Benson's Economic & Market Trends
No Bull Prize in Economics
November 8, 2011
The crux of any economic theory starts off with the magic words "first assume that" and then using dazzling logic follows an irrefutable happy conclusion. The real key to using economic theory and logic is in the assumptions. Assume the correct things about the world, and you have a chance of getting the outlook right. Assume the wrong things, and any model will generate totally unreliable garbage.
My experience in the business and investment world over the last thirty five years has taught me a few things about assumptions, so if you are interested in surviving the slings and arrows of outrageous fortune, putting some good business policies in place is crucial. Always assume nothing, verify everything, assume the worst could happen and, if things can go wrong, they do and will. Even my motto around the house "if it isn't broke, I can fix that" is based on experience. I have learned wisdom can be as simple as substituting facts for assumptions.
As a baby boomer facing retirement down the road, I can't help but wonder whether there will be anything left in the Social Security Fund and my personal investments by the time I need them. I rely on assumptions when making my own investment decisions and if they are not right, I could outlive my money and starve. Now, many corporations and government pensions, insurance company annuities, and retirement advisors rely on investment, economic, and corporate projections that are all based on critical assumptions. The assumptions used by big business and big government are all generated and reinforced by legions of economists, accountants, actuaries and pundits, who, by the way, are all bought and paid for by the government and powerful corporations. The experts are paid very, very well. Why? Because, it seems, the experts are paid twice. The first time is to figure out what an assumption needs to be to get the result the corporation or government wants to hear. The second time is to justify the assumption by creating up a bunch of bull to hand out to the public. The bull in turn is fed to the public by reporters and TV hosts who are also paid very, very well not to question the experts or their assumptions.
It's these bull assumptions I keep hearing that hit me over the head and between the eyes like a two by four. The biggest bull is that both corporations and state and local governments assume their investment portfolios will grow an average of 8.5 percent a year. This assumption continues today, despite the fact that 10 year treasury securities have on average yielded less than three percent over the last three years, and currently yield two percent. So, an 8.5 percent investment assumption on a safe asset is laughable and only one of many assumptions about the present and future that might as well be from Mars. Another such assumption is that banks can hold assets on their balance sheet at cost and not what they are worth today, or that real economic growth will be three to four percent a year for the next 10 years. One of the craziest assumptions, however, is that inflation is contained and the money available for retirement will cover the future cost of living. These are just a few on the list of unrealistic and hopeful assumptions that stretches on and on. If you're a Baby Boomer like me, and fearful of the future, instead of looking at happy business and government assumptions, perhaps we should all be looking at hard cold facts and make decisions based on them, not fiction or hope.
For instance, even if the reinvestment rate of investment in pension and retirement accounts was 8.5 percent, pensions and retirement accounts are still under-funded by trillions of dollars. Governments don't want to tap taxpayers, and corporations don't want to contribute to those funds from earnings. Why? Because it's a mathematical fact that when you start with underfunded pensions, and have core government interest rates as low as three percent, virtually all of the defined pension plans (regardless of whether companies and governments will be asked to actually step up to the plate and contribute) are close to being bankrupt.
It's also a fact that the Federal Reserve has guaranteed to keep short-term interest rates near zero well into 2013 and beyond. Indeed, the Federal Reserve is running an overt and knowing policy of keeping the rate of inflation well above the rate of interest. For a saver or senior depending on a pension, this is not reassuring. In other words, basing a retirement model on 8.5 percent investment returns is about as realistic as assuming that pigs can fly. The government also wants to change the nature and composition of the Consumer Price Index to keep reported inflation down. Under-reporting inflation will give Social Security and Medicare less money and save the US Treasury hundreds of billions of dollars. But retirees are already short-changed by the government price indexes because most of what retirees pay for is rent, food, fuel, and other utilities that go up rapidly in price. Meanwhile, the Consumer Price Index includes a lot of high-tech gadgets and games which show price decreases because computers run faster and store more data. Much of what is consumed is videos, games, and social networking. As I get older, my problem is that I want to eat and drive somewhere, and not play computer games or socialize with silly twits on Facebook. Over time, Social Security will be forced to change its name to "Social Insecurity" because cuts in retirement benefits are coming, and the value of the dollars paid to retirees will drop because of inflation.
At my age, I've given up dreaming of winning a Nobel Prize based on dazzling logic applied to delightful assumptions. Instead, I have settled for simply trying to understand the interplay of political reality smashing against the rock of hard economics caused by older workers retiring faster than younger workers are entering the labor force. In short, I just want to sniff out the bull that is being handed out as laughable assumptions and twisted by economic logic into total crap. I'm only looking for a "No Bull" prize in economics, in a world where in print and on TV the bull never stops.