The Cryptocurrency Bust

Cryptocurrencies are down about 75% from the beginning of the year.  See https://www.cnbc.com/2018/08/20/after-the-bitcoin-boom-hard-lessons-for-cryptocurrency-investors.html.  Many investors have taken losses in the range of 70% to 90%.  Those who borrowed to buy cryptocurrencies learned the hard way that investments may or may not work out, but debts have to be repaid either way.  There may be some winners, but clearly there are plenty of losers.

The problem with cryptocurrencies is that they basically have no intrinsic value.  They're only worth what someone else will pay for them.  If buyer interest falls, people holding cryptocurrencies end up holding the bag.  If you want to buy cryptocurrencies, that's your choice.  But understand it's a speculative choice and lots of speculations end badly. 

The reason why stocks, bonds, real estate and a few other things have stood the test of time as good investments is they generally have underlying value.  If you want to build wealth, invest in value.  If you want to speculate, hope to win but don't be surprised if you lose.  If you want a decent retirement, avoid wishful thinking and focus on the higher percentage plays.  See  http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.

To Manage Your Money, Manage Your Emotions

Building up your wealth is simple:  spend less than you get.  But it's hard for many people even though it's simple.  Put a little money in their hands and it's gone as quick as a flash.  Put a lot of money in their hands and it's gone quicker than a flash.  This is no way to get rich.  If you spend everything you get, how will you put together a down payment for a house, college costs for your kid(s), or retirement?  Sometimes, you can borrow.  But loans have to be repaid, so you'll enrich banks, not yourself.  Retirement on just Social Security can be okay--if you move to Panama or Cambodia, places where your only option may be McDonald's if you want a taste of America.

Controlling your spending is the first and most important step to building wealth.  Don't begin by reading the vast array of materials that discuss how to invest.  It doesn't matter how you make money investing in ETFs, mutual funds, S&P 500 futures contracts, or covered stock options if you don't have any capital to invest. 

First, learn how to save.  This means getting control over your emotions.  Learn how to deny yourself immediate gratification.  Learn how to value long term rewards.  Learn how to ignore the latest trends.  Learn that keeping up with the neighbors could mean you're just as foolish as the neighbors.  Aside from basic spending for food, shelter, clothing and transportation,  essentially all spending decisions are driven by emotion.  The latest smart phone?  Designer clothes and accessories?  The trendiest restaurant?  A luxury nameplate on your car?  An extra 500 square feet in your house?   These things are marketed to people with impulse control problems.  Status won't give you a comfortable retirement.  You need money for that.

You've probably seen the news stories reporting that half of all Americans have no retirement savings and most of the rest don't have very much.  How could this be when America is one of the wealthiest nations in the world?  The hard truth is most people don't have the emotional composition to get rich.  And they don't have the willpower to get control over their emotions enough to begin the process of saving.  Sure, an illness or layoff can wreck your financial plans.  But they're not an excuse not to try.  If you don't try, you'll fail for sure.  Those who try actually succeed in many cases.  Give yourself a chance.  Get control over your spending impulses and save.  The only people who laugh all the way to the bank are people who have money to deposit in the bank. 

For more, see (a) http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html; (b) http://blogger.uncleleosden.com/2010/07/how-to-think-about-saving.html; (c) http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html; (d) http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html; (e) http://blogger.uncleleosden.com/2011/03/how-to-avoid-running-out-of-money-in.html; and (f) http://blogger.uncleleosden.com/2010/11/how-much-do-you-need-for-retirement.html.

Where Is the Stock Market Headed?

With the Dow Jones Industrial Average having dropped over 2,000 points since its peak a week and a half ago, this is the $64,000 (or more) question.  The recent market surge resulted to a large degree from too much optimism.  Market players have selectively focused on the good news (strengthening economy, big corporate tax cut, rising employment levels), while shrugging off the bad news (growing signs of inflation, rising interest rates, and increasing political discord).  Life is like a rose--pretty petals, but thorns as well.  If you ignore the thorns, you'll get an ouchie sooner or later.

So what happens after today's ouchie (1175 points off the Dow)?  The recent market surge seems similar to the valuation-driven bull markets of 1987 and 2000, which resulted in sizable drops of 25% to 30% in the Dow followed by gradual recoveries that took two to three years.  But we should bear in mind an earlier drop off. In 1973, the stock market (measured by the S&P 500) peaked after a long run up, not unlike the one we've had since 2009.  Then, it declined some 40% or more and didn't recover until some seven years later.  The 1970s were also a time of rising inflation and political scandal (Watergate), with the only resignation of a President.  Political turmoil affects economies and stock markets (look at Venezuela, where a lot of folks can't even get a square meal because of political strife).

Expect more market turmoil tomorrow, the next week, the next month, and maybe the next year.  The market could easily drop some more.  We're running out of good news.  There may be little major legislation coming out of Washington, given the political quagmire.  The Fed may go easy on the tightening, but it's not going to cut interest rates simply to support stock prices.  It's already done that, perhaps too much--and today's drop was likely a consequence.  The economy seems to be slowly gaining altitude.  But there's nothing going on that will provide it a quick major boost.  The federal government can't increase the deficit, given its recent deficit-funded splurge with the tax cut bill.  Corporations seem not to be rushing to increase reinvestment of their tax savings.  The Trump administration may spark a trade war with China and other nations.  And the stability of the federal government cannot, in these times that try our souls, be taken for granted.

History teaches that it's not a great idea to sell your stocks in an effort to staunch losses.  People who try to time the market generally fail to get back in and enjoy the resurge that will likely come (although the resurge could be a long time coming). Instead, try to spend less and save more.  Keep your investments diversified.  And don't stop knocking on wood.

Hurricane Harvey? North Korean Missiles? Stocks Shrug

So, okay, Hurricane Harvey may be the worst storm to hit America in a while.  The damage is really bad, and getting worse.  Projections for recovery time are lengthening by the minute as rainfall totals rise.  The economic impact will clearly be big.  Energy extraction and refining are being hit.  The Gulf states have a number of petrochemical and plastics plants, but they aren't manufacturing much.  The Gulf ports are major transshipment points for a lot of stuff, but not much transshipment is taking place.  The cost of rebuilding may reach $100 billion or more.

Meanwhile, the fat kid in North Korea keeps firing off missiles, in one instance over northern Japan.  He may think he's being clever, pushing the world to see how far he can go.  But shooting missiles over another country is a way to start wars.  The Japanese held their fire.  But North Korea's missiles aren't the picture of reliability and sturdiness.  If one flies in an unintended trajectory, or falls apart at the wrong time, physical impact on Japan or maybe South Korea is quite possible.  Then what?  Kim Jong Un has been on a path of escalation in recent months.  He's announced that Guam--U.S. territory--is his next target.  Since he seems intent on escalating, he will approach a flashpoint. 

But do stocks care?  Not one bit.  Even though U.S. stock futures dropped sharply last night, all indexes closed up today.  Mega hurricane--meh.  Barrage of North Korean missiles--meh.  Discord rife between and among the President, Congress and both political parties--meh.  Merrily we roll along.  Plus ca change, plus c'est la meme chose. 

Why do we have such insouciant stocks?  The likely explanation is the Fed.  Market participants have gotten so used to Fed bailouts that no one believes stock indexes can fall more than about 3% at the most, and therefore don't panic sell portfolios.  In some respects, this market stability may seem desirable. 

But market stability based on government subsidies is ultimately chimerical.  The Fed produced that stability by screwing over large numbers of people.  By keeping interest rates extraordinarily low for almost a decade now, the Fed has decimated pension plans.  A lot of middle class people who depended on their pensions are now lower middle class, or even poor.  Retirees and others who relied in part on interest income from their savings have learned to like dog food in lieu of steak, or even hamburger.  Holders of long term care insurance policies have faced extortionate rate increases, or possibly the prospect of spending old age in homeless shelters until they qualify for nursing homes that take Medicaid (which sometimes aren't exactly top class institutions).  Those that still have some faith in the future and want to save for a rainy day need to tighten their belts and put aside more principal, rather than count on the compounding of interest income to make their golden years glow.  That means reducing current consumption, which is a drag on the economy and may partially explain why economic growth remains tepid.

As long as the Fed supplies financial opioids for stocks to mainline, the market will be copacetic.  But problems lurk.  Stock valuations may not truly reflect investment values.  Instead, they probably incorporate a large dose of government subsidy.  That would mean people are paying too much for stocks.  This story won't have a happy ending.  Market forces can't stay suppressed indefinitely and government subsidies can't last forever.  The failure of Communism in China and the Soviet Union prove that point.  Things generally feel good when you're on narcotics. But you don't get good quality sleep on opioids--and investors shouldn't be sleeping too soundly now.

Buy Your Retirement

If you're having trouble saving for retirement, think of it this way:  your retirement is a purchase, and the more you spend, the more luxurious it will be.  Retirement is a purchase--you're buying rest, relaxation, entertainment and time to do whatever you want.  You may have to buy a fair amount of health care and other services such as lawn care, housekeeping and so on.  But whatever the case may be, the more money you have for retirement, the nicer it will be.  No need to think of saving as a sacrifice.  You aren't giving up things up.  You're simply spending for a better retirement instead of a bigger TV. 

So, if you can't save for retirement, then spend on your retirement. It will be one of the smartest purchases of your life.  For more, see

http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html, 

http://blogger.uncleleosden.com/2010/11/how-much-do-you-need-for-retirement.html, 

http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html,

and http://blogger.uncleleosden.com/2010/11/stress-test-your-retirement.html.

The Truth About Housing Prices

Ten years ago, this blog predicted that housing prices, which had fallen sharply in the mortgage crisis of the mid-2000s, would not recover until 2024.  http://blogger.uncleleosden.com/2007/09/when-will-housing-prices-recover.html.  That prediction may have seemed preposterously negative to many.  But real estate prices have meandered and stagnated since then.  Although some markets have recently enjoyed brisk gains, many others remain sluggish and below their earlier peaks.  Trulia, the real estate website, yesterday released a study that predicted real estate prices nationwide would not recover until 2025.  https://www.trulia.com/blog/trends/home-value-recovery-2017/.  Looks like my prediction of ten years ago was pretty accurate.  While my analysis and Trulia's aren't directly comparable (I focused on nationwide average prices adjusted for inflation and Trulia used nominal prices unadjusted for inflation while measuring recovery in all housing markets nationwide), the basic conclusion is similar.  It will take a shipload of time for housing prices to fully recover, and the mid-2020's may be when the housing market as a whole could once again start to accentuate the positive. 

Housing historically has increased in value about 1% faster than inflation.  Stocks have tended to average around 3% above inflation.  Buy a house if you need shelter and can afford it.  But pay off the mortgage, don't borrow against the equity, and save and invest in retirement and other accounts for your golden years.  Some people who can't save money end up relying on their homes to finance retirement.  But that's a much poorer choice (pun intended) than taking advantage of the greater potential of stocks and other financial investments.  Your house is your castle.  But it's not your best option for financing retirement.

The Truth About Getting Rich

Wealth is relative.  That is, people tend to consider themselves wealthy by comparing themselves to those around them.  The fact that most people today live healthier, longer and more comfortable lives than King Henry the Eighth is irrelevant to them.  They care more about where they stand compared to the people next door or the colleague across the hall or the persons featured in today's news.

This means you can feel rich only if you have more wealth than others around you.  That, in turn, means you have to be different from most people.  You can't be just like everyone else and yet be wealthier than everyone else.  But if you see yourself as just an ordinary, middle class person, does that mean you haven't got a chance to be wealthy?

No.  You can be wealthy.  While some wealthy people inherit their riches, most millionaires get there on their own by saving more.  It helps if you earn more.  You'll have more money to work with.  But earning more helps only if you save more.   If you spend all your above average earnings, expect to dine on dog food in your retirement.

You have to resist temptation to spend.  An 856 inch big-screen TV and a 4,300 horsepower SUV won't make you wealthy.  The same goes for $700 shoes and $1,200 handbags.  You have to be comfortable with fewer European vacations and plenty of home cooking.  When people laugh at your frugal ways, you have to focus on getting the last laugh.

Most people won't make it.  They won't become wealthy.  That's inherent in the definition of wealth as a relative concept, and it's also a result of the human tendency toward conformity and group think.  But plenty of middle class people end up having comfortable retirements or better.  In part, that's because of social welfare programs like Social Security and Medicare.  But these programs alone don't provide a good retirement.  You must be responsible and save.

What to do?  It's not complicated.  The main thing is save early, often and in significant amounts, like 15% to 20% of your income.  Invest in a diversified portfolio to increase your chances for good long term returns.  (See http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.)   There are a variety of ways to build up your wealth:  http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.  Look at each dollar you receive as a saving opportunity.  Remember that no matter how much money you make,  in the end you will have a finite income (we all do), and what you spend can't be retrieved.  It's gone. So don't waste that opportunity to save (see http://blogger.uncleleosden.com/2010/07/how-to-think-about-saving.html).  Avoid debt as much as possible (see http://blogger.uncleleosden.com/2010/07/why-you-should-avoid-debt.html).  Don't give up, even if you have financial setbacks.  Like so many other things in life, quitters aren't winners when it comes to building wealth.

You can have a somewhat decent retirement even if you don't save much, by building up your benefits and eliminating debt. (See http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html).  But if you want to climb into the ranks of the wealthy, be different.

Investing in a Time of Trump

If there's one notable feature of investing in the nascent Trump Presidency, it's uncertainty.  Although macroeconomic statistics are generally good, we are startled every day by a spinning kaleidoscope of tweets, leaks, executive orders, allegations, innuendoes, news stories, fake news stories and occasional court rulings that splatter across our field of vision and further contort the cognitive dissonance in the political scene from the recent election.  When all news and news-substitutes seem to be open to challenge, what can an investor rely on?

The ever-rising market only makes things worse.  With such political confusion, it's far from clear that the economic and tax policies espoused by President Trump will be implemented any time soon.  Why does the market persistently climb higher?  One can only suspect that some market participants have conflated optimism with delusion.  The background music to today's market may not be the Grand March from Aida (https://www.youtube.com/watch?v=TX0qN6QEvGg), but rather Jimi Hendrix's Purple Haze (https://www.youtube.com/watch?v=cJunCsrhJjg).

What can an investor make of all this?  Bear in mind that you can't see a lot of what's going on in the market.  There are major undercurrents, often computer driven, that cause daily market schizophrenia.  Large investors can push the market one way or another in the course of making large purchases or unwinding large holdings.  Mom and Pop investors won't see this or hear about, except maybe after the fact.

Computerized trading can be particularly scary.  It no longer consists of following pre-determined algorithms.  Much of today's computerized trading is dynamic, using artificial intelligence-type programs that try to figure out as the trading day progresses where prices are headed and buy or sell to take advantage of the anticipated market move.  Since much of the trading these programs are observing is done by other computers, we have computers reacting to other computers.  Price, which traditionally has been a judgment call made by intuitive and irrational humans, is now the product of chains of logic.  That logic tends to respond to short term stimuli, such as price movements in the last few minutes, seconds and even milliseconds.  It doesn't factor in the uncertainty in Washington.

People know the future is cloudy.  But the computers don't.  Computers don't feel fear, nor do they have to save for retirement or build up a cash reserve to guard against a layoff or a large unexpected expense.  People may hold onto their cash, wondering if the market is too bubbling given the chaos in the White House.  But a computer may boldly keep buying, egged on by the trades of the past 20 milliseconds.

If you're hesitant about the market, keep your powder dry and your cash in an FDIC guaranteed bank account.  There's no computer program that can understand and explain Donald Trump.  Today's stock market may be too heavily driven by short term inputs, without a full understanding of longer term risks.  Remember the old computer adage: garbage in, garbage out.  If today's computerized trading is pushing the market up based on an incomplete picture, prices will eventually rise too far, if they haven't already.  Then, le deluge.

Happy Halloween, America

This may be the scariest Halloween ever.  Two ghouls are in the lead for the Presidency.  They claim to be people, but that seems to be just a masquerade.  Even in their guises as humans, they are horrifying.  Parents could use their names to scare children to eat their vegetables and do their homework.  But then the children would have nightmares.  The parents already do.

The financial markets are being inflated by the Federal Reserve into a monstrous bubble, a bloated spectral presence that could bring back the demons and vampires of the 2008 financial crisis.  Pension plans, annuities and long term care insurance are being scared to death by ultra-low interest rates.  Anyone hoping to retire is hanging garlic over their front doors.

Overseas, demons, banshees and poltergeists bedevil us.  The Middle East is a seething mass of murderous conflict, seemingly a nightmare from which we can't wake up.  North of the Middle East, a fiendish demon toils at midnight, boiling eye of newt, toe of frog, wool of bat, and tongue of dog into a toxic mix that he flings in all directions while chanting diabolically in a language not heard since ancient times.  In North Korea, a beast with curved horns labors with a crooked smile revealing jagged teeth to find ways to deliver inferno thousands of miles.

Our industrialized economy spews noxious fumes that heat the Earth hotter and hotter.  Everything we ingest--food, water, and air--causes cancer or heart disease.  Even sweetness itself, in the form of sugar and other natural sweeteners, silently stalks our health. 

Alfred Hitchcock never made a movie so scary.  The real world would scare the bejesus out of Vincent Price.  If Stephen King needs inspiration, he can simply pick up a newspaper.  The truth is we have Halloween year round.  The only thing that happens on October 31 is people wear costumes.  The rest of the time, we can only try to stay safe, if that's possible.  Happy Halloween, America.

We're All Temporary Workers

According to data collected by the U.S. Bureau of Labor Statistics, middle aged Americans are, on average, likely to have held 11 or 12 jobs by the age of 48.  See http://www.bls.gov/nls/nlsfaqs.htm#anch4.  The same group will have, on average, experienced 5 or 6 periods of unemployment by the age of 48. See http://www.bls.gov/nls/nlsfaqs.htm#anch42.  Only about 10 percent of these workers will have had between 0 and 4 jobs by age 48.  In other words, the long lasting, stable employment that we anticipate for adulthood is mostly a mirage.  Few of us enjoy that kind of certainty.  Indeed, it's fair to say just about all of us are temporary workers.

Of course, there are differences among workers.  Some are considered full time, others part time.  Some are permanent--either full time or part time--and others are temporary--either full time or part time.  But the average American, with about 12 jobs by the age of 50, is realistically a temporary employee, just with better benefits if he or she is considered "permanent" and is working full time.

The impermanence of employment means fewer employees qualify for defined benefit pensions, even in the few jobs that still offer pensions.  It also means that in the real world, workers have trouble building up their 401(k) and IRA accounts, because they're periodically hit with a spell of unemployment or have to rebuild benefits at a new employer.  Many workers draw down their retirement accounts during episodes of joblessness.  When they resume working, they have less time to build up their balances again.  The only ways to counteract the temporariness of employment is to save furiously, or, if you're lucky enough to have a job offering a pension, to somehow stay put long enough to qualify for the pension, no matter how boring the job or overbearing the boss.

The wobbly, and sometimes turbulent, work lives of most people place this year's politics in sharp focus.  The debates over Social Security, health insurance, trade policy, jobs programs and wage stagnation become all the more crucial when we consider that, in the end, we're almost all temporary workers. Proprosals that enhance stability for workers, like protecting and strengthening Social Security and Medicare will be popular.  Measures like free trade agreements are likely to be losers.

But don't count on the government to bail you out.  You're not a major financial institution, so assume that there will be no bailout for you.  Save as much as you can--and then save some more.

A Generation of Stagnation; Retirement Walks the Plank

We are now looking at a generation of stagnation.  The recovery from the 2008 financial crisis still wobbles like a drunk.  Even though we now have full employment, wages barely keep up with inflation (if at all).  And recent statistics indicate that inflation is growing as fast as a parched lawn.

Regardless of what this Federal Reserve official or that says, the central bank will raise rates as often as humans walk on Mars.  If you're wondering when rates will return to historical norms, the answer is never.  At least, this is the only rational assumption you can make.  With Asia's growth slowing, Europe's growth nonexistent, South America in free fall, Russia going negative in numerous ways, and the Middle East becoming more unstable with each passing day, and no drivers of growth in America except the Fed money printing presses running 24/7, the only future forecast that seems sensible is to expect stagnation for--well, the rest of your life.

With stagnation instead of brisk economic growth, the government's ability to support retirees will be limited.  While Social Security and Medicare won't disappear, they will likely be parsimonious.  If you drop your porridge bowl, they won't refill it.  And pension fund and personal investment returns are being decimated by low interest rates on bonds and bank accounts.  Your retirement is starting to walk the plank.  What to do, then, about your future?

Spend less, save more.  This is a no brainer.  It's not what the Fed wants, because hesitant consumer demand constrains economic growth.  But the Fed be damned.  Your long term well-being requires the thriftiness of Ben Franklin, and if that results in lower economic growth that makes the Fed look bad, well who cares?  (Or, you can substitute more lively terminology if you wish).  With interest rates so low, you can't use the financial magic of compounding to build much of a retirement (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html). You have to set aside more principal, and hope that the few crumbs of interest income you get will elevate your retirement diet above dog food.

Put some money in stocks.  The inequality of wealth in America has increased because the Fed's easy money policies tend to inflate asset values.  Since the rich own most assets, their wealth  has increased disproportionately from central bank policies.  Realistically, with stagnant wages and a Republican controlled Congress, you can't expect the inequality of wealth to diminish.  (Maybe things would be different if Bernie Sanders is elected President, but both the Democratic and Republican establishments are using all their smoke-filled back room influence and power to prevent that.)  So you might as well join 'em if you can't beat 'em.  Owning stocks can be gut wrenching in times of market turmoil.  But so is a retirement spent eating dog food.  Learn to live with the market's turbulence, and collect the rates of return that the 1% are getting from equities.

Work longer.  This increases your lifetime earnings, which allows you to save more and build up your Social Security benefits.  If you're lucky enough to have a pension, it will likely increase your pension benefits.  Okay, so working longer means a shorter retirement.  But, like we said, retirement is walking the plank.  Just try to avoid having to live in a cardboard box on the sidewalk with a couple of cans of cat food in your raggedy backpack.

Avoid debt.  You can't go bankrupt if you don't borrow.  If you do borrow, some of your future income will go to banks and other lenders in the form of interest payments, instead of enhancing your future lifestyle.  Granted, you may need to borrow for big ticket items like college, cars and a house.  But otherwise, avoid debt.  And pay down the debt you have as you approach retirement.  Especially, lose the mortgage.  Financial advisers may tell you it's okay to have a mortgage in retirement.  But guess what?  If you have a mortgage, that means you may have more financial assets to invest in ways that pay fees and commissions to the financial advisers.  Meanwhile, you have to pay interest on the mortgage debt.  Who's better off?

For more on ways to yank your retirement back off the plank, read http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html, http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html, and http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html.  Good luck.

Do the Financial Markets Regulate the Fed?

When the Federal Reserve decided last week to hold short term interest rates at zero, the stock market's reaction was to drop.  Even though easy money has been a shot of glucose for stocks since the 2007-08 financial crisis, the market seemed to be saying that there can be too much of a good thing.

Yesterday, Fed Chair Janet Yellen stated her view that rates should rise sometime this year.  The market reacted positively, even though rising interest rates logically should push stock prices down (since fixed rate investments that compete with stocks would offer higher yields than before).

The implication is that the market is leading the Fed.  The market wanted rates to rise, and when they didn't, the market pouted.  That may have prompted Chair Yellen to make more noise about rates rising, and then the market cooed with approval.

Why would the market want rates to rise when conventional wisdom holds that stocks should love easy money?  Maybe it's because the stock market absorbs information from a variety of inputs, both short and long term.  Easy money is positive in the short run, but can be corrosive in the long run.  Accommodative policy by the Fed and other central banks has continued for almost 8 years now, and is distorting asset values and relationships to the point where the social contract may be changing.  With interest rates so low, the ability of pension funds, insurance companies and other asset managers to provide pension and annuity income is becoming impaired.  (For more, see http://blogger.uncleleosden.com/2015/04/is-federal-reserve-wrecking-retirement.html.)  When private parties can no longer provide retirement income, greater responsibility falls on the government.  Social Security and similar programs become more essential.  If these programs suffer from fiscal imbalance, taxpayers become more burdened.  We can't toss retired and disabled people into the gutter, but who besides taxpayers can cover their needs?

Another change in the social contract is that easy money favors the wealthy.  Low interest rates have pushed up the value of risk assets--stocks, real estate, commodities and so on.  The distribution of income and wealth have become more skewed in favor of those who need the money the least.  Such growing inequality makes it more difficult to attain social and political compromises and consensus.  A resentful and angry society may lack the optimism and initiative for investment and risk-taking that would foster strong economic growth.  (Note that jaded, cynical Europe is hardly a hotbed of innovation.)

The voices that are heard at the Fed tend to be those of elites--Wall Street executives, influential academics, power players like IMF Managing Director Christine Lagarde.  A lot of these voices have advocated keeping interest rates at zero.  But the accumulated knowledge of many thousands of participants in the real financial world seems to signal that continued distortion of asset values is doing more harm than good.  Maybe the market is regulating the Fed.  And maybe, at least this time, that's a good thing.

Is the Federal Reserve Wrecking Retirement?

We're now in the 7th year of Federal Reserve induced ultra low interest rates.  The Fed has kept short term rates at zero (actually negative, once you take inflation into account) through monetary policy.  Long term rates fell as well, especially after the Fed devoted years to quantitative easing (i.e., purchasing bonds in the open market).  Those people old-fashioned enough to actually save money have been bedeviled by the near-absence of interest income.  While some have been desperate enough to gamble with risky investments like junk bonds in order to generate more income, many and perhaps most have simply tightened their belts and spent less.  After all, if you're not getting any interest income, the last thing you want to do is spend down your principal.  That's like eating the seed corn--there will be no more harvests once the seed corn is gone.

Insidiously, the years-long pandemic of low long term interest rates has undermined retirements.  Pension funds, insurance companies and other persons and entities trying to provide for America's retirees have historically depended on long term bonds to provide a stable source of predictable income.  Pensions funds, insurance companies offering annuities, and other providers of retirement income tend to have relatively predictable obligations (i.e., the payouts they must make to current and future retirees), and look for predictable sources of funding to ensure that they can meet their obligations.  U.S. Treasury securities, agency bonds and high quality corporates were the bread and butter of retirement funding.  But these same stable long term investments have since the 2008 financial crisis been paying lower and lower interest rates. It's getting harder and harder to finance defined benefits.  While pension funds, insurance companies, municipalities and the like have sometimes turned to stocks and alternative investments, the volatility of these alternatives makes them a poor substitute for the plain vanilla fixed-rate, meat-and-potatoes high quality bond.

Of course, pension providers could contribute more funding to pension plans to make up for the shortfall in interest income.  But how many corporations, states and municipalities do you see leading the charge to put extra profits or taxpayer dollars into pension plans?  Many seem to be looking for spots on the increasing crowded sides of the road to dump current and future pensioners.

Corporations have curtailed and terminated defined benefit pension plans.  States and municipalities are in the process of doing the same.  Multi-employer pension plans are going belly up like fish in a toxic waste spill.  Soon, almost all of America's workers will be left with largely self-funded defined-contribution retirement plans, like the 401(k), or with self-funded retirements using IRAs.  Experience teaches that self-funded retirements are usually not as stable or comfortable as retirements funded with defined benefit pensions.  And that's just for the 40% of Americans who have any retirement savings at all.  As for the 60% who have none (as in zero, zilch, nada), the opulence of life on Social Security beckons. 

To be sure, Fed policy isn't the only reason why interest rates are low.  Economic and political instability in many other parts of the world are driving capital into safe dollar-denominated investments.  Low inflation tends to keep interest rates low.  But the Fed, as the single most powerful force in the money markets, has played a crucial role in eradicating high long term rates.

While Wall Street, corporate America, the 1% and many of the unemployed have benefited to varying degrees from the Fed's suppression of positive interest rates, there is, as economics teaches, no free lunch. There are costs to persistently low interest rates, and much of the cost has fallen on those middle and modest income workers who have or hoped for a defined benefit retirement.  Okay, so we already know the wealthy enjoy a heads-we-win, tails-those-little-people-lose advantage.  But we shouldn't buy into the Fed's story that it's creating stability to prevent a Great Depression.  What the Fed has done is transfer losses and instability that could have manifested themselves in another Great Depression, to many of America's current and future retirees, whose golden years may now be more unpredictable and depressed than they had hoped. 

How To Reduce Volatility in Your Retirement Income

The S&P 500 has dropped three days in a row, and after all the market calm of recent months, many investors must be thinking that the apocalypse looms.  There are understandable explanations for the recent downdrafts.  Islamic radicals of the Sunni variety have rapidly seized several towns and cities in Iraq, along with American weapons and vehicles provided to the Iraqi government (and the administration worries about giving small arms to moderate Syrian rebels?).  Iranian paramilitary troops, who are Shiites, supposedly are fighting alongside Iraqi government troops to retake territory seized by the Sunni radicals. Is Iran now a more important ally of the Iraqi government than the U.S.?

Russian tanks have reportedly rolled into Ukraine, where the fighting is escalating.  Bashir Assad is winning in Syria, and the moderate rebels that the U.S. supports seem to be almost inconsequential.  Most of East Asia is squabbling over this island or that, with contending nations issuing many a proclamation declaiming a neighbor as a ratfink, a double ratfink or even a triple ratfink. 

Domestic politics also create uncertainty for the markets.  Eric Cantor, House Majority Leader, was just defenestrated in a primary election by a guy from far right field whose name, even if we mentioned it now, you probably wouldn't recognize.  (But we're going to, because it's Dave Brat, a marvelously fitting name for a guy who ousted the Majority Leader.)  Cantor, who outspent his opponent's six-figure campaign by $5 million, convincingly proved that money isn't everything.  Not even in politics.  The Koch brothers must be scratching their heads about what checks to write next.

The markets will always be plagued by volatility.  And it tends to pop up when you least expect it.  That might be inherent in the definition of volatility, but you know what we mean.  Yogurt happens, but you don't want your retirement finances smeared with yogurt.  While there are no complete protections against the ups and downs of life, here are a few ideas for calming the financial waves.

Build Up Social Security Benefits.  Disregard the hyperbole.  Social Security will be there when you retire.  Maybe not exactly as it is now, but nevertheless in a meaningful form.  Any politician who votes to eliminate or sharply reduce Social Security retirement benefits will end up doing an Eric Cantor faster than Eric Cantor as voters reject the idea that they should have to eat dog food in their old age.  Work as long as you can to build up your benefits.

Get a Pension.  If you're lucky enough to get a pension, stick out it long enough in that job to qualify.  Although classic defined benefits pensions are usually found these days only alongside the remains of diplodocus, lasso one if you can.  Other pension arrangements, like cash balance plans, are a lot better than no pension. 

Save More.  Saving more is a salve for portfolio instability and financial insecurity.  Those that have the saving jones won't have to get loans.

Use Retirement Accounts.  Retirement accounts like 401(k)s, IRAs and so on offer tax advantages that let you leverage your retirement savings, while limiting your ability to prematurely spend your savings.  A particular advantage to a 401(k) account comes if your employer provides a matching contribution, which is the freest money most people can get.  Use these accounts as much as you can.

Diversity Your Investments.  The values of all assets wax and wane.  But they usually don't wax and wane in unison.  More commonly, some assets get yeasty while others do the fallen souffle thing.  And vice versa.  So a diversified portfolio is usually kind to your antacid budget.  There are moments, like the 2008-09 financial crisis, when it seems like almost all assets belly flop.  But these cognitively dissonant interludes are the exception and not the rule. 

Consider an Annuity.  A fixed annuity (one that pays a specified dollar amount per month) or a fixed annuity adjusted for inflation can be a reasonable way to provide a steady income.  Annuities aren't cheap, and you should buy only from an insurance company with a strong credit rating. Don't put more than about one-third to one-half of your portfolio into an annuity because cash needs in old age can be unpredictable and it helps to have a nice pool of cash or cash equivalents.  Be very cautious about variable annuities--they often have high expenses, and the point here is to reduce volatility, not subject yourself to it in another form. 

Health Insurance and Long Term Care Insurance.  Financial volatility can sometimes come from sudden increases in expenses, and not just decreases in portfolio values.  Health care and long term care needs are the biggest landmines in the journey through retirement.  Most retirees are covered by Medicare, but if you're not, then buy something else.  The Affordable Care Act, despite all the teeth-gnashing on the right, is likely to be a good option if you don't have anything else.  If you have a significant net worth, consider buying long term care insurance, especially if you have a spouse who may depend on that net worth after you've gone to the great Dance Party in the sky.  It's expensive, but so is long term care.  If you want more than the quality of care given to Medicaid patients, long term care insurance may be a good choice.

Part-time Work.  Okay, you want to hear about retirement, not employment.  But part-time employment reduces the extent you need to draw down your savings, so you can keep more powder dry for later.  It also lessens your risk of dying from the boredom of day time TV.  It may boost your Social Security benefits (depending on your work history).  And the dignity of work is better than the indignity of looking for sales on dog food.

How Government Inflation Policies Would Smack the Middle Class

The federal government proposes to use inflation to smack the middle class.  The Federal Reserve has an inflation target of 2%, and some Fed officials, fearing that deflation is around the corner--have recently been openly grousing about how inflation--running just above 1%--is too low.  They want to take away your spending power faster.  One of their primary tools for fueling inflation is to obliterate positive interest rates--or, stated otherwise, to deprive you of interest income.  Your faint memories of the distant past, when interest income actually required you to fill out Schedule B for your tax return, will become entirely ethereal.

Meanwhile, the Obama administration has proposed to use a less generous inflation adjustment (the Chained CPI) for Social Security recipients and federal and military retirees.  The Chained CPI would also be used to adjust tax brackets, with the effect that taxes would be higher than under the currently used CPI.  In other words, the Fed wants to increase inflation, while the President wants less protection for retirees and taxpayers from the ravages of inflation. 

Those whose incomes are middle class or lower (i.e., $100,000 a year or less) tend to be vulnerable to inflation.  They have little discretionary income left after necessary monthly expenses, and consequently, not much of a buffer against increases in inflation.  Retirees are especially defenseless.  Add the heavier taxes resulting from the Chained CPI, and the federal government's inflation policies could effectively reduce middle class and retiree incomes in real terms.

With the sluggish U.S. economy 70% dependent on consumption, it makes no sense for the federal government to deploy inflation as a weapon against those with middle class or lower incomes.  Reduce incomes and people will consume less.  If these federal policies somehow stimulate greater economic growth, it isn't hard to figure who will benefit the most from that greater growth, and it ain't gonna be the lowest 80%. 

The Chained CPI hasn't become law yet, and not all Fed officials want to ignite inflation.  So the worst may not come to pass.  But the lowest 80%, already facing uncertain employment prospects and stagnant wages, really don't need to be squeezed by inflation policies that make sense only to those well-to-do people who are insulated from their impacts.

The Federal Reserve's Obligation to Support Stock Prices

The Dow Jones Industrial Average is setting a new record almost every day.  Stocks are up 10% in 2013, and the year isn't even three months old.  Since the recent closing low on Nov. 15, 2012 of 12,542.38, the Dow has risen over 15%.  Stocks are on a tear and fresh money is coming into a market that's going up at an annualized rate of 50% or more.

A principal reason for the hyperventilation in the markets is the Federal Reserve's ultra lax monetary policy.  Even though unemployment has fallen from over 10% in 2009 to 7.7% now, and the economy has resumed moderate growth, the Fed has spent the last four years swinging its scythe far and wide to cut down any positive interest rates that might sprout up.  At the same time, it has printed shiploads of money through its quantitative easing policies.  An abundance of cash, having few other alternatives, has flowed into stocks.  At this point, the market depends on the Fed to maintain and increase its accommodation.  Moral hazard abounds.  Investors have put their precious savings in stocks relying on the Fed's promise to practically give away money for a really long time.  If the market falters now, the Fed will have to step up and accommodate some more, enough to prop up stocks.  It can't allow investors to suffer a third evisceration of their portfolios in less than 15 years.  If the market stages another major downturn, investor and consumer confidence will surely collapse, sending the U.S. into another recession and putting the U.S. financial system under enormous stress. The stock market has become Too Biggest To Fail.

Of course, the Fed would deny that it has any obligation to support stock prices.  Legally speaking, that's true.  But the U.S. Treasury had no legal obligation to support Fannie Mae and Freddie Mac, yet it nationalized them in order to prevent a collapse of the financial system.  The Treasury Department had no choice, given that the market had implicitly assumed that Fannie and Freddie were federally guaranteed.  By relentlessly inflating stock prices, the Fed has put itself in a comparable position.  It has implicitly guaranteed that stocks will not suffer a major collapse. 

The Fed is already honoring its implicit guarantee.  It's stated that the most recent round of QE (call it "QE Unlimited") will go on until unemployment falls to 6.5%.  The market has risen about 10% since the Fed announced this target.  A gnawing risk of the Fed's current policy mix is inflation, and the Fed has said it will step back if inflation flares.  But the question is whether it actually will.  Having drawn investors back into stocks after the market crash of 2007-08, the Fed may hesitate to take away the punch bowl if doing so will precipitate another bear market and recession. 

 Of course, it can't leave the punch bowl at the party forever.  But, given the pickle it's currently in, it may let the party go on too long.  We are at a crossroads in the history of central banking.  If the Fed pulls off its current maneuvers and nurses the economy back to health while keeping inflation in the 2% range, it will have established the paradigm for monetary management of the economy for decades and perhaps centuries to come.  If it fails, however, central banking as we now know it will likely become a thing of the past.

Political Risks of Social Insecurity

The financial press has reported that the United States ranks 19th worldwide in the retirement security, lagging behind Slovenia, the Czech Republic and Slovakia, among other nations.  http://www.cnbc.com/id/100534205.  We're one step ahead of Britain, but well behind France and Germany.  The Scandinavian countries rank at the top, along with Switzerland, Austria, the Netherlands and tiny Luxembourg.  Even Japan, after more than two decades of economic malaise, ranks 15th, four steps higher than America.

This probably doesn't surprise many Americans, particularly those who are approaching or in retirement.  They have probably already viscerally sensed their comparative insecurity.  Herein lies great risk for politicians who would reduce America's social safety net.  Our net is modest compared to the protections offered by most of the industrialized world.  If it's cut, the pain--particularly for moderate and lower income Americans--could be pronounced.  It's one thing if your retirement benefits may not cover as many restaurant meals as you would like.  It's another if your cost of living increase is so paltry that you can't afford needed prescription medications.

That we have a fiscal imbalance is because our taxes are even lower on a comparative basis.  (See http://usatoday30.usatoday.com/money/perfi/taxes/2009-11-25-oecd25_ST_N.htm.)  America could without enormous pain pay for its current social safety net without having to borrow.  We just don't want the taxes it would take to get there. 

Many politicians in Washington sound off about cutting Social Security and Medicare benefits.  This isn't just Republicans.  President Obama has been quick to offer reductions in Social Security.  One is to change the Social Security inflation adjustment from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to the Personal Consumption Price Expenditures Index (PCE).  The effect of this change would to gradually erode the relative value of Social Security benefits, with the most elderly being the hardest hit over time.  Is is really a good thing to whack the most vulnerable, who may have exhausted their savings and be unable to work? 

Consciously or subconsciously, Americans know that their retirement benefits aren't great.  And many of them won't be happy with politicians who make their retirements bleaker.  If the President and the Republicans somehow reach a Grand Bargain to stabilize or even balance the budget, the political impact may surprise them.  As Republicans clumsily attempt to embrace diversity, their core of older, white Americans may abandon them if they lead the charge to cut retirement benefits.  President Obama, instead of being viewed as a latter day FDR, may end up appearing to fall into the mold of Herbert Hoover.  And the liberal left, annoyingly shrill as they can sometimes be, may end up inheriting the White House in 2016. 

Idolatry in the Financial Markets

A lot of investors, it would appear, are throwing money at increasingly esoteric investments in order to prevent inflation from eroding their capital.  Junk bonds, asset-backed securities and real estate investment trusts have become fashionable.  With the Fed waging a 24/7 scorched earth campaign against positive interest rates, risk is being embraced.  One can only hope that the end result isn't like embracing a cobra--"risk on" investing strategies aren't risk-free.

A false premise widely circulated by financial sales people and cable TV pundits is that you have to preserve your savings from the ravages of inflation.  And, certainly, over long periods of time, inflation can significantly diminish your capital.  But you can't overlook the costs and risks of trying to protect yourself from inflation.  If those risks smack down your net worth, you haven't accomplished anything except lose money and then suffer inflation's death of a thousand cuts.  There's nothing wrong with losing a little ground now and then to inflation, while saving and investing with a view to long term financial equanimity.  If you lose ground to inflation for one, two or even a few years, don't panic.  Try to position your portfolio so that you can make up the "losses" later on.  Also spend less and save more.  This will increase your net worth without requiring you to dial up the risk.

The same is true of keeping pace with market averages.  The Dow Jones Industrial Average, the S&P 500, or whatever benchmark you might follow may be convenient ways to assess the performance of money managers who want to take your savings.  But market indices don't need to be your financial goals.  If your portfolio is conservatively deployed and doesn't keep pace with the S&P 500, you haven't "lost" unless you decide you're a loser.  As long as you are saving enough for retirement, your kids' college costs, and whatever other goals you might have, it doesn't matter a rat's left ear whether or not your investment returns match one market index or another.  If your portfolio is more cautiously invested than the stocks found in an index, you won't suffer the volatility of the index.  Maybe the Dow just reached a record level (although this really isn't a record once you factor in inflation).  But looking back at what happened in 2000 and 2007 after the Dow previously reached record levels will tell you that keeping up with market indices can be a losing proposition. 

Keeping pace with inflation and with market averages are, for individual investors, false idols that they need not worship.  Building your net worth isn't a contest.  It's a process.  There are lots of ways to make your retirement years golden.  Do whatever helps you sleep at night.

The Fiscal Cliff Negotiations: Just Who Is Barack Obama?

Recent negotiations over the fiscal cliff, which seem to be faltering after initial signs of progress, raise a persistent question about Barack Obama:  has he any political principles?  After campaigning this fall to protect the poor and middle class, he agreed in fiscal cliff negotiations to changes to the income tax structure and Social Security that are more damaging to the poor and middle class than the prosperous segments of American society.  By accepting Republican demands for the Social Security inflation adjustment to be the Chained Consumer Price Index, Obama has effectively reduced inflation protection for Social Security recipients, military retirees and federal civilian retirees, the vast majority of whom are low or middle income.  At the same time, because the same inflation adjustment would be made to income tax brackets, the brackets would rise more slowly during inflationary times.  That would effectively result in heavier taxation across the board, a seemingly regressive result.  Additionally, Obama agreed to raise the threshold for higher tax brackets from his original position of $250,000 to $400,000.  To be cynical, this might be viewed as a gift to the upper middle class professionals who often are his supporters and contributors.  And to be more cynical, it can be observed that many lower income folks, especially older whites heavily reliant on Social Security and/or military pensions, tend to be Republican more often than Democrat.  Perhaps the President sees little to lose in imposing austerity on them.

One wonders if Obama, after four years of dealing with the Great Recession, understands even the basic structure of the U.S. economy.  Our economy is 70% consumption.  Money in the hands of the poor and middle class gets spent.  They don't have enough to save hardly a penny.  This spending stimulates the economy.  Money in the hands of the upper middle and upper classes is frequently saved, allowing the rich to get richer relative to other income categories.  By raising taxes on the poor and middle class while cutting benefits to Social Security recipients, and military and federal civilian retirees, the President is reducing consumption and its stimulative impact on the economy, while exacerbating the inequality in wealth distribution.  What policy sense does this make?

During his first term, Obama demonstrated time and time again at critical junctures that he is a clever politician and dealmaker much more than a leader.  He craftily co-opted his most serious Democratic rival, Hillary Clinton, by making her secretary of state.  And he kept the liberal wing of the Democratic Party at bay by putting one of their number, Joe Biden, in the Vice President's residence.  But he has few loyal constituencies.  His one signal achievement, the Affordable Care Act, may transform life in America.  But transformational legislation doesn't necessarily bestow greatness on a President.  Lyndon Johnson's Great Society programs transformed America far more than anything Barack Obama has done or will do.  Indeed, the Voting Rights Act of 1965 enfranchised black and other disadvantaged Americans, paving the way for Obama to win the White House.  But Johnson has been denied the mantel of greatness.  While this is due in large part to his foreign policy catastrophe in Vietnam, it's also because Johnson, like Obama, was a consummate politician without any large loyal constituencies.  There's no one running around singing Johnson's praises.  Obama will always be remembered as the first nonwhite President, and there's a measure of greatness in that.  But John Kennedy was America's first non-Protestant President, and in 1960 that was an achievement not far from Obama's achievement in 2008.  Kennedy is remembered today for his charisma and charm.  But he doesn't rank among the great Presidents.  And, because Obama seems to value a deal more than principles or loyalty to constituents, neither will he. 

Costs of Quantitative Easing

The law of unintended consequences haunts economic policy.  The Federal Reserve's quantitative easing program, now in its third phase, is meant to provide economic stimulus.  However, it also drags on the economy.  Let us count the ways.

Reduced Interest Income.  Hundreds of billions of dollars of interest income have been lost because of the Fed's longstanding campaign to drive down borrowing costs.  Losses of this magnitude undoubtedly have dampened consumer demand.  Even though QE likely sprung loose some personal income by providing lower mortgage rates for homeowners to refinance, tight standards applied by banks making mortgage loans have limited the refi impact of lower rates.

Reduced Retirement Savings.  As bond yields shrivel up like corn in today's drought-ridden Midwest, many retirements look bleaker.  Even though the stock market has boomed, large numbers of shell-shocked savers abandoned stocks after the 2008-09 market crash and haven't participated in the gains.  Instead, they ducked into bonds.  Although the improbable bond rally of the past few years generated capital gains for many bond holders, the basic return sought by bond investors comes from interest paid.  That has been paltry.  As retirements look bleaker, many workers cut back on current consumption in order to save more.

Pension Pain.  Despite appearances from some recent press coverage, pension funds cannot take large risks, overall, with their portfolios.  However much publicity pensions' alternative investments may generate, a large part of pension assets must be invested in high quality bonds.  As returns on these puppies shrink, employers corporate and municipal confront the necessity for greater contributions.  Workers may be laid off, citizens may receive fewer public services, state and local taxes may be raised, shareholders may endure lower returns, and those workers still employed may have to make greater pension contributions.  All of which would further discourage current consumption.

Insurers Backpedal.  Insurance companies' returns on their investments are falling.  This means policies that depend on long term returns, such as annuities and long term care policies, become more expensive or even impossible to buy.  Or else, they offer fewer benefits.  Policy holders suffer.  Those people who want to provide for themselves, through long term care policies, annuities, whole life and similar products, have a harder time.  More people end up having to rely on government programs like Social Security, Medicaid and so on.  That's not good in an age of serious federal deficits.

Yield Curve Flattens Bank Incentive to Lend.  Back in the days when they made loans, banks would borrow short term (usually through demand deposits, interbank loans via the fed funds market, and savings accounts) and lend longer term.  The difference between short term interest rates (historically lower) and longer term interest rates (historically higher) provided profits for the banks.  But the yield curve (the graph of interest rates from short to long) has been flattened by the Fed's monetary policies.  There isn't that much difference any more between short and long term rates.  Potential profitability for banks has been squeezed.  Banks have less incentive to lend, and fewer loans means less potential for economic growth.

The Fed has sworn on a stack of printed money to keep short term rates darn near invisible until at least mid-2015.  It may achieve some of its objectives.  But it will also create unintended consequences.  The impact of these opposite reactions to the Fed's actions may be greater than the central bank foresees.  There are few real life experiments in economics.  But if we look at the most obvious example of the impact of a central bank squashing interest rates for years at a time, we can see that Japan has remained moribund for two decades since its financial and real estate crashes in the early 1990s.  The Bank of Japan has ruthlessly stamped out any positive upswings of interest rates in that nation.  But that hasn't produced the spark needed to revive Japan's economy.

It now looks like the Fed will keep rates unnaturally low for the better part of a decade.  Given Japan's experience, one wonders what is in the Fed's playbook.  If it's a sensible fiscal program from Congress and the White House, the next question would be what is the Fed smoking?  But if the Fed is acting on the reasonable assumption that we will have fiscal dysfunction for the foreseeable future, only the arrival of Godot, it would seem, would offer reason for optimism.