Elections, Investments & The Battle For Future Wealth
by Daniel R. Amerman, CFA
There was a major battle that took place in the United States in November of 2012, but it wasn't fought between the Republicans and the Democrats.
The result was an overwhelming victory – because only one side showed up for the fight. For the most part, the other side didn't even realize that a battle was being fought.
The winners came well-organized in their tens of millions. These were the people who have been promised government benefits for Social Security and Medicare, now and in the future. These were the people whose jobs are dependent on government spending, and these were the people who are receiving transfer payments from the government.
The casualties in this battle were the tens of millions of conventional long term investors and retirement investors, who in many cases had been responsibly saving and producing more than they consumed for decades, building a nest egg to take them through retirement with security.
What decided the outcome was a lack of knowledge, as most of the people whose future standard of living will likely be slashed by what was being decided in the election were not even aware that a battle was being fought. So the battle was over in a rout before the election was even held, as long-term investors lacked even the basic choice of being able to vote to defend what they have been building.
No Contest
Now there are many millions of people who would likely disagree with this assertion that there was no battle, or that it was effectively over before it began. They might say that the election was indeed about what the future role and size of government should be, and that it was actually a very hard fought election, whose outcome ended up being decided by a very small margin if one were to look at key battleground states.
And there is truth to that statement, as a matter of political philosophy. However, when it comes down to the actual specifics of what was being voted on in the election as they relate to the division of wealth in the future between private investors and government beneficiaries, some of the key issues weren't even on the table to be voted upon. That is because in their search for votes, the candidates weren't disagreeing with each other on these critical issues for long-term investors.
The Division Of Limited Wealth
When it comes to long term investment success for the average investor in the future, perhaps the most central of all questions pertains to the division of limited wealth.
The United States has a number of different programs that are destined to become extraordinarily expensive - far more so than they are today - just with the inevitable demographic factors of there being more and more Boomers reaching retirement age and relying upon Social Security and Medicare, even while there are proportionately fewer workers in the labor pool to support them.
According to recent calculations by Archer and Cox, the former chairman of the House Budget Committee and the former head of the SEC, the real total deficit is approximately $87 trillion - not $16 trillion as official government numbers indicate - and the amount of unfunded obligations is growing by a rate of approximately $7 trillion a year. Which means that the real annual deficit, if we don't use governmental accounting gimmickry, is over $8 trillion a year - instead of over $1 trillion per year.
Now the issue with wealth is that there's only so much real wealth available in the form of goods and services, regardless of all the financial games that are played with the compounding of paper wealth. Either the goods and services are there to support people, or they aren't.
When we look at Social Security, Medicare and most financial planning, the assumptions are that economic growth rates will be normal compared to the past. As discussed in my previous articles such as "Three Converging Factors May Slash Economic Growth By 71%" (linked below), there's a very strong case to be made that that will not turn out to be the case. But regardless of whether the future is one of normal economic growth, low growth or no growth, it will not change the basic fact that there is only a limited number of resources available.
http://danielamerman.com/articles/2012/OverC.html
And if we take the extraordinary future cost for these governmental programs and say that there's only so much wealth available to be split among government beneficiaries, the then current producers of real goods and services, and those who are planning on supporting themselves through the sale of retirement investments, then we start to realize we may have a serious issue there.
Here is a basic but essential question: If the government beneficiaries are taking the lion's share of what is available, and indeed locking that into the law, even while the younger generations who are still actively employed are struggling to maintain their own lifestyles while bearing the extraordinary expenses of those promises, then where does the real wealth in the form of resources come from to cash out the trillions of dollars in retirement wealth that pension funds and tens of millions of retirement investors are counting on?
You can't cash out what isn't there. And if we have an extraordinary growth in government spending that greatly exceeds the rate of national economic growth, then the private sector must necessarily have a reduced growth rate, and investors cash out much less of the wealth of the future than they had anticipated. This issue of how a government's rising share of the economy cripples private sector growth rates (which conventional long-term investing absolutely relies upon) is explored in more detail in my article, "High Government Deficits 'Crowd Out' Stock Market Returns" (linked below).
http://danielamerman.com/articles/Crowding.htm
Now when it came down to the US elections in 2012, what is crucial to note is not so much where the differences were, but where the differences weren't. That is, neither candidate dared to talk about cutting government benefits to retirees, at least not for a very long time to come.
Neither one dared even consider discussing the possibility of reduced benefits for those who are currently older, because they knew it would be the equivalent of a political death penalty to do so. The average American voter, for what they believe to be very good and fair cause, wants what was promised to them. They want what they have been making their payroll tax payments upon for decades now, and they will not stand for having that taken away from them – at least, not openly.
So despite the philosophical debate about lesser or greater governmental spending growth, when it came down to the actual specifics of what this nation does about an impossible level of future promises that would essentially consume the economy, that issue was not even on the table. Because the voters wouldn't let it be there.
The Political Redistribution Of Wealth
For all long-term investors, there was another critically important issue that again was not even discussed by either party in their election campaigns.
The fundamental situation is that tens of millions of people, either directly through their investment portfolios and/or retirement accounts, or through their pension funds, are investing long-term based upon certain assumptions when it comes to the compounding of wealth.
At the heart of the issue -- and something that has been built into financial and retirement planning models for decades -- is the assumed payment of normal interest on bonds, money market funds, certificates of deposit and other financial instruments. It has been built right into the assumptions the entire time that we're all going to get interest payments that are significant enough to be used to both compound the value of our investments during our savings years, and to provide us the cash to support our lifestyle in retirement.
Indeed when we look at the classic "Investment Life-Cycle" approach to financial planning, then the older an investor gets, the more of their money that should be in fixed income investments, particularly as they approach retirement age. This is because modern financial theory holds that these substantial interest payments are in fact more reliable than stock market appreciation, at least in the short term.
The problem, however, is that there is a gaping hole in this theoretical model. For when it comes to the real world, interest rates are near 0% as a matter of deliberate government policy, and there are near continuous massive market interventions by the Federal Reserve to make sure that those relying upon interest income won't get any to speak of.
In other words, as a political decision, the federal government has effectively destroyed one of the very foundations of conventional investing and retirement planning.
For those who are familiar with the term -- and I have written about it extensively -- this is one crucial aspect of Financial Repression. Financial Repression is effectively a hidden tax that the government uses to take wealth from investors on a wholesale basis. As covered in my article linked below, this hidden tax currently redistributes more than $500 billion a year from savers to the government - lowering standards of living even while it cripples investment performance.
http://danielamerman.com/articles/2011/SaveTaxC.html
Now again, this critical issue was not even discussed by either major candidate in the debates. Here we have government interventions destroying the very foundation of long-term financial investment and retirement planning, but this deliberate government policy was not even on the agenda for voters to weigh in on during the election.
This is straight-up political distribution and redistribution of wealth on a massive basis from investors to the government. But because the public does not understand what is being done, it is not a campaign issue, and there is no way to vote against it.
Modern Investment Theory & Unconditional Surrender
So we have a situation where the wealth of the future is being grabbed by law, with overwhelming voter support, to the extent where it's difficult to see how the real resources of goods and services could possibly be available to support conventional retirement investors with the lifestyles that they assume they will be able to enjoy.
Simultaneously we have deliberate governmental policy devastating the very foundations of financial and retirement planning, destroying the strategy underlying decades of savings for tens of millions of people all across the country – and yet, this government policy is not even a subject for election debates.
What is going on, and why aren't investors defending themselves?
Let me suggest that there are two major reasons why this is not controversial within the investment community, and why investors are not rising up in the tens of millions to do battle on these issues that are so vital for their financial futures.
The core of the problem is that financial planning is based on modern investment theory, and this academic theory does not recognize the concept of limited wealth. Built into the models – and this is something that I have been in vigorous disagreement with my peer group for the last 20 years – is effectively unlimited wealth. That is, investor wealth is held to compound in isolation, and is not limited by the rate of economic growth, nor by other claims to that same limited wealth. It is just not allowed for in the models.
By definition, modern investment theory is blind to the possibilities of a scarcity of resources, or to the effects of other groups competing for that same wealth.
That brings us to the other major problem, which is that of politics trumping investment theory. That's what we see right now every time someone buys a bond, puts money in an interest-bearing checking account or puts money into a money market fund. They should be getting a higher rate of return than they are, but as a result of Federal Reserve policy, they make a near zero interest return on their investment. Which is destroying the very fundamentals of conventional financial planning and having a direct effect on the standard of living in retirement as well the actual age at which retirement is occurring for tens of millions of people in the real world.
When it comes to the distribution and redistribution of wealth, modern investment theory does not recognize the concept of politics trumping finance, but rather it is blind to it. Modern investment theory does not allow for political actions deliberately overriding the assumptions upon which that theory is based, even as the dominant force in today's financial world is that of politics overruling investment theory.
Battlefield Versus Clover Field
As an analogy for this financial battle, let's consider a World War I battlefield where we have vast numbers of soldiers/investors marching forward.
The artillery is raining down, the machine guns are cutting them down in vast numbers, and yet the lines of soldiers/investors never pause - they continue marching in lockstep towards their destination.
What is going on here?
As followers of the prevailing investment paradigm, whether they personally realize it or not, these soldiers/investors are following a school of thought, the theoretical foundation of which by definition excludes the predominately political division of limited resources in the future.
Their financial plans are oblivious to the artillery shells falling around them, because the existence of those artillery shells is precluded by definition.
Moreover, the deliberate stripping of wealth away from investors by way of Financial Repression and government intervention in markets is not allowed for in modern financial theory. So even as the machine gun fire of effectively zero interest rates destroys the carefully constructed theoretical foundations of financial planning, this is also ignored. That is because the existence of machine guns is also precluded by definition in the theoretical principles that underlie conventional retirement planning.
So everyone continues forward in their lines of tens of millions, marching in lockstep into the cannon fire, into the machine gun fire, because the theory upon which they rely asserts by definition that neither cannons nor machine guns exist, but that instead we can have great confidence that there will be an endless field of clover as the destination, vast enough to support every individual investor and every pension plan with effectively unlimited wealth.
For such is the core assumption that underlies conventional financial planning. That is, we already know the outcome, which is the compounding of investment wealth for all of us at historical rates, indefinitely and independent of everything else that's going on around us. And so the march of the investors continues, much like the early battles of World War I, until the damage reaches catastrophic proportions, by which time much of a generation is gone.
Five Fundamental Criteria
Are there alternatives to marching straight ahead into artillery and machine gun fire for decades to come?
I would say that there are, but that if we're going find a useful and sensible alternative to modern financial theory, we need to consider a quite different approach that meets five fundamental criteria.
First, we have to assume that we can only achieve average results for the general approach that we are taking.
That is, the response by many people to extremely challenging financial conditions is not to change their personal paradigm, but to try to be better within the paradigm that isn't working in the first place. The assumption is made that they can invest better than those around them, and they continue with this approach for years at a time.
Now that can work for some individuals, but simple math shows that it can't work for large groups of investors. Therefore, most of the people who may be risking their financial security on their particular strategies performing better than the similar strategies of those around them will in fact achieve results that are either average or below average, by the time all is said and done.
So we can't all rely on being smarter every year than all of those around us, while pursuing variations of the same strategies that they are using. Instead we need to work on a more fundamental level where just by our basic choices - which will be quite different from those around us - we are positioned so that merely being average in the execution of our strategies achieves the superior results that we need.
Second, we need to choose an approach by which our wealth will grow with future inflation.
When we have extraordinary promises that increase each year at a rate that is greater than the rate of economic growth, then we can fairly safely anticipate what the government is going to do as a political decision: it will be paying those promises in form but not in substance. That is, in dollar terms, the government is all too likely to be paying future retirement benefits more or less in full, but they will be with dollars that aren't worth nearly as much as they are today.
If you take a look at what has been happening to the annual increases in Social Security payments, and compare that to the annual price increases of food at the grocery store, you can get a pretty good picture of what's going on right now.
As investors we are best off aligning our financial interests with inflation, so that the greater the degree of inflation, the better that we do -- even if all we're doing is achieving average results for the strategy chosen.
There is a third criteria which is also important, and that has to do with this dominant financial force right now of near zero interest rates. As discussed, this is closely tied in with Financial Repression, as it also is with the global force of quantitative easing.
By definition, the purpose of Financial Repression is to take money from investors and redistribute it to the government. So the goal then should be to employ a strategy where the greater the degree of Financial Repression and the longer it lasts, the more wealth that is "naturally" distributed to us instead of away from us, even assuming that all we achieve is average results for the strategy chosen.
Our fourth criteria is rooted in the relationship between inflation and Financial Repression, which by design work together hand in glove to redistribute money from investors to the government. So our long term strategy for the future needs to be such that we prosper in a world of simultaneous inflation and repression, with both sides feeding into our net worth even as it's unfortunately destroying the lifestyles of those around us.
The fifth criteria is perhaps the most important of all. The rules of the game are based on law and regulation, they are based on politics, and there's a very good chance that what we're seeing with government control of interest payments is only the first step. We can anticipate that the government will continue to take actions to change the rules and the playing field in a manner that will redistribute wealth from investors and pass it through to politically favored sectors of society.
Now so long as elections come down to both sides promising transfer payment beneficiaries their future payments in full while neither looks after the true interests of long-term investors, this battle's already over before it's ever been fought. And those investing using conventional strategies will be paying the price in full.
So then, the fundamental questions become: "Is it possible for me to change my strategies and invest in such a way that the more wealth the government takes away from other investors, the more wealth that flows to me? Can I do this as a natural result of how I position myself, with no active trading or assumption of ongoing brilliance required?"
The answers can't be seen from inside the prism of modern investment theory. But let me suggest that it is the answering of these questions that are the most essential steps that an investor can take in today's investment environment.
When it came to the specifics of the issues explored in this article, a major battle was lost without even a fight in 2012. And there is little reason to expect different results in the elections to come.
