Chris's Plan to Fix America #3: Social Security

Social Security is one of those political sacred cows. It's not an easy topic to cover, not only do people have strong opinions, but most of them are ill-informed. Talking points on the conservative side make it sound like we are losing money every day, and talking points on the liberal side claim Social Security is running a surplus. The truth is that SS is currently in a surplus, but it is making promises for future payment that can't be met. The social security administration's projection is that by 2018 social security will be in a deficit. The national debt clock estimates that the promises that social security has already made amount to a $15.1 trillion unfunded liability (meaning a deficit for which there is no anticipated income). The 2003 Trustees' Report believes this number is actual $26 trillion.

In theory, once the 2018 transition happens social security will begin to pay benefits out of the social security trust. Using this money, Social security could pay all promised benefits until 2042. However, the trust contains no money, only government bonds. What this means is that any payments will have to come out of the current year's budget. 

What all this means is that social security needs reform. If the system is not reformed, not only will it bankrupt our country, but the promised level of benefits will not be paid.

The Plan

Institute a system of private investment accounts. Anyone younger than 40 will be required to use a private investment account, and will lose any claim to future Social Security benefits. Those people between 40 and 65 will be given the option of transitioning to a private account and will receive a bond in the amount of accrued savings. Those people who choose not to transition as well as those people who are already receiving Social Security payments will be unaffected. 

Social Security was never free money, currently every worker in the country has 7.65% of their paycheck taken for social security contributions. That 7.65% will now be put back in the worker's paycheck with the intent that it go to their private investment accounts. Currently, the employer is also required to match the 7.65%, for a total paid of 15.3%. Employers will still be required to pay their 7.65% in order to defray the costs of closing out the social security system.

Further, the US government will establish a set of investment standards that are considered "Retirement Grade". Those investment firms that conform to the required standards will receive government insurance against catastrophic loss of principle. (You may not make money, but you won't lose money). Further, these "Retirement Grade" accounts will receive special tax benefits which exempt it from dividend taxes. 

Any money in these accounts at time-of-death would be subject to 40% taxation upon liquidation in order to defray the cost of insuring against catastrophic loss and defraying the cost of the transition. Heirs would, however, have the option of transferring the balance to their "Retirement Grade" accounts at a significantly reduced tax rate.

Why it works

Long-term social security rates of return are pathetic when compared with market interest rates.

A pay-as-you-go system robs the country of that savings, once the private accounts are online, it will create an influx of business investment. 

Low-income workers would be positioned to receive significantly higher benefits. 

Private investment accounts would allow people true ownership over their retirement benefits. US Supreme Court ruled in Flemming vs Nester that social security does not represent a contract with the American public and that benefits can legally be changed, cut, or even taken away at any time.

Warnings

This plan will almost certainly increase debt in the short-run. As younger people stop paying their share into the system, revenues will drop off. However those in retirement or about to enter retirement will not change their plans. As a result, revenue increases while expenses stay the same (or increase). However, once the public is weaned off of social security, we will have a 7.65% tax that can go towards paying down the debt of the transition. 

Chris's Plan to Fix America #2: Stimulus Plan

The Theory:

The question of proper economic stimulus is one of the areas where economists disagree. It should speak to the complexity of the economic dynamics that thousands of PHDs study an issue and yet fail to come to consensus. The two schools of thought I'll talk about are Keynes and Hayek. For a fun summary of each schools' thoughts, watch this youtube rap (yes, I said rap… about economics): 

In short, Keynes argues that once circular flow is established, market participants will have the resources to enact the necessary market changes in a timely manner. As a result, the government should focus on spending money on just about anything to restart circular flow. Hayek disagrees. 

Hayek argues that people choose to stop spending and save because demand patterns change. As a result, no matter how much money you spend, people still don't demand the existing product mix. When the government spends excessively, it distorts demand for a particular market and generates inflation. Hayek argues that it's actually our actions, particularly low interest rates and borrowing, during the expansion that creates the recession. 

Hayek's arguments make a lot of sense. If millions of people and billions of dollars of capital are employed making something that either isn't demanded or is demanded at a much lower rate, those people and that capital need to move out of the industry. Imagine if 10% of our economy had been involved in the production of typewriters when computers started hitting the markets. Suddenly, people no longer demand typewriters. No amount of government spending could keep people employed making typewriters. 

The question is how does this affect stimulus plans? One of the biggest complaints with Hayek's philosophy (and conversely the biggest draws to Keynes) is that it requires followers to sit and do nothing, but that isn't exactly true. Hayek merely warns about creating inflation and distorting markets.

Why current stimulus plans don't work:

Will a pure Keynesian approach work? Yes. However, if your goal is job creation, it won't work well. Stop and think about where the money from the stimulus plans go: building roads and bridges, environmental research, high speed rail systems, low-income housing, etc. Not one of these creates initial jobs, and most of the spending is on things that were not in demand before the recession. What this means is that the effects of the stimulus will be slow and obscenely expensive.

Think about the resource structure created when the government pours money into road construction. People are hired to build roads, capital is purchased to build roads, and the roads get built. Now what? People had jobs, but the private industry isn't buying new roads. If the government doesn't keep spending money, these created "jobs" will cease to exist. Therefore, government spending outside of areas in demand by private markets can only create secondary jobs (Road construction worker got money from job, now spends it, giving someone else a job).

The New Plan:

Any company that employs fewer than 50 people may take up to a $25,000 tax credit for expanding their workforce by 1 person and paying them at least $50,000.

What it does:

Puts small businesses in a position to quickly adapt to market conditions and decreases the risk of trying to expand into new opportunities. 

Why it works:

Current stimulus plans attempt to "stimulate the economy" or "increase investment", but the big picture is that all of these efforts are attempts to get people employed. In fact, it's the unemployment that makes recessions so bad. Very few people care about reduced output or exchange rate implications. Why then, shouldn't our stimulus focus on the very thing we're trying to fix?

Ask an entrepreneur how much money it would take for them to hire someone new at $50,000, $60,000, or $80,000 a year. The answers you get will fluctuate widely, but not one of them will exceed the salary paid. How then is it that the current stimulus plan is estimated to have cost over $250,000 per job? Mismanagement and ideology. 

Does this plan distort markets? Yes. But it distorts the labor market, causing wages to rise. It distorts the market for new business, which brings new products and innovations to the economy. Further, since the plan is a tax credit, if it doesn't work, it costs us nothing. Finally, when the credit goes away in a year, the products being built and services being offered are still the ones in demand by the market, since the market has been the customer all along. Sure the profitability goes down without the credit, but the business still has a chance to be profitable.

Chris's Plan to Fix America #1: Debt

With the government default looming and congress scrambling to push their stop-gap measures, it's a good time to analyze how we got here, how it affects us, and what we should do. 

You can think of this situation like a person with a credit card. The person knows that they won't have enough money or credit to pay all of their bills, and they know there is no way to forego the spending or raise the money before they run out. As a result this person calls the bank to get a credit limit increase. In reality, the bank would require the limit to go down again in a month or 2. However, the spend-happy politicians don't want it to, and are fighting against debt-ceiling plans that cut spending back to this level in the future.

How we got here

We in America have a long tradition of wanting what we can't (or shouldn't) have. We have lots of problems with delaying gratification, and in large measure, our populous is financially uneducated. I'll refer you to the Illinois man interviewed on national TV while waiting for a government payout claiming that he was "waiting for obama money" which he thought came from "Obama's stash". I'll also show you this graph of the personal (not government) savings rate:

In addition to failing to save, our population is borrowing more than ever before. Look at this graph of consumer (not government or business) credit outstanding:

Since our population can't seem to constrain their spending, why would a governmental body elected by our population? We are in a period of extreme gluttony, but we may be hitting the ceiling of what our government can hand out. 

How it affects us

We've come to rely on the government for lots of things that we don't even realize. One of the hidden dependencies is a little thing called risk-free debt. The government issues bonds, which hold no risk, and provides the markets with liquid, low-interest alternative to holding cash. This allows big banks (and investment firms) to forego unprofitable investments in leu of flexibility and guaranteed return. All the while, the money is funneled into banks that have lots of highly profitable opportunities, for a cost. In addition to the people who would fail to get paid in the event of a government default, this vital banking mechanism would crumble.

Thousands of people are currently employed by the US government. Many more than I think should be, but that's a topic for the next section. While I may not agree with their employment, you cannot argue that they provide a service. If the government defaults and cannot pay their debts, they also cannot pay their wages. In addition to thousands of people losing jobs, any services that are depended on will cease to exist. 

Social services such as social security, medicare, medicaid, etc. which people have planned for, depended on and expect on a regular basis will cease to function. 

When the government needs to step in and intercede in a situation, it costs money. It doesn't matter if that means buying trailers for hurricane evacuees or sending in the military to stop genocide in a foreign country. A government default would throw serious concerns on the validity of all government debt and not only make it harder for the government to raise money, but make it significantly more expensive (the government does pay interest on its debt, and after a default that rate would increase).

What we should do

A large part of the problem is that the federal government is already far too large. It's easy to expand the government to do something if they're only taking 15% of your income to begin with. When the government can't pay it's bills and it's taking over 30%, people get upset. Many of the services offered by the federal government are also offered in the private industry. Our government needs to begin transitioning out of these industries. 

All stimulus programs need to be immediately ceased (I'll writeup why in another CPFA note). 

Alternatives to the current social services need to be explored. (I'll also have a individual write-ups on many of these)

National defense spending is our largest budget item (as it should be) but it's too big. While the specifics of any plan should be drafted by the military's generals, we need to focus on shrinking our presence in non-war countries. We need to reanalyze which capital investments can be prolonged without catastrophic results. We need to focus on transitioning peace-keeping operations to local governments, and we need to encourage non-essential personnel to move to the reserves and seek jobs in private industry. 

A constitutional amendment prohibiting deficit spending without a 2/3 majority needs to be put in place. Our national debt has climbed to the size of our economy. We can't hope to fix it unless we stop making the problem worse. As long as politicians can garner support by spending money we don't have, they will. 

Gulf Drilling Protesting

Protesting Drilling in the Gulf is inherently hypocritical, but in a way only an economist would see.

The protestors want to see an end to drilling. This would mean that domestic supply of oil decreases. People that know a little economics will draw the immediate conclusion that when supply decreases and demand stays the same, price increases.




But price isn't the side of the graph that we want to be looking at. This argument focuses more on the mechanics of why price increases. You see price, as we use it, is a rationing method; communists and socialist use lines (first-come first-serve), capitalists use price and money. The increase in price is a reflection of a decrease in quantity available. This may seem repetitive and elementary, but it's important to be perfectly clear about this.

Now the hypocrisy. Consider the average drilling protestor. They have enough education to follow the news, understand what's going on, and care what they see. They have enough free time and money to take days off work, not for vacation, but for standing on the side of the road with a picket. They wake up in the morning and drive to work. They drive to Walmart to pick up groceries (unless they're one of those people who go out of their way and drive farther to go to an organic grocery store). And when they protest they drive to either the protesting headquarters or location in their own car.

In the days of factory worker strikes, workers banded together to limit the hardships they endured when leaving work and protesting. We've all seen black and white pictures of these lower to middle class workers picketing against the evil business they worked for. Those photos shape how we think of protestors, even if it does it subconsciously. The fact of the matter is that today's protestors are very different; in many ways, protesting today is a rich man's game.

Now consider what happens to the individual if the protestors get their way. The price of a gallon of gas increases, quantity decreases. Those in the upper socioeconomic brackets (some protestors might be in this group) sigh and pay the extra money for gas to continue their lifestyle (their time is worth more than $7 a gallon). Those in the middle bracket (this is where most of the protestors fit in) will curb most of their unnecessary driving, but will continue to drive to work (they have to make a living) and the other places they see as "necessities".

But wait, if the upper and middle classes aren't eliminating much of their gas usage, where does the decrease in quantity consumed come from? The only bracket we have left, the lowest class. Increases in gas prices seem a lot worse when you're choosing between food, heat, and gas. The brunt of the hardships of an end to drilling in the gulf are felt by the poorest people.

It is the utmost hypocrisy for a middle or upper class worker to claim that for environmental reasons we should cease oil production, but that the downsides should be felt not by them, by those below them.

As a side note to those who view oil companies as evil, and therefore view my arguments with skepticism. Consider this nugget of information provided in a presentation by Louisiana Economist Lauren Scott:
All US oil companies are corporations that sell stock. Therefore, the owners are the stockholders.
43% of oil company stock is owned by mutual funds and asset management companies that have mutual funds.
27% of oil company stock is owned by institutional investors like pension funds.
14% of oil company stock is held in IRA's and personal retirement accounts.

Employment Thursday

It was likely to happen sooner or later, Initial claims rose for two weeks running. Last week they rose from 454k to 473k, and this week they came in at 480k. There is an indicator that this is not cause for alarm though: The 4-week moving average (often used with this number to smooth out the fluctuations) decreased this week from 473k to 468k. This decrease is due to a much higher initial claims number 5 weeks ago. Long story short, this isn't good news, but it isn't bad enough to fret over.

I posted the Krugman article a few days back and actually got some reaction over it. Krugman's estimates that we need 300k job creation a month may seem unreachable, but you should consider the mechanics of the job market. Just as high unemployment leads to lower wages, job creation leads to more job creation. Basically, more people with jobs = more people spending money = more demand for products/services = more demand for labor to fulfill that demand for products. Because of this cyclical behavior, the job market actually follows more of an exponential growth pattern, see depiction below.



What this means is that its ok for us to see modest job growth in the short run, so long as it's growth.

Consumer Inflation

Catastrophe averted. Consumer Inflation rose by a slightly elevated .4%, mainly due to increases in the price of fuel. The Core Consumer inflation (excluding food and energy) came in at 0.0%. The increase in prices at the producer level could show itself in next months report (it makes sense that there could be a lag) but we'll have to wait and see. At the very least, we won't see contractionary monetary policy before Christmas.

Return to business

It's been nearly two weeks since my last post. Things just got kind of crazy. I'm back now, so lets look at the things that happened while I was away.

First the good news, Retail Sales came in very strong. I wish I had a graph to show how retail sales behaves during recessions, but unfortunately I don't. They change the way they measure retail sales so often that it's nearly impossible to put together that kind of a graph. Using the current system of measurement, this is what Retail sales looks like:

With this release, we have enough data to call this a trend. Businesses should be using these numbers to make hiring/firing decisions this spring.

The other good news came out this morning. Industrial Production (a.k.a. manufacturing) is up again. While this signals good news for manufacturers (and their workers), it also reinforces one of the strongest indicators that we wont fall back into a recession. The Capacity Utilization report is part of the Industrial Production release. It came in positive, and take a look at the graph (especially in relation to other recessions, indicated by the grayed areas):

Only once did capacity utilization increase and then fall again during a recession, 1982-83. We have seen a much more significant rise than the 82-83 false signal. What this report shows is two-fold: we are likely getting better, but things are worse than they've been since this report has was started in the early 70s.

Now for the bad news, and I'm afraid it's really bad. Inflation reports for producers came in today significant above what they should be. To give you some scale, if you annualized the raw data producers would see a 21.6% yearly inflation rate (it came in at a 1.8% monthly rate). The core (excluding food and energy) came in at a much more manageable, but still elevated .5% monthly rate (annually 6%).

The produce inflation rate is subject to wild fluctuations, and one data point does not make a trend. Take a deep breath because this could just be a number of coincidences that go away next month, but seeing an elevated consumer inflation rate tomorrow is about the worst thing that could happen right now.

Let me paint a picture for you to explain what will likely happen with an elevated consumer inflation report tomorrow. The Federal Reserve transitions from "Want money? Take it interest free!" to "Price Stability is our chief concern." Markets will crash. The Federal Government attempts to pick up the slack, but its spending not only creates deficit problems (further lowering the value of the dollar) and borrowing problems (lenders begin to question whether the Government will honor its debts) but its spending causes crowding out of private investment (their spending increases demand, which in turn increases price, lowering private spending). The Fed and the Government do policy battle.

You see, according to the Fed we are no longer in a recession. They are happy to help out the recovery, so long as it doesn't impact the only number they truly care about, "Price Level." Now that that number is threatened, don't count on unconditional Fed support.

If you think that I'm exaggerating, take a look at 1932-1938. The exact same thing happened. They were actually in recovery, the Fed returned to its pre-recession stances, and, voila, another recession. Definitely expect a post tomorrow.

I won't really talk about jobs until Thursday, but I wanted to post something. I typically despise Krugman. I could rant for quite a while about all the problems, but suffice it to say, he and I don't typically see eye-to-eye. That being said, he put out a great summary of the employment situation going forward. (To see the post on his site, go here)

"It was truly amazing the way last week’s employment report was hailed by many people as a sign that our troubles are over. Here we are, having suffered huge job losses, and needing to make up the lost ground — and a report showing that we’re still losing jobs, but not as fast, is grounds for celebration?

Anyway, I thought it might be useful to create a sort of benchmark for the level of job growth that would really count as good news. I start from the fact that we’ve lost about 8 million jobs since the recession began — that’s the official number plus the preliminary estimate of the coming benchmark revision. I then take EPI’s estimate that we need to add 127,000 jobs a month. EPI points out that when you put these numbers together, they say that to return to pre-crisis unemployment within two years we’d have to add 580,000 jobs a month. That’s not going to happen.

But let’s set a more modest goal: return to more or less full employment in 5 years –which means seven lean years of depressed employment. To keep up with population growth over those 7 years, the United States would have had to add 84 times 127,000 or 10.668 million jobs. (If that sounds high, bear in mind that we added more than 20 million jobs over the 8 Clinton years). Add in the need to make up lost ground, and we’re at around 18 million jobs over the next five years — or 300,000 a month.

So that’s a useful benchmark. Even if we add 300,000 jobs a month, we’re looking at a prolonged period of suffering — a huge cost from the Great Recession. So that’s kind of a minimal definition of success. Anything less than that, and it’s bad news. It sort of puts that wonderful report that we only lost 11,000 jobs in perspective, doesn’t it?"