Socially Security - A ponzi scheme?

For those of us who followed Obama`s presidential campaign, here was an orator who invoked mass emotion through one fundamental theme - CHANGE!

The result of that message was - history written - Barack Obama became the 44^th President of the United States of America.

And has there been change? Well, a lot has already been written, spoken and analyzed about the Obama regime, so we`ll refrain from getting into that mode. But recently, President Obama once again attempted to "change" the state of the US economy. How? By cutting payroll taxes from 6.2% to 4.2% for 2011.

Higher wage earners surely have reason to celebrate, but, it pays to know that these taxes are used to fund Social Security and Medicare, and the one-year reduction would probably be made up for by an additional $112 billion of borrowed money. How does borrowing more seem to solve the already alarming national debt scene?

With the dire state of finances of the social security program well known, this cutback will only accelerate movement of this program into (supposed) negative equity.

Is this another ponzi scheme?

... as many think it may be

What Social Security really translates to is the transfer of large sums from the young generation to the old in the form of Medicare and Medicaid benefits. In doing so, the structure assures successive young contributors that they would have their turn, in retirement, to get back much more than they put in.

With future benefits supposedly secured, this younger generation focuses less on saving. Hence it is not surprising that this transfer has fueled a huge increase in personal consumption, reducing national savings rate (saving as a share of national income) from 10 - 15% in the 1950s-60s to negative during the last decade.

The coming generational storm to worsen things further...

Society`s fiscal abilities are seriously challenged by the aging of the world`s baby boomers and the coming tidal wave of senior citizens who will live longer, consume more, and produce less.

Impending retirement will become a case for concern since the number of people retiring will increase more rapidly than the population of tax payers. The retirement of the baby boom generation will dramatically alter the balance between the nation`s working age population and retirement-age population.

You have to consider the fact that the boomer generation is much larger than the generation that preceded it, so the payroll taxes easily provided for the current retirement benefits. It was a case of the many supporting the few. But the next generation is much smaller than the one about to retire, so very soon it will be a case of the few supporting the many. Does this still sound logical to you?

Also, it is obvious that the average benefits for each retiree will also be expected to increase, further adding to the pressure on the budget of the federal government. It could also complicate the budgetary problems of the government and limit investment growth, wages, and productivity.

To put some numbers to this - when the boomers fully retire, the next generation will need to pay each of the retirees, on average, $50,000 in today`s dollars to cover retirement benefits. Experts are estimating the annual costs of this close to $4 trillion!

On the brink of collapse

Represented below is the Congressional Budget Office estimate of the Social Security Tax Revenues and the approximate spending in comparison.

Chart: CBO estimates of Social Security Tax Revenues and Outlays

Source:CBO

Facing retirement under-funded

Those retired look at a mix of three alternatives to meet their retirement expenses: Social Security, pensions, and personal savings centered on homeownership. Tragically, today most private sector employers do not provide pensions, and state and local government`s public pensions are drastically under-funded. In addition, a collapsed housing and stock market have drastically reduced Americans` personal savings. In short, the retirement pool rests largely in social security.

According to recent studies, people in the bottom two income quartiles depend on Social Security for 84% of their retirement income, and even the second richest quartile depends on Social Security for 55% of its retirementincome. The only segment of Americans who do not rely heavily on Social Security are the richest 25%.

The bigger problem is that payout of Social Security is quite meager. Now this is a problem because it now has a new role to play as a de facto national retirement plan. Currently it replaces only about 33-40% of a worker`s average wage from the year prior to retirement (compared to Germany where it replaces 70%). That is simply not enough money to live on when it is your primary -- perhaps your only -- source of retirement income.

The Result

Fiscal policy watchers have warned that the current government spending on these programs will set the federal budget on an unsustainable path. The Government Accountability Office (GAO) has calculated a solution to prevent a long-term fiscal shortfall: double-digit annual economic growth every year for the next 75 years. This scenario is absolutely implausible considering that the Social Security trustees have projected average annual growth in real GDP to be 1.9% over the next 75 years. The GAO projects that balancing the budget in 2040 would require as much as a 60% cut in total federal spending or a 100% increase in federal taxes.

The large and rapidly-growing debt burden of the US federal government may possibly not lead to a default given to the government`s ability to print whatever amount of money it needs. It is true that the US government could turn to the printing press (with the help of the Fed), but it is vital to understand that an attempt by the US government to use monetary inflation to cover the bulk of its liabilities would, in effect, be an attempt to stealthily transfer tens of trillions of dollars of wealth from the most productive parts of the economy to bondholders and the recipients of entitlements. This type and scale of wealth transfer would destroy the dollar and devastate the economy, all for the sake of maintaining an illusion of being solvent.

Governments have promised big, but put aside little. The promises will eventually have to be broken. The only question remains as to how much more damage will be done in the period between now and when default is confirmed. All in all, this creates large uncertainties over the long term surrounding the world’s reserve currency and the fiscal issues surrounding the US economy. An allocation to gold would be ideal as this disaster unfolds.

The views expressed in this article are the personal views of the Fund Manager of Quantum Gold Fund. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This information is meant for general reading purpose only and is not meant to serve as a professional guide/investment advice for the readers. This article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.