A Vicious Cycle - Podcast Transcript

November 2005

The following transcript is for the podcast entitled “A Vicious Cycle.”

Welcome to the PACT America podcast.

Today I'd like to talk about the stock market.

You know, I'm getting really tired of hearing from people that say that the stock market would be so much better than Social Security. Maybe if that's how it started out in the first place, that might be one thing. But it's all about the transition.

I'll say it again. It's all about the transition.

You just can't take a massive program like Social Security and overnight transform it into a system of investing in the stock market. Right now, Social Security is a "pay-as-you-go" system, and that means that the money that's coming into the program in the form of taxes is immediately going out of the program in the form of benefit checks for retirees. There's not just some massive sum of cash lying around that we can use to start investing in the stock market.

So in order to try to convert that system, this "pay-as-you-go" system, over to one that's invested in the stock market, it's going to require massive transitional borrowing. What this means is that the government will have to borrow money by increasing our national debt, and then it will use that money to allow younger workers to invest in the stock market. So the taxes that younger workers still pay in will be used to pay the benefit checks for current retirees just like the system is right now. But now we're going to start borrowing money on the national debt to invest in the stock market. That doesn't make too much sense, now does it?

First of all, you're going to have to pay interest on the money that you borrow. Right now the interest rate on the national debt is averaging somewhere about 4.5%. So this is kind of like borrowing money on a credit card or borrowing money from the bank and using it to put in the stock market. There's probably no... No good financial advisor out there is going to tell you that that's a good idea.

Because your stock gains are going to have to get at least that much just to break even. So that means that if stocks return 4.5% in a year, you made zero on your investment, because you as a taxpayer will still have to pay the interest on that national debt. So you're going to be paying the interest on that debt through your taxes, and then in your private stock account, whatever gains you make, they'll have to be reduced for that amount.

So if stocks gain maybe 7% in a year, you're only going to see about 2.5% after you get done paying the interest. And if stocks decrease, let's say they're negative 5% one year, well not only do you have that loss, but you still have to pay the interest on the debt. So I mean... It's a ridiculous plan.

And I guess what I'm trying to say is, "Depending on how they were going to structure this idea, the interest payments on the debt could keep going long after the private account holder is dead. So yeah, you might get a temporary little bit of gain, but overall it's going to be bad for the country."

You know, people have this warped idea that the stock market just returns an average of 7% or so given a long enough timeframe. That means that even if stocks go down, if you just keep buying, over the long run they'll go up. Well that's kind of flawed logic.

You know, there are two primary factors that influence stock gains: economic growth and money flow. You know, economic growth is fairly obvious, but let's talk about that for a second.

When you're investing in the stock market, you're kind of investing in the economy of the United States of America. So over the past few hundred years, yeah, there have been great gains, because over that time period, you took a small little colony that emerged as a nation and eventually grew to be one of the greatest civilizations in history. So of course your stocks are going to do well during that time period.

But if you start taking a closer look at things, you know, a lot of these gains didn't come until after World War II. And what happened during that time period? First of all, you had these smaller, smaller privately held companies, you know, like mom-and-pop shops and just family run businesses that were being replaced by these large national and multinational corporations.

Also, you had our economy was starting to expand outside of our borders due to technology and other things like shipping routes and just the speed that we could move goods around the world. That allowed us to take a larger market share of the global economy.

So where are we going to go from here? You know, we're outsourcing all of our jobs, which is kind of cannibalistic in nature. Which means, here's what that means... So let's say a corporation outsources a job to a different country, because they're going to save a lot of money in labor. Well, when they produce goods in that foreign country, what are they going to do with them? They've got to sell them. So right now they're selling those goods back to Americans, back to people in our country.

But that can't last forever, because you can't take away people's jobs and then continue to sell them goods. You know what I'm saying? And we're already starting to see that. Corporate profit margins are just being driven down, because you have to realize that your consumer has to have the money to buy your goods. And if you take away the consumer's jobs... It's a system that can't last.

So right now you're seeing this temporary thing that in the end is going to have some negative consequences for our country. And people say that free trade is so great, but... (sigh)

They fail to see some of the long-term things.

You know, you can't grow rich by trading with a country that's poorer than you are; it's called a reversion to mean. In a free market economy, if you trade with a country that's poorer than you are, their workers are going to want those jobs, because they'll be improving. But as your workers start to lose jobs, their standards of livings are going to go down.

So what happens is a reversion to mean where the foreign country starts to increase, but then our country starts to decrease until they reach sort of a balancing point. Well how does that make any sense?

You know, so this is only benefiting those at the top, the richest of the rich.

But let's get back to talking about the stock market.

(pause)

So maybe you can see like how this economic growth has transformed, you know? And well, it's like looking to the future, can the stock market possibly continue to give these returns? Not really. There's only so far you can grow or only so far you can go.

And one of the reasons that this isn't going to work out so great is if you start look at what's happening, which is the second factor that influences stock returns: money flow.

Money flow is a measure of whether money is entering or leaving the market. So if you look at the previous decade when times were good, there was a lot of money flow coming into the market, and that was due to several factors. One, you had a lot of programs that were just being developed to encourage people to start saving like 401(k)'s. You had all these discount brokers and online brokers that made the markets more accessible to a wider group of people. You know, commissions were lowered, so it was more affordable for people to buy stock. And because economic times were good, people had extra money to invest.

So you had a lot of money entering the market, and that helped to drive up prices. It's kind of like eBay, you know, that online auction. If there's an auction that has a lot of bidding, or people start to bid on it, the price naturally goes up.

Well in the stock market, sometimes people assume that when stocks go up it's because there are more buyers than sellers. Well that's not exactly true, because when you think about it, the number of buyers and sellers is always the same in terms of the transaction. Because for every share of stock that's sold, there can only be one buyer who buys that share of stock. So while there may be more potential buyers, what happens is that when prices rise like that it's because you find the buyer who's most willing to pay the highest price. You know, it's price discovery. It's a means of figuring out what someone is actually willing to pay for something.

So you've got this Baby Boom generation, this huge demographic who is being taught that if they want to have a comfortable retirement, they need to start investing in stocks. So through their careers, they're putting in all this money into the stock market, which is positive money flow. Because they think that they need to be invested in the stock market, and they're invested through pensions, personal savings, and other types of retirement accounts.

Well that positive money flow is causing stocks to slowly go up, faster than they would from economic growth, because the two are separate. And what happens is if you look at stock prices right now, even after the bubble burst, they're still overvalued. You know, you've got famous investors like Warren Buffett, one of the wealthiest men in the world, who is always complaining about stocks being overvalued.

(pause)

And it's because of this money flow.

So if you look forward to the future, what's going to happen when all of these Baby Boomers start to retire? You know, they're going to need to start selling some of these stock assets to pay for their retirements. So you're going to start to see negative money flow.

And I mean this cycle has always happened as one generation starts to retire and a new working generation starts to invest. But because the Baby Boom generation is so large in comparison to the next generation, that it's going to cause a significant amount of negative money flow.

Now here's another problem: pensions in America. Right now, corporate pensions are severely underfunded. The government agency that regulates pensions say that pensions have never been in worse financial shape. How did it get to be so bad?

Well one of the reasons is because when returns were doing so good in the last decade, corporations thought that they didn't really need to contribute that much. You know, because the gains from the market were making these pensions go up in value so high that these corporations... In some instances, it didn't make sense to contribute more money. So while they should have been contributing at an even scale continually year after year after year, there was these years where there weren't any contributions, or very limited contributions.

So now when the market values went down, not only did that happen, but suddenly corporate profit margins really went down and corporations were struggling to make a profit. So now, not only do they need to start pumping tons of money into their pensions, but they don't even have the profits to do it.

And what's going to happen as we look forward?

Right now these pensions are underfunded. They can get away with this now, because they don't need to be paying out the benefits. But as soon as all these Baby Boomers start to retire, they're going to need to pay those benefits. And what these pensions are kind of banking on right now is the same idea that the President had for Social Security. You invest in the stock market, and you allow those gains to make up the difference. You know, so you're expecting these higher gains and these higher rates of interest that are going to make up the difference in the long run. Unfortunately, I don't think that's going to happen.

Because you've got these corporations with underfunded pensions using those assets to purchase stock in corporations that have underfunded pensions. You know, that doesn't make any sense.

And as they... It's going to turn into this vicious cycle, because you've got normal retiring people drawing money out of the stock market to pay for their retirements, then you've got these corporations who are counting on those gains, but suddenly those gains are now going to be less. So that means the corporations are going to have to start coming for more money out of their own pockets. And as corporations use their profits to make up the difference to cover these pension liabilities, that's going to decrease corporate profit margins.

So suddenly the next younger generation is going to say, "Hey, all these profits are being eaten up by these pension liabilities. Why should I invest my money in the stock market? This no longer seems like such a good idea."

Can you see the vicious cycle there?

And right now we've already seen some major corporations declare bankruptcy, and dump massive pension losses on the government. You know, the airlines for one, that whole industry.

Because what happens is once you have one company that declares bankruptcy and dumps billions and billions of dollars of losses on the government, then its competitors are saying, "Hey, now that company has a competitive advantage because they no longer have to worry about paying for those liabilities. You know, that's no longer affecting their profit margins. So we should declare bankruptcy now too."

And you know, it sounds... It sounds like a company would never want to declare bankruptcy over pensions, but it's a huge cost. You know, these pension liabilities represent a significant amount of the worth of the company. So yeah, in some situations it does make sense.

So our pensions, these corporate pensions, are going to start being dumped on the government, but the agency that insures these pensions won't be able to cover it all. You know, right now if your pension gets dumped on the government, your benefits are going to get slashed. They could be cut by as much as 50%.

But what's going to happen is when some of these other corporations start to dump these pension losses on the government, you know, they're just not going to be able to handle it all. So then it's going to come to the taxpayers. Do you really want to have to pay for some corporation who decided that it didn't want to have to pay its bills? You know, do you want your tax money going to pay for someone else's pension when your own pension benefits are probably going to be get cut? No.

So we need to handle this problem, and we need to handle it right now.

You know, we need to say, "Hey, wait a minute. This is not going to cut it anymore. We don't want to say... We don't want you just to be investing your underfunded pension assets in corporations with other underfunded pensions, because those profit margins are not going to make up this difference."

We're talking about as a whole these corporate pensions are underfunded by hundreds of billions of dollars. You know, one billion dollars is one thousand million.

(pause)

We've got to get this under control, and we've got to do it right now.

So what I'm saying is we need to... We need these PACT America accounts that are invested in these government bonds, where we can change this funding model for the government agency that regulates pensions, which will say, "Hey, if you want... If you want us to insure your pension, you need to start investing a certain percentage of your pension assets into these government bonds. And these bonds in these accounts, they're going to be individually held by your employees. So no matter what else happens to this corporation, those employees are going to have a certain core benefit of government bonds that will protect them from some of these other issues."

You know, and people think that bonds aren't such a great investment, but I mean right now, we're paying 8% interest on over $500 billion worth of Treasury Bonds. Eight percent is pretty good. You know, so it's like we've got to start doing this, we've got to start forcing these corporations to invest in these bonds which will be a more safe investment. Because right now it's just going to create this vicious cycle that's going to take a lot of people down with it.

(pause)

So don't talk to me about investing Social Security in the stock market. You know, that's just going to try to change it into the same problem that all these pensions have, and I mean it would just sabotage the program quicker than anything else.

(long pause)

I'm not trying to scare people, but I'm saying that we need to use some common sense here. We need to tackle this problem before it becomes a huge issue. We need to...

Too often in government, the government is reactive, which means they wait until something bad happens before they do anything. Well we need to be proactive. We need to get on top of this right now; we need to make sure we get it handled right now so that it doesn't become this huge problem in later years. We need to be proactive, not reactive.

And I don't really think that we can just trust the government, or trust these corporations to do it on their own. You know, it's not going to be... It's not going to be something they're going to want to do on their own. We need to force them to do it.

We need to say, "Hey, you need to take some responsibility. This is your liability, this is your deal. You need to live up to it." And the PACT America accounts can make that happen.

(pause)

Well I think that's probably a pretty good podcast.

This is Adam Florzak keeping it real.