Saturday, April 24, 2010

Inflation and Economic Update, April, 2010

This week we saw big headlines touting the growth in spending by consumers on stuff. This is big news to the “mainstream” economists and drove the stock market higher. Prosperity, economic growth, they say, is beginning.

At the same time, employment has not begun to increase, new unemployment claims continue at high levels, the government keeps extending benefits for the unemployed, production has gone up a very small amount, and bank lending of all kinds has continued to decline.

Housing in an interesting sector. Last month’s housing purchases were significantly higher, much higher than expected. The increase in home purchases, of course, was trumpeted by the administration and its media cheerleaders as a great success. Ignored by them was that the tax credits for home buying that the administration had pushed through were set to expire soon, at the end of April, a few days from now. People were rushing to take advantage of the government giveaway (i.e., the government would take less of your money in taxes). April’s figures for home sales will look good, too. Just wait until after May. Reality will set in. Without artificial support, the housing market will tend back to its original course downward in terms of sales and prices. In the meantime, foreclosures are increasing.
So, why do they say that the economy is recovering?

One of the unquestioned tenants of mainstream economics is that consumer spending is a primary driver of an economy. If “consumers” are spending, then the economy will grow and wealth will increase. I put “consumers” in quotation marks because the mainstream economists disconnect the “consumer” from any kind of productive activity. A job, they reason, is merely the process by which a consumer receives his money to spend. That is why government jobs, subsidies, handouts, dole, public works, infrastructure construction, and government money projects ad nauseum are all equated with jobs in private, productive companies. It isn’t that anything is produced, it is that people have money to spend. They don’t think that government spending per se is important, just that it gets money into the hands of consumers, who are the motive power in our economy.

Ayn Rand, in “Equalitarianism and Inflation” published in the Ayn Rand Letter in June and July, 1974, offered to bring in savages from around the world to help out in the spending.

If asked, they might say that the increased demand will elicit more production. They will suggest that the increase will come from the manufacturer bringing on unused productive capacity. Bernanke, from the Fed, would say that when production has reached full capacity, we could see some prices begin to rise, but he will also, deep down, expect to see more capacity created, somehow. It is not clear to them. It isn’t real. Most important, it isn’t production that is important, but spending.

So, since consumers last month started spending more, the mainstream economists believe that the economy is recovering.

But, you ask: Where is this money coming from? What does it really mean?

I think that there are two sources for this upsurge in spending. First, it does look as if the economy is bottoming out, and people are a little relieved that the downward spiral is not continuing. That relief, plus the government and cheerleader hype, make people feel as if they do not need to keep a lid on their plans and personal spending. Things have worn out, things are out there beckoning to be bought, people miss their old lifestyle of buying, buying, buying. Off they go and spend some money. So, some of the increase in consumer spending is coming from people who had recently been paying off loans or saving, but are now putting money into the consumer market. This isn’t necessarily bad (nor good), but if these are productive people, their spending isn’t directly harmful. I don’t think that we have a means to tell if this is a large portion of the upsurge in spending.

The rest, and an important part of the upsurge in consumer spending, comes from non-productive people, and is therefore, harmful. This is money from all of the government programs, including, but not limited to: unemployment benefits, “shovel ready” programs, graft, handouts (individual or corporate), new government employees, corporate bailouts, and on and on and………. We have more dollars chasing a limited amount of goods, and prices will tend upward.

I saw a presentation by an inflation watch group that claimed some food prices had climbed over 50% recently. The price for oil is continuing upward, especially as the large developing countries actually develop for a change and new car sales continue rising there.

Boom-bust cycles are fed by credit expansion. There is no credit expansion right now. We are not going to see asset booms for a while. Someone said we have a boom in government. We do. The government is spending. To the extent that the money is made-up stuff, we have a direct feed into prices and they will rise. When the money funding the government comes from previously exported dollars (i.e., China buying Treasury Bonds), it is made-up money, and prices will rise. To the extent that the money comes from our own economy, it is savings that is being consumed rather than invested for wealth creation, and we will continue to stagnate. Neither is good. Back to the 70’s, back to stagflation. Since BO and his gang do not look at history, we could see price controls again. We could see the FBI back in corporate offices again. We will see more attacks on capitalism and more destruction of our way of life, of our freedom.

Saturday, April 17, 2010


For many very good reasons Objectivists and others became very active and vocal on the issue of health care. Destroying our health care industry, in this case by attacking the health care insurance industry, gives the government more power in fundamental ways and undercuts our ability to enjoy our lives, or actually stay alive. ObamaCare needed to be stopped. It needs to be reversed.
In very much the same ways, Obama’s attack on our economy will have the same effect. With an economy hindered, we will have less time and strength to fight for our freedoms, we will have more people dependent upon the government and thus reluctant to stand up to him. We will have more lawlessness. We will have a bigger fight to wage.
Central to a modern economy is the financial industry. We have seen how important a sick financial industry is and what the results can do to not just the U.S. economy, but to the world economy. At this time, Obama’s main target is the banks. He is threatening to hamstring them, shrink them and limit their size, and place even more controls on them than any sector of our economy has seen. He is encouraging the international community to do the same.

In a recent radio speech, Obama said, "Every day we don't act, the same system that led to bailouts remains in place, with the exact same loopholes and the exact same liabilities. And if we don't change what led to the crisis, we'll doom ourselves to repeat it. Opposing reform will leave taxpayers on the hook if a crisis like this ever happens again."

All of that is true, but it isn’t the loopholes and liabilities in the banks that create the problem, but the government. This story needs to be told and distributed. We need the Tea Party people to know this, we need the population to know this.

I see two parts to our problem. One, many people see the health care fight as a universal one in which everyone has a stake. They do not see the same for the attack on the bankers. This is a case where Obama is using the standard tactic of divide and conquer. Not only that, but many people who support the resistance to ObamaCare view the bankers as villains, or view regulation of banks to be a minor, separate issue that will have little effect on themselves. It is an ignorance of economics and of how business functions.

Second, Objectivists have no better understanding of economics and the importance of finance. Generally, our understanding of economics is little better than that of the man in the street, and for basically the same reasons. Further, most have not seen a reason for looking into economics. We understand the importance of knowing something about capitalism as a political system. We also understand the importance of business creativity, production, and markets. But we know little about how it all works and how the various parts will effect our daily life. We are thus vulnerable.

Expanded bank regulation, especially the attempt to shrink the banks needs to be opposed with significant effort. We need to make clear that our ability to have freedom and prosperity depends upon strong, market-driven banks. That government interference in banking is detrimental to everything we hold dear. We cannot let Obama have a unopposed path to destroying the economy.

What to do? The same things we have done already for healthcare. Plus, learn. Ask questions.

In a recent PJTV program discussing the mid-April Tea Parties, Dr. Yaron Brook said that this is the time to stand and work for freedom. This point in time is the best opportunity that he has seen. He also said that it might be our last chance, that is, if we fail now, it will be more difficult and perhaps impossible in the future. He means that in the future we will be too busy trying to stay alive and the forces opposing us would be armed and unwilling to let us speak. One vital key to our economic health and political freedom is the financial industry. We must try to save it.

Wednesday, April 7, 2010

Background notes: Annuities, Retirement Plans, and the Government

After seeing comments by Burgess Laughlin on my earlier post about the Treasury request for comments on “life-time payments”, I realized that there were some underlying history and understandings that I had not included. This background is not general knowledge and it would be helpful, I think, for this information to be available. This is not a research paper. I am not including references and quotes from “authorities”. I am giving you my understanding of the situation, which provides some of the foundation as to why I came to the conclusions I did in the earlier post.

Annuities are one of the oldest financial products. Originally, an annuity was purchased when a person was ready to receive an income stream. It is purchased from an insurance company because the insurance company has the expertise in computing life expectancy and using long-term, incoming producing assets. When purchased, the life expectancy of the person to receive the income was computed, the current interest rate considered, and the income stream is determined. The income stream continues for the entire lifetime of the annuity owner. Some owners die early, some late. If the insurance company has made good life expectancy computations over sufficient number of owners, it will be able to meet all lifetime payments and make money.

Two things have changed over the years. One, annuities became tax shelters. You can purchase what is called an annuity without beginning the income stream, or as it is called today, annuitizing it. The interest rate may be fixed at purchase, or the interest rate may be adjusted before annuitizing as the market changes. The interest rate is not adjusted after the income stream is begun. When you purchase the annuity and don’t begin the income stream, it accrues interest, that is the principle grows, deferring income taxes until the income stream begins. Actually, there is no requirement that you begin the income stream. You may withdraw cash as you wish from the annuity until it is all withdrawn, and will have some taxes to pay. Under current law, if you withdraw money prior to 59½ there will be an additional 10% tax penalty. If you annuitize it, you will also pay taxes on the growth.

The other development is the creation of “variable” annuities. After hearing severe criticism that interest-bearing vehicles provided poor returns, the insurance industry created annuity vehicles with “sub-accounts” that were similar to stock and bond mutual funds. The poor returns of fixed annuities are actually worse than most critics argued. After internal costs, i.e., the insurance company’s costs and profit margin, taxes, and inflation, the return on an fixed annuity tends to be negative. Variable annuities are almost identical to what were now called fixed annuities in tax treatment and structure, but their return was based upon the results of the stock and bond sub-accounts that the owner selected. Of course, as opposed to an interest bearing account, returns based upon stock or bond markets might show declines in the principle. Some insurance then added optional benefits to variable annuities to try to overcome some elements of the potential negative return, adding costs and complexity.

After the tech stock crash ten years ago, another type of annuity gained popularity called the indexed annuity. Its return was tied to a stock market index, but did not actually contain stocks. The returns were lower than the market to allow the annuity company to engage in hedged trading to counteract equity market declines. An owner could have higher return than a fixed annuity but not have the fear of the declines in the stock market.

Annuity products came under attack from several quarters. It was claimed that annuities themselves had higher internal costs than they needed, and thus the insurance companies were making too much money at the publics expense. Since these products were offered to the public through normal sales channels that insurance companies used, it was claimed that salesmen were taking advantage of the public to earn huge commissions, especially when the owner was elderly. Finally, it was argued by the Federal Regulatory authorities as well as others that placing an annuity within a retirement plan or IRA was often a bad idea because the retirement plan already deferred taxes, so a major reason for purchasing an annuity before retirement was not applicable and were sold within retirement accounts only to earn the insurance companies excessive profits and salesmen huge commissions. (Regarding some of these accusations, it is true that that some of the products offered on the market had excessive expenses and commissions.)

Thus, for the federal government to now suggest that annuities are important and to suggest that they should be a required option in a retirement plan is a complete change.

What is interesting is not just that there seems to be a change in attitude, but where this change is taking place.

There is no part of the federal government that concerns itself directly with the retirement income of individuals. Even with Social Security, the administration only follows the law. It is the Congress that has had some concern over the years, putting in place various tax-advantaged options as incentive to retirement savings.

You might say that the Treasury has some connection with pensions because its responsibility for pensions paid to retired government employees. Actually, there is no comparison. The only similarity to a federal government pension and that paid by any other organization, including, I believe, state and local governments, is that the recipients are retired. The federal pension is financed in the same manner as Social Security, that is, it is paid from current revenue. In addition, federal pensions are indexed to inflation. Pensions paid by others are funded at retirement and placed in annuities, which is a lifetime stream of income at a fixed rate of interest. The Treasury doesn’t have to concern itself with the funding, just the cash flow.

Three government agencies have interests in tax-deferred retirement plans: the Labor Dept., the IRS, and the SEC/FIMRA (was NASD). The interest of the Labor Dept. is to ensure that lower level employees are treated the same as the managers (e.g., upper management is penalized if the lower level employees don’t contribute sufficiently to defined contribution plans). The IRS is responsible to make sure that regulations are complied with to maintain the tax-deferred status of the plan. The SEC and its little “independent” regulators oversee the compliance with security regulations if securities are offered within the plan. The system has no governmental body that is concerned with the success of a plan or the decisions of the employee during their work years or retirement.

Now the Treasury is leading such an effort. Not the Labor Dept., although it seems to be tagging along with the Treasury. But why is the Treasury involved at all?

There can be only one connection. One of the primary investments for fixed annuities for the insurance company is “safe” government bonds. Insurance companies don’t use only government bonds, but it is certainly a major component. If a significant number of people began buying fixed annuities, the market for government bonds would expand.

If you look at the questions for which the Treasury wants answers you will see a concern about the costs of annuities. My expectation is that they will find that using private insurance company fixed annuities would be too expensive. This conclusion fits with the anti-business philosophy you find in many different parts of the economy, the financial sector, and the current administration. They want to cut out the middlemen, including the salesman and the profit seeking business. As with the justification for removing funding of college tuition, they would see supplying government created annuities as a cost savings to the retiree. They would also be able to fund the annuity entirely with government bonds.

So, as a result of their “studies and analysis” they would ask the Congress to allow the creation of government annuities and require all employers above a certain size who have 401(k) retirement plans to offer the annuities for “investment” or for an income stream at retirement. Then, brick wall. You see, offering them and not selling them will not have the results the Treasury is expecting. Few people will buy annuities, even with the government backing. Certainly any advisor, money oriented writer, or publication will point out the complete lack of benefits for the buyer.

No. If the Treasury wants to see bonds sold to retirees in the form of annuities, they will have to require the bonds to be “bought”. It isn’t going to happen any other way.

That is why I say that the Treasury is going to grab retirement accounts. That is why I am concerned. That is why I wrote the post I did.

This process may take a couple years. It might not come to pass. There are certainly many obstacles that stand in the way.

But if they could sell ObamaCare, they can sell this. If they can legally require people to buy health insurance, requiring them to buy annuities to keep them from needing welfare in later years will not be a big jump. All the government wants to do is to “assure” retirees that they will have an income for the rest of their lives. It is the same type of justification that Obama has used for other intrusions into our lives. It is in line with the justification for Social Security. If it can be done, I am sure that Obama and his Gang can figure out all the buttons to push to get what they want.

Saturday, April 3, 2010

Treasury Grab of Retirement Assets, Personal Consequences

I have been thinking more about the consequences of the Treasury’s grab of retirement assets. It is what the Treasury is calling the issue of providing a “Lifetime Income Option in Retirement Plans”.

The idea is that they will take control of assets in defined contribution retirement plans, probably only 401(k) plans because those show the largest accumulations. The owners of the retirement accounts would then receive a government issued annuity backed by Treasury Bonds, i.e., the interest paid on Treasury Bonds will be used to fund the annuities and provide for the periodic payment to the retiree when he retires. There are a lot of details that are uncertain. For example, I have seen the suggestion that accounts under $250,000 are too small and won’t be touched.

Right off, there are several problems, not only for the retiree but all of us. In this post I am not considering the unparalleled damage done to the economy by removing such a huge pool of savings from private hands. Nor am I including the additional amazing damage to the rights and concept of property that seizing retirement accounts would entail. (a good blog on these points, see Bokor) My focus for this article is on the financial consequences that are more immediate.

It is somewhat difficult to predict exactly what is going to happen because none of the details are available, and may not be until the Treasury begins moving retirement accounts into the annuities. The following is clear. At some point the government will begin seizing accounts. It may seize only the accounts of retirees and those it deems close to retirement. It is unknown if they’ll seize more. But it will at least seize those and issue annuities for at least those who are retired. This may not be for just the newly retired, but anyone who is retired and has an account large enough to be attractive to seize. Since the reason for seizing retirement accounts is to use the money for government purposes, it will convert the assets to cash to buy government bonds, probably a newly created special class. The government will sell the securities in the seized retirement accounts.

This point is absolutely necessary to understand: The government will be selling the seized securities.

Since it will be selling at least the securities of the retired and the soon to be retired, we can count on those securities entering the market. What will happen when these securities hit the market? Who will buy them? Where is the money going to come from to soak up all of the securities being offered? Remember, the government is beginning to soak up funds for the massive amount of new Bonds due to BO’s deficits. The Fed may try to pump in the money, but it will take maybe up to a trillion dollars to cover the securities being offered by the Treasury, if they only offer amount for retirees and the soon to be retired. Even the Fed would be wary to begin pumping that much money. The Fed is currently trying to find a way to remove nearly $1T from the economy without letting interest rates rise.

Further, as people realize what is going to happen, there will already be selling. The market will have dropped significantly already by the time the Treasury begins selling the newly seized retirement accounts.

What is going to happen is that the markets for stocks and possibly bonds will both tank (and interest rates will skyrocket). With the amount of selling pressure that the Treasury will exert upon the markets, the stock market will see drops beyond anything in its history.

Generally, I am not an alarmist. I am not one of those who have expected the stock market to dive at various points in over the last forty years. I didn’t take Harry Browne or Peter Schiff particularly seriously. So my thoughts here are not the conclusions that I reach in most circumstances. I am saying that I am very concerned about the consequences of this particular potential action by the government.

The drop in the stock market in the recent panic occurred because it was a panic. The media began pushing the idea that our economy was failing months before real signs could be seen. The government didn’t really react one way or another at that time (I mean in terms of immediate actions that pushed the market lower.). Much of the dive was panic and fear, and not due to immediate economic factors.

The stock market dive in 1929 had much to do with the attempts of the Fed to stop price inflation by sharply reigning in the money supply (see Economics and the Public Welfare by Benjamin Anderson). Then the panic was due to government caused economic factors.

The panic and dive of the stock market as a result of the seizing of retirement accounts will be due to massive selling pressure from the government trying to raise money by selling stolen securities. It will be very obvious. Even if they try to do it in a phased manner, e.g., over the course of a year, it will be steady and relentless. And since everyone will know what is going on, there will be few buyers.

Let me compare the potential situation with another scenario. There are some commentators who suggest that as the baby-boomers retire, they will be selling off their retirement assets causing the market to decline. It might be suggested that there is little difference between the government doing it and the actions of the retirees. I suppose that there are some retirees who will sell all of the stocks on retirement day and buy bonds to have an income in retirement. It would be a bad idea, but there are many bad ideas floating around out there being used to “guide” people in their personal financial decisions. The difference here is that the government is going to seize all of the assets of this group and sell them off comprehensively. For the two to be similar, all of the baby-boomers retiring that year would have to sell all of their stocks without regard to current market conditions. I am expecting the Treasury to ignore current market conditions because they have the requirement to come up with the money. There certainly will be some heat, at some time, but will it be soon enough, loud enough, and principled enough to stop it? The Treasury won’t stop before the markets come down. They may later, but there will already have been much damage.

One factor in the Treasury’s “thinking” that should not be forgotten is that their justification for seizing retirement assets and issuing annuities is for the benefit of the retiree. The Treasury is doing a good thing for those poor, innocent, clueless old people. The rationalization will see the Treasury through any disaster that occurs. It won’t be their fault, but the market, capitalism.

You might think that the extreme drop in the equity markets would be a good buying opportunity. It isn’t. This sell off is planned to be a continuous thing, because the Treasury is aiming at all of the retirement assets of everyone (at least over a certain size of account). It will need the following years of stolen securities even more because the people at the Treasury will not be expecting the drop in market value that will occur. As every politician in history has planned on things not changing when they enact their plan to extract money from the economy, the Treasury and its supporter will not expect the market drop, so their plans on what to do with the money will be thwarted and they will need more. Lots more. If there is any economy left after all that BO has planned for us, the markets will only begin to recover when the retirement plan windfall dries up and the government has no more to sell. That is, the market will recover if the government hasn’t taken all other assets as well.

The bond market may react a little differently. Many of these retirement accounts have significant government bonds, which the Treasury might just hold as is. Depending upon when this occurs, since BO’s deficits already requires expanded bond sales, interest rates may already be higher and the Treasury may not want to put more bonds on the market. Some of the money that came out of the stock market before the Treasury begins selling the stolen securities may have gone into the bond market, especially if the interest rate had begun to rise. There are too many variables, including the foreign Treasury Bond investors. How the foreigners will react, and how the dollar will be affected will take much consideration. Certainly a sell off of our stock market will not be considered a good thing for the dollar. It should drop.

For the retirees and the others that had their assets seized by the government the situation will be dire. They may have said to themselves that at least they would get an annuity equal to their retirement account. But instead, they will get what the government received for their assets as the market fell. Don’t expect the government to keep tabs on whose account held what. Expect that the original owners of the retirement accounts will be treated very badly. Explicitly, the original owners of the seized retirement accounts could receive $0.50 on the dollar, $0.35 on the dollar, $0.10 on the dollar. Who knows? We can count on these victims to end up with a government annuity worth much less than their original retirement account, that it will not payout a significant percentage, and since the government may go broke, that it may not last as long as needed (if our failing health care system doesn’t do them in first). If what the government provides is a standard annuity, the income will be fixed, and all of the retirees will be left defenseless to the continuing price inflation. Given the potentials for rising price inflation in the next several years, the retirees could experience severe hardship.

What should you do? Right off, regardless of your age, when you see that the government is going to be able to get its hands on retirement assets, stop contributing to your retirement plan. Stop! Get your friends and relatives and colleges and everyone to stop contributing. Save your money from being taken. Next, to the extent you can, withdraw your assets from all retirement accounts. Yes, there is a tax penalty. For anyone over the age of 59½ it will be a straight shot of income tax. For those younger, it will include a 10% penalty for early withdrawal. You have to do the math, but to leave the money in the retirement accounts is to subject yourself to the risk of the government seizing it.

Don’t put any money into the markets. Keep cash. Sell what securities you own in any taxable accounts that you can. I expect many more will be doing the same, so try to be the first. The market is going to go down and down, even before the Treasury starts liquidating the retirement accounts it has seized. Some cash from those sales is better than less. Liquidate. You might try foreign investments. You might try commodities. You might try monetary metals. You might try foreign cash. As people flee the Treasury’s asset grab and the equity market, the government may attempt to put in place controls to achieve its purpose of seizing assets. If so, many of these avenues may be closed off. Again, keep up to date on news and make cautious decisions.

What we can do now is to express our opposition to the Treasury’s plan. We also have to keep a careful watch on the progress of their plan and, if it gets approved, its implementation.