‘Farewell Welfare’ — Part II

Donald Trump’s inauguration dominates the news over here.

The main point of discussion is whether he’ll be polarising or galvanising in his agenda to go back to the future.

In typical ‘buy the rumour and sell the fact’ style, it appears that what’s required to ‘make America great again’ has rattled the markets in recent days.

The Dow is down around 70 points. The magical 20,000-point threshold is yet to be breached.

Gold is off a little. But, at US$1,200 an ounce, it’s well above the December low of US$1,125…when mainstream analysts were forecasting that the barbarous relic would continue going lower.

Trump is proposing spending cuts of US$10.5 trillion over the next 10 years. Already, the Democrats and Republicans are arguing over where the fat is to be trimmed from.

Entitlements? Defence? Health? All very touchy subjects when it comes to cutbacks.

In March 2017, the US credit card is going to be maxed out. The debt ceiling will be raised…again.

Everyone acknowledges something has to be done to rein in spending; however, just don’t look for it to come from my area of self-interest.

While watching the pre-inauguration coverage on Fox Business, I couldn’t help but notice the number of ads for annuities and reverse mortgages.

Obviously, demand for products that supplement retirement incomes is sufficient to warrant the cost of the ads.

Living longer (and low interest rates) may be bad for retirees, but it’s great for the businesses providing these products.

In the not-too-distant future, expect to see more of these ads on Australian television.

Demand for these products is only going to increase, as society resigns itself to the ‘farewell welfare’ inevitability.

Welfare is not an Entitlement

To recap on ‘Farewell Welfare’ Part I: Welfare is not an entitlement. It’s an expense to current and future taxpayers. In a compassionate society, the majority are prepared to pay this tax cost — within reason.

Where welfare is being funded from tax receipts (as opposed to a National Social Security fund with income-generating assets), its perpetuity is conditional upon the taxpayer base significantly outnumbering the welfare recipient apex — hence the term ‘pyramid scheme’.

The pyramid principle has worked for the past century — my parents, grandparents and great-grandparents have all been age-pension recipients.

The growing population base in the Western world (climaxing with the demographic bulge of the baby boomers) has ensured a tax base sufficiently broad enough to support the welfare apex.

But, as Bob Dylan sang, the times they are a changin’…

To avoid being blindsided by the incremental squeeze being placed on governments of today and tomorrow, boomers need to understand the numbers behind the inevitable changes to be imposed on age pensions.

Germany and Japan have a negative birth/death ratio (more people are dying than being born). In Australia, the Netherlands, the UK, France and the US, the birth/death ratio is only marginally positive. The highest birth/death ratios are in countries like Ghana, Honduras and Algeria — where families, and not the state, care for their elderly.

In the West, we have a situation where generous static promises are careening headlong into the reality of a dynamic world.

Western society would do well to remember the wisdom of Ayn Rand (author of Atlas Shrugged):

You can avoid reality, but you cannot avoid the consequences of avoiding reality.

We can pretend the Social Security Ponzi scheme can continue, but our denial will not change the physics applying to an inverted pyramid.

The following charts (courtesy of Ineichen Research and Management AG) lay bare the financial and demographic reality facing the Western world.

The first chart is a compilation of private and public debt levels (as a percentage of GDP) in various countries.

private and public debt levels

Source: Ineichen Research and Management AG
[Click to open in a new window]

The left-hand side of the chart is dominated by the West, with Japan a clear ‘winner’ in the debt stakes. Australia ranks 10th, with slightly more than 200% debt-to-GDP.

What these numbers DO NOT show is the level of unfunded liabilities — future welfare and health costs — for each country.

For example, the guesstimates on US unfunded liabilities (money to be sourced from future taxpayers) range from US$50 trillion to US$200 trillion. Using the lesser figure of US$50 trillion would add approximately 300% of GDP to the ‘official’ debt levels in the chart.

An honest politician (now there’s an oxymoron) would acknowledge that this is not repayable, and commence a dialogue with all responsible citizens on how best to manage the expectations of taxpayers, and those who receive taxpayer-funded benefits.

The ‘poorer’ countries — the ones with higher birth/death ratios — are among the least-indebted countries. Or, to put it another way, these are the countries that have had to live within their means and not indenture future generations into tax-paying servitude.

The above chart is a clear indication that the West is living well beyond its means — on a public level, the West is running welfare and health schemes that cannot be funded, and, on a personal level, it’s been about living lifestyles (and buying homes) above our pay grades.

Debt repayment is a function of variables: time, income and interest rates.

The following chart on the median age in various countries shows that the West is running out of time.

median age

Source: CIA World Factbook
[Click to open in a new window]

The most-indebted countries have the highest median ages. The combination of our elderly living longer, the boomer demographic bulge, and families opting for only one or two children has skewed the Western median age higher.

The traditional pyramid structure of society is starting to look more like a ‘rocket ship’.

Time is working against the budgets of Western governments — the employed (on average) have less time to reach retirement (fewer taxes being collected), and retirees are spending more time in retirement (more taxes being paid out).

Not a great business model.

To change the time variable is (in theory) simple — those currently working need to extend their working lives well beyond the age of 70.

This would mean more time employed, and less time retired.

Good luck to the political party trying to sell this ‘ask not what your country can do for you’ message.

If governments persist with the welfare illusion (the one that makes you believe you can have money for nothing…I can already hear the howls of reader protest over that comment), and do not apply further restrictions to the asset and income tests, then the only options are to increase taxes and/or continue funding the shortfall with increased levels of public debt.

Taxpayers and ratings agencies are going to be none too happy about these options.

Politicians always opt for the line of least resistance. Therefore, changes to taxation rates, pension eligibility age and age pension means testing will be phased in…a sort of glide path to closing the gap between revenues and expenditure.

The sort of change outlined above is meant to be subtle — it creeps up over time, and society begrudgingly accepts the price to be paid.

But this best-case ‘glide path’ scenario may or may not be the case.

What if the interest rate variable changes? After all, we are in the midst of the lowest interest rates in the history of money. Therefore, it’s not unreasonable to assume the most likely change to the interest rate variable will involve it going UP (Janet Yellen has already stated US rates may rise in 2017).

Should rates move up 1% or 2%, the impact on public and private budgets would be significant.

Tax revenues (government income) would decrease, as households spend less on consumption and more on debt servicing. On the flipside, government expenditure increases with higher debt-servicing costs. Lower income and higher expenditure puts added pressure on the government to look at the two biggest items in its budget: welfare and health.

The West has not paid the full price for three decades of wanton spending. The GFC started the process of correcting the imbalances, but policymakers have used every weapon in their armoury to keep ‘the dream alive’ — propping up stock and property markets with the ultra-low interest rates, plus indirectly underwriting budget deficits with QE.

Since 2008, central bankers have put enough ‘fingers in the dam wall’ — but the debt and demographic pressure is building.

When, not if, reality eventually trumps illusion and the dam wall breaks, most people will be unprepared for a world where we are forced to live within our means.

A world where debt is shunned would be completely alien to us — with wide and far-reaching consequences.

Whether it is the ‘glide path’ or ‘bursting dam’ scenario that awaits us, a prudent investor would do well to prepare for the worst and hope for the best.

The debt and demographic numbers in the West are baked into the cake…they are irrefutable.

Welfare promises — made in times of lower life expectancies, when less people were at the apex of society’s pyramid (and during the greatest credit boom in history) — are going to be reneged upon.

Anyone recently retired or planning for retirement in the next 10–20 years should include this reality in their financial plan.

Change is coming, and it definitely won’t be in the form of more generous welfare payments.

After decades of political generosity (vote-buying) with welfare entitlements, the time is fast approaching where more and more people will be saying ‘Farewell Welfare’.


Vern Gowdie,
For Markets and Money

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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