2 percent – which is extremely low. It costs the government very little to borrow. For now.
In the longer term, however, that which cannot be sustained… simply cannot be sustained. Policy makers in the United States are being confronted with some very unpleasant facts:
The Aging of America
An aging population means that more and more retirees must draw Social Security benefits on the backs of fewer and fewer workers. Increasing medical costs are wreaking havoc with Medicare projections, compounding our Social Security deficits. And the Social Security trust fund is an accounting fiction: It contains no actual assets, but only a formal commitment from Congress that it will pay benefits to Social Security equal to the face value of the bonds the Social Security Administration holds. The treasury’s demand for revenues is shortly to become extreme.
Meanwhile, a resurgent China and troublesome Iran will see to it that there will be little relief for defense budgets anytime soon. And an increasingly global economy severely restricts the ability of the United States to raise revenue through taxation. Standard & Poor’s has already downgraded the United States from AAA-grade debt – and Fitch has downgraded the outlook on U.S. bonds.
Why? Because of the prospects that the U.S. will either eventually default on some of its bonds, or – much more likely – print more and more money to pay off its debts with cheap currency. Which amounts to the same thing. The Chinese government has already said it considers the U.S. to be already in default.
Here are our thoughts:
- We believe Social Security will survive, but it will be substantially cut back – probably through a combination of means-testing and an increase in the retirement age. In coming years, we could very well see an expansion of the current Social Security taxes. The net effect could mean benefits about 30-40 percent below current levels, on an inflation-adjusted basis.
- It is therefore extra important for our clients to save effectively for retirement. Social Security was never meant to be more of a supplement to retirement income. It will be even less than that, at some point in the coming years.
- Medicare will not be able to keep up with demand. In fact, Congress has already stripped Medicare of $500 billion in funding over the next 9 years to fund “ObamaCare.”
- Medicare is likely to be means tested, at least to some extent, in future years. We may also see an increase in Part A deductibles, and stagnation in Part D (prescription drug) coverage. Part C, or Medicare Advantage, may well not be there in its current form in future years.
- Again, it is extra important for our clients to set savings aside now, in order to protect themselves against reductions in Medicare benefits.
- Our aging baby boom population will also hit the nursing homes like a tsunami, beginning very soon. Nursing home and long-term care costs will rise to meet demand. But don’t count on much help from the federal government. Medicare provides only bare minimum coverage for long term care. Medicaid can kick in, for now, and help those in need – but only after they have impoverished themselves.
- It’s critical to develop a long-term care crisis plan for your family now – through a combination of savings, family support and insurance. If you have aging parents, now is the time to have the long term care conversation with them. If you don’t have a plan in place, nursing home costs may well threaten your family’s legacy. And Uncle Sam isn’t going to be able to help much.
- Long term treasury bonds are a bad long-term buy. Your upside with bonds is limited to the yield to maturity – and yields are pathetically small. If the government prints money – and the Fed is already printing trillions – inflation stands to destroy all your interest, and then some.
- Hedge against inflation. Assets like commodities, TIPs, real estate, oil and gas, all have their place, but they don’t replace a healthy allocation to equities, either.
- Keep expenses down. You can’t control what the stock market does. But you can control your expenses. Don’t needlessly pay too much in mutual fund expense ratios when you can buy index funds and ETFs for a fraction of the costs.
- Cover your rear. As always, make sure you have adequate life insurance, medical insurance and disability income coverage in place. You can recover from a bad investment. Your family can’t recover from your death or sudden incapacity. But you can prepare for it, and take care of them no matter what happens.
The good news is we do seem to be coming out of the last recession, albeit slowly. But remember that every dollar we borrow must come out of future growth. This means that growth will probably be slow going forward. Protect your gains, safeguard against losses, and remember that slow and steady wins the race.