The Retirement Trap

A fixed income retirement may lead to a real fix: "Un-retirement"

By Tony Allison, March 19, 2007

Walking into the Sunset

Wall Street continuously reminds us “Everything is Wonderful.” As long as you keep buying its “investment products,” you too can retire to a beautiful lake, just like those handsome senior citizen couples in the financial services commercials, walking hand-in-hand into the sunset. But in reality, storms are brewing over the horizon. Millions of Baby Boomers, even those who have saved hundreds of thousands of dollars, are likely to face a retirement of dwindling choices and lowered expectations. Ultimately, the stark reality is many, many retired Americans will face “Un-retirement,” looking for work in their 60’s and 70’s to make ends meet.

The pitfalls of retirement are a subject you have likely read about, perhaps ad nauseum. But for most Americans, this subject cannot be discussed often enough, or emphasized loudly enough. The obvious approach is to start saving and investing, as much as you can. But for many it is easier said than done. Many Boomers have children at home and elderly parents they must look after. That is one of the demographic challenges facing this generation; having children later than earlier generations and seeing the costs of child rearing skyrocket, along with medical care costs for their own parents. There are also cultural factors at work. Baby Boomers, un-chastened by the Depression that defined the lives of their parents and grandparents, have pretty much lived for the moment. And they have been encouraged to do so every step of the way by Madison Avenue and the televised popular culture.

Given that background, many Boomers look at retirement planning as a necessary evil, and something to be ignored if possible. Those who are more involved often see their future as an extension of the past, projecting their retirement based on the past 25 years, an era of uncommon prosperity, characterized by falling interest rates. The Retirement Trap can be avoided, but a clear-eyed, sober view of reality is an important place to start.

Soaring Trillions

My purpose is not to scare you or annoy you, but to encourage critical thinking of your own situation, and to ultimately take action. The government, despite what many Baby Boomers might think, is not likely to provide cradle-to-grave services and protection. By its own admission, the Federal government has unfunded liabilities for Medicare and Social Security over $50 trillion, destined to rise much higher with inflation. Fifty trillion in unfunded liabilities. A number most cannot fathom, but one they will one day have to face. The government has no money set aside or squirreled away. Far from it, as our current Federal debt of $9+ trillion continues to grow every year (not even counting those pesky “off budget” items such as the War in Iraq). As our population continues to age, the government will have even more difficulty expanding its tax base to pull in the necessary revenue to feed the explosive debt obligations.

The numbers do not add up. Congress has admitted as much in its hearings with Fed Chairman Ben Bernanke. It is not a secret, but because it does not affect the current election cycle, difficult choices are deferred to future politicians. Unfortunately the average person cannot defer planning for retirement until age 61. The gathering clouds of trillions in unfunded liabilities and burgeoning government debt will eventually rain down on the unsuspecting Boomer, looking forward to a gentile retirement on a golden pond.

The 76 million Baby Boomers, born between 1946 and 1964, today represent approximately 28% of the population. The leading edge of those 76 million will begin to retire in 2008. Most of them believe their Social Security, Medicare, 401-k and IRA savings will lead to a smooth transition into retirement. Others have no idea how they will retire, but figure things will work out. They always have for the Boomers.

A Nation Addicted to Debt and Consumption

Unfortunately, the problems facing future retirees go much deeper than just those of a government in hock. As a country, we have become addicted to debt and consumption. Jim Puplava stated it clearly in a recent interview with Peter Schiff of Euro Pacific Capital. “We have gone from a country that used to save, under-consume, invest and produce, to a country that has a negative savings rate,” said Puplava. “We now live on debt and no longer produce much. We just borrow and consume. That is an economic model that does not work.”

“Americans are still consuming as if we were still producing everything, but we are not,” noted Schiff. “The only reason we can consume so much is because of all the savings and hard work of our parents and grandparents. We’re just squandering our inheritance. Modern economists measure the economy based solely on GDP numbers. If it’s just consumption based on borrowing, they don’t differentiate that. They confuse the cart with the horse. The horse is savings and production. The cart is consumption. You don’t drive an economy by consuming. The consumer is not the engine. The consumer is the caboose!”

How are we going to pay for the imported products pouring into our country? “What good are our services to the Japanese and Chinese?” asked Schiff. “We can’t put those services on a ship to Japan. We need to make something they need.”

Source: Moody’s

A More Expensive Future

That gets to the crux of the issue for future retirees. Things are likely to get a lot more expensive for Americans in the future. Schiff explained in his interview with Jim that every country has its own fiat currency. And every country produces products in factories around the world. Unfortunately, not that many of those factories are located in America anymore. The world’s 6 billion people want those products. Everybody bids on the products they want. Americans walk away with a disproportionate amount of the world’s output because our dollar is worth so much more relative to other currencies. Thus we have an advantage in this daily “auction.” But it is not an advantage we’re entitled to. We used to be, because we produced a disproportionate amount of the world’s goods and were entitled to a disproportionate amount of consumption. That’s not the case any longer.

Source: Moody’s

The only reason we can consume more than we produce now is because foreign governments are subsidizing us, mainly to protect their key export market (the US consumer). What if the rest of the world decides it no longer wants to give its savings to the US Treasury to finance its deficits or its wars? China is rapidly developing its own consumer market, and Japan is greatly expanding its trade with China. Once Asian central banks decide to seriously diversify their trillions in dollar holdings into Euros, gold, tangible assets etc., the dollar will begin to lose its value. Stronger foreign currencies will gain purchasing power and the dollar will lose it. People abroad will be able to consume goods they cannot afford to now. This is how Americans will see their standard of living lowered. It may not be this year, but that day is coming.

“Our currency will ultimately buy a lot less,” said Schiff. “Things will be more expensive for Americans. We will be doing without things that many people around the world are doing without right now. And they’re doing without them because we have them. There are not an unlimited amount of goods. They’re scarce. When it changes, if Americans have investments denominated in the currencies gaining in purchasing power that the US dollar loses, they can at least preserve their own relative standard of living. You don’t want to be holding a bunch of dollars when the music stops.”

Beware the “Conservative” Portfolio

I frequently mention to clients nearing or in retirement that they can’t enter their golden years relying solely on the purchasing power of a fixed amount of US dollars, looking forward to a 20 to 30 year retirement. The two-headed monster of a future currency devaluation and future inflation make fixed income assets questionable at best. The only way the US government is going to meet even a portion of its trillions in unfunded liabilities is to print vast, unimaginable sums of currency. Financially, those liabilities cannot be paid without massive tax hikes and severe budget cuts. Politically, that will be impossible to implement. But the currency will be printed. The currency’s purchasing power will be another matter.

Millions of Baby Boomers, as well as older retirees today, will rely on fixed annuities and long term bond portfolios to survive. Unfortunately, this fixed stream of US dollars will be at a growing risk of currency debasement and inflation. Over long retirements, 20 years and more, Boomers will face the horror of eroding purchasing power, and by extension, an eroding quality of life. The “conservative approach” may have worked in the days when our nation produced more than it consumed. But those days are gone. We as a nation have consumed the wealth created by our forefathers.

This is the reason I believe a fixed-income “conservative” portfolio, denominated solely in US dollar assets at retirement is not conservative at all. It’s a gamble that the US dollar will not lose its purchasing power at an accelerating rate. That is a gamble most retirees cannot afford to take.

Think of this chart like the exchange rate between two currencies. What this chart shows is the DJIA depreciating relative to gold. In 2000, gold was 1/44th a share of the DJIA. Today, gold is now worth 1/16th of a share of the DJIA, meaning it now takes far less gold to buy a share of the DJIA than it did six years ago due to the depreciation of the dollar. This shows the importance of looking at one’s assets in terms of purchasing power, not just how they are doing in US dollars.

Global Economy Offers Opportunity

The global economy is expanding rapidly. The industrial revolutions in China and India are pushing the development of their economies at unheard-of rates. Technology continues its relentless advance. Continue to educate yourself. Continue to question the status quo. Self-reliance is how our country was founded, and what made it the strongest in the world. Listening to Wall Street salespeople tout their products is not enough. A comfortable retirement is going to take more than hoping for the best. Walking hand-in-hand into the sunset is a dream most of us share. Walking into a future of prosperity or leading a life of “quiet desperation” will depend on the choices you make. Take the time to make them wisely.

Today’s Markets

The US stock markets rallied, Monday, with the Dow Jones Industrial Average finishing up 115.76 at 12,226. The S&P was up 15.11 to finish at 1402, and the Nasdaq was up 21.75 at 2394.

Big buyout news, centering on the possibility of British bank Barclays PLC merging with Dutch bank ABN Amro, helped propel stocks higher as investors set aside their recent focus on the subprime mortgage market. Today’s advance kicked off a week of forthcoming economic data, starting with a report from the Chicago Federal Reserve that said regional manufacturing slowed in January. Tuesday begins the start of the Federal Reserve’s two-day meeting on interest rates. Few expect any change to short term rates, but investors and analysts will be reading the Fed “tea leaves” looking for any change in the Fed’s language that would hint at where rates are headed in the coming months.

The NAHB/Wells Fargo housing market index fell to 36 in March from a downwardly revised 39 in February (originally reported at 40). It was the first decline in the index since September, when the index hit a 15-year low of 30. A year ago, the index was at 54; two years ago it was at 70. The index shows that about one-third of builders have confidence that the housing market is healthy.

"This is a strong signal that housing will remain a drag on the economy through spring and probably summer as well," wrote Patrick McPherron, an economist for Moody's Economy.com. He concluded that, after seasonally adjusting the numbers, optimism about prospective buyers was an all-time low.

Those that have been repeatedly calling a bottom in the real estate market since mid-2006 may be somewhat premature.

Wishing you a good evening and a prosperous retirement,

Tony Allison

Contact Information

Tony Allison, Registered Representative
PFS Group
PO Box 503147
San Diego, CA 92150-3147
(888) 486-3939 Toll Free
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