The 2nd Edge Of Modern Financial Repression: Manipulating Inflation Indexes To Steal From Retirees & Public Workers - Part II
By Daniel R. Amerman, CFA
Below is the 2nd half of this article, and it begins where the 1st half which is carried on other websites left off. If you would prefer to read (or link) the article in single page form, the private one page version for subscribers can be found here:
The Double-Edged Risk For Retirees
Both of the two closely interrelated aspects of modern Financial Repression are likely to have a devastating impact on the future standard of living for tens of millions of retirees. These current and future retirees are investing to supplement Social Security and/or a pension, and this means the two edges of financial repression will be slashing them both coming and going. Unfortunately, the overwhelming majority of the population doesn't see the blade or the deliberate nature of the attack, making it very difficult to build effective defenses.
For future retirees, in each year up to retirement and each year afterwards, there will be a steady squeeze which reduces the standard of living that can be paid for by Social Security and pensions. Their expenses are likely to be increasing at rates that are well above the increases in benefit payments which are tied to inflation-indexing as determined by the government. For current retirees - sadly there is nothing theoretical about the subject of this article, for this is the day to day reality of what many millions of them have been experiencing in recent years. There is no fooling a retiree who is living on a modest stipend - for there is no safety margin to cover the difference between money coming in and money coming out. For current retirees who entirely depend on benefit payments, every day they experience the reality of the difference between what the government says is happening to their cost of living, and what is actually happening to the cost of their groceries, or a meal out, or a tank of gasoline, or their electric bill, or their annual property tax bill.
Let's return to our illustration of a 10% real rate of inflation, versus a 3% official rate of inflation that is used to calculate annual increases in Social Security payments. We'll assume that we are talking about a 60 year old named Brian who had for many years been hoping to retire at age 65, but because his financial planning investment strategy didn't work out as hoped, Brian is now shooting for 70 - if he is lucky. The current purchasing power of Social Security, in combination with Brian drawing down from what he hopes will be his retirement savings in 10 years, would be tight but doable, in terms of his future retirement standard of living. However, when he goes to the chart, and sees that with the illustration assumptions, in 10 years the purchasing power of Social Security may only be 48% of what it is now, Brian realizes that it simply won't work, and that he and his wife, Angela, wouldn't be able to retire at all with an above-poverty-line standard of living.
(The above chart was created in 2007, thus ten years out is 2017. While the chart could have been easily updated to the current year, it was left in its 2007 form to reinforce a very important point: this isn't a new, surprising, or short-term development, but instead, governments resorting to inflation-index manipulation has been predictable for a long time, for the same fundamental reasons that such manipulations are likely to persist far into the future.)
Brian realizes that with his current plan, he can't retire at 70. He also doesn't know what his health will be in his 70s, and he isn't entirely confident that he will still have a job in 5 years, let alone in 10 or 15 years. For these reasons, Brian and Angela decide to tighten their belts right now, and drop their standard of living, to try to save as much as they possibly can before their incomes fall in retirement. Perhaps between additional savings and earnings on those savings, they will be able to retire in ten years, or at least have the option if life makes the decision for them.
Which brings us back to the first edge of Financial Repression, the time-honored method governments can use to reduce the real value of massive debts. Having been badly burned with their more aggressive stock investments, Brian and Angela want to stick to "safe" and liquid investments this time around, particularly since they don't know for sure when they will need to start cashing them out. So they choose short-term, high quality investments. Where interest rates are being manipulated by the Federal Reserve to stay at levels well below the rate of inflation, as part of a deliberate government policy of Financial Repression.
For simplicity's sake, we will assume that the relationship between short-term high quality investments and real inflation is the same as that between the official rate of inflation and real inflation. Which would mean that over ten years, with a 3% annual return, and the value of money declining at 10% per year, the purchasing power of a dollar that Brian saves today will be worth 48 cents in ten years (pre-tax).
Brian anticipates that in 10 years his Social Security benefits will only buy half of what they do today. So he and Angela try to prepare by saving as much as they can, in an uphill struggle against the future.
And it gets worse.
Fifteen years from now, when Brian turns 75, Social Security payments only have 37% of the purchasing power that they do today. And the dollars saved to make up the difference in purchasing power also only have 37% of the purchasing power.
Five years later, when Brian reaches age 80, Social Security payments only have 27% of the purchasing power that they do today. And the dollars saved to make up the difference in purchasing power also only have 27% of the purchasing power.
Which is where things get still worse - because Angela has a bigger problem than Brian does. That is because on average, women are younger than their husbands, and will live for longer, meaning Angela could easily have ten or more years of inflation and financial repression exposure after Brian has passed.
And 30 years from now, Angela's solo Social Security payments may only buy 14% of what those payments would buy today. While the dollars saved 30 years before might have only 14% of the purchasing power they have today - pre-tax, even after having been invested at market rates for 30 years.
What makes this bleak scenario all too likely is the other side, and the financial interests of the sword-wielder. Because of 30 years of systematic inflation-index manipulation, the government is saving 86 cents on the dollar when it comes to retirement beneficiary payments. That fantastic, incredible, unpayable $14 trillion in national debt from 2011 is worth only about $2 trillion in inflation-adjusted terms by 2041. Thus, the impossible numbers of unfunded obligations, the $62 trillion and more - turn out to be possible after all.
From a very cold, impersonal, mathematical perspective - the steady power of exponential mathematics was simultaneously applied from two different directions to quite effectively deal with the seemingly impossible 1-2 combination of current debts and promised future payments that are rapidly increasing. From the self-serving perspective of politicians seeking to stay in power - there is a compelling political logic to choosing a slow and highly technical deceit that most voters will never fully understand, as opposed to repeatedly voting to reduce retirement payments in the open (these political considerations are covered in more detail in the "Inflation Index Manipulation" article linked above).
From the perspective of the tens of millions of current and future retirees who built much of what is the United States - there is all too likely to be an intensely personal tragedy, repeated in city after city across the nation, as well as in other nations. Honest hard-working people who played by the rules their entire lives, who made a lifetime of contributions, who did everything they were supposed to do in order to enjoy a pleasant and prosperous retirement - find themselves facing impoverishment in their later years, caught in a multi-sided financial trap with seemingly few ways out.
This is unfair, it is an outrage, and it is just plain wrong.
One solution may be to scream and shout and spread the word, and if enough people do it - that could help. However the situation - and the math - being what they are, the most practical and effective solution may be to leave the conventional retirement investing box altogether, move to a different level of understanding, and learn to flip the government's mathematics of retirement destruction into a personal arbitrage opportunity for building safety and wealth.
The Triple Risk For The Military, Teachers & Other Public Sector Employees
The greatest danger of all is reserved for those who currently still serve the public in their careers: military personnel, police, firefighters, teachers and the many other public sector workers. (While they fall in a different category, the millions of private sector employees whose incomes are also explicitly tied to official inflation indexes are also at risk.)
As the public workers face the severe challenges in making retirement investments in an intertwined world of financial crisis and Financial Repression, what may appear to be their greatest benefit relative to many in the private sector, may instead turn out to be the lead weight that drags them down. The advantage – and also the problem – is that they have a job and source of income that is (generally speaking) more secure than the uncertain prospects faced by many in the private sector. However, in these days of financial strain, unless they get a promotion, their pay is going to be limited to increasing with the rate of inflation. Much like Social Security beneficiaries, the only raises they will receive are those associated with the official index for inflation. Indeed, because they are paid by the government, public sector worker salaries come out of the same pool of money as entitlement beneficiaries, and will effectively sink or swim along with the entitlement beneficiaries.
So let's consider the total challenge that is faced by a soldier, firefighter or teacher who is trying to prepare for retirement in 10 or 15 years. Like everyone else, in an environment of Financial Repression, they face steady impoverishment from the first edge, that comes in the form of a declining purchasing power for future retirement benefits. Like Brian and Angela in the previous illustration, they face the danger that their public pension may have only 48% of its current purchasing power in 10 years, or only 27% in 20 years.
Like everyone else, these workers will face the second edge of Financial Repression, that steady reduction in the purchasing power of their savings. These public employees face the danger that a dollar they invest today to offset their benefits falling by half in 10 years, will itself only have half the purchasing power that it does on the day they first invested.
There is third danger for those who serve the public. Savings come out of current income after expenses have been paid. However, the salaries of actively employed public workers (as well as private sector workers whose income is explicitly tied to inflation indexes) will be feeling the same annual squeeze in purchasing power that current retirees will.
So, as public employees attempt to save ever more money, their household expenses (all else being equal) are likely to be rising as a percentage of their income each year, which translates to less money being available to save each year. This then places them in the situation where 1) their ability to save diminishes every year along with the purchasing power of their salaries; 2) the purchasing power of their savings declines each year; and 3) the purchasing power of their public pensions declines each year.
This may sound like a horrible example of Murphy's Law in action, and so it may seem for many unprepared future public sector retirees. But, there is no coincidence here. All one needs to do is step back, perhaps way back, and look at the big picture from a governmental perspective. The governments of the Western developed world are broke, and have no way out, unless they make some radical changes. And this was the case long before S&P cut the credit rating of the United States.
Governments have massive current debts, along with impossible spending burdens ahead. The largest components of those spending burdens are salaries for public sector workers and transfer payments for entitlements - each of which are inflation-indexed. The "magic bullet" of manipulating the inflation indexes to steal from savers, public workers and retirees is what makes the math work.
Because they have three separate exposures - salaries, savings returns and retirement benefits - public workers face the likelihood of having three distinct "shots" taken at their current and future standards of living. This year, next year and every year thereafter.
The Choice Between Impoverishment & Finding New Solutions
While there is a significant chance of a financial and economic meltdown when it comes to the governments of the West, particularly if the euro and European economy were to collapse – there is no certainty of a meltdown. This meltdown may look inevitable to some people when we consider current laws and the way the banks and economies are currently structured. However, for personal financial survival, it is also essential to keep in mind that the rules are what the government says they are. Think of governments as being enormous, dangerous beasts who have been backed into a corner and are fighting for their lives. Bloodied, wounded beasts with full control over not only what the language of the law reads - but perhaps even more important - which laws are enforced and how they are enforced. With how inflation-indexing works being only one example.
As we are already seeing in Europe as well as the US, the general governmental reaction to the increasing failure of government policies is not to say "we screwed things up, we're all resigning in shame and here is your power back and a return to sound money". Rather the government's reaction to its own failure is to try to ratchet up its own power in the name of emergency, and to increase its control over its own citizens in the process.
The use of Financial Repression to emerge from enormous debt levels is not theory – it is proven history. It is what worked the last time the governments had this level of debt outstanding. The situation is worse this time around, but the double-edged sword of Financial Repression is already being aggressively wielded today by the US government against its own citizens. This can be plainly seen when we compare the real cost of living and how that changes on an annual basis in comparison to either returns on savings or the official indexes that are used to pay salaries and entitlement benefits. In my opinion, there is no question that the net result is that we are not being adequately compensated for saving our money, and that standards of living are falling for people who are completely dependent on payments that move exactly with official government inflation indexes.
I have been writing about these issues for a number of years because they are the only way that the math adds up. They're a viable way for politicians to steadily steal from an increasingly impoverished public while still maintaining sufficient "plausible deniability" about what the government is doing to avoid being thrown out of power.
Now something the government is very well aware of are the strategies which many people are entering into in an attempt to escape meltdown, as they bet on currency collapse and hyperinflation. Unfortunately, as will be covered in later articles, if the future is instead one of Financial Repression (or Financial Repression on the path to meltdown, or after meltdown, or both), then with some very popular strategies that are entirely meltdown based, investors may find themselves in the equivalent position of having put a noose around their necks, tightened the noose, and waiting for the government to pull the lever. With the lever likely being pulled at the exact time that these investors thought they were going to be reaping the fantastic rewards of their gambles.
There is an alternative. That is to seek out strategies that are thoroughly nonconventional from a meltdown perspective, as well as in comparison to normal financial planning. Perhaps the best approach is to say: "I don't know what the future will be, so I want a strategy that protects what I have if it's meltdown, with a strong upside potential. And I want a strategy that protects what I have if it is financial repression, with a strong upside there too. What I want is a strategy that works for me both ways."
A continuation of Financial Repression into the future will likely severely damage many conventional long term investment strategies. There are the direct effects of the first edge, which means fixed income investors steadily lose the value of their portfolios to inflation. However, it is the second edge of Financial Repression that is the deadliest for traditional investment strategies. In the linked resource following this article, "The 6 Logic Flaws In Financial Planning That Threaten Retirement For Millions", there is a quite pertinent discussion of "Logic Flaw #3", which is the relationship between retiree consumer spending and retiree stock investment values.
There is more detail in the linked resource, but in short form: the Baby Boom has been buying stocks which are absolutely dependent on growth in consumer spending in order to fund their retirements, with an intention to sell at the very time the Baby Boom is reducing spending in retirement, not taking into account that age-driven reduction in Boomer spending will slash much of the value of stocks that depend on growth in consumer spending. This then creates a loop as reduced investment values lead to reduced retirement spending ability, which further reduces investment values, and so forth.
If retirees and public sector workers - along with inflation-indexed private sector workers - have falling real incomes because of inflation-index manipulation, then this has a devastating effect on consumer spending growth, which, per Logic Flaw #3, then means that a stock market priced for never ending growth is radically overvalued, and subject to a punishing and long-term decline.
The repression may or may not be successful at preventing a total financial meltdown. Crucially, however, meltdown investors must understand that if currency collapse is dodged, even if there is a sustained but high real rate of inflation that is deliberately deployed as part of a strategy of Financial Repression, part of the very design of the playing field and tax structure will likely be to squeeze out and crush the assets of those pursuing simplistic and traditional meltdown strategies. The government actively makes the rules, and history shows that in times of emergency, motivated governments change rules very quickly on a wholesale basis. Unfortunately, however, too many people mistakenly believe that a desperate government that is scrambling to prevent financial collapse will merely passively maintain the current rules.
As close to financial security as can be found in these perilous and volatile times can best be achieved through pursuing unconventional strategies designed to handle both repression and meltdown.
