Matt Yglesias notes
Imagine a society with no Social Security, and also no imprudent or short-sighted people. Everyone puts a healthy share of their annual income away in a savings vehicle, and everyone manages to retire on a decent income. Thanks to the ups and downs of the financial markets, there’s a certain inefficiently noisy quality to the income of retired people, but due to the magic of infinite prudence the problem is very manageable. Now imagine that demographers are predicting a one-time demographic adjustment in the ratio of old people to non-old people in the population. This will lead to a decline in the rate of economic growth, and therefore to the expected return on investment. Either workers will need to start increasing their savings rate, or else they’ll need to accept lower living standards when retired. In other words, they’ll face the exact same choice we currently face in the form of higher taxes or lower benefits. Of course people could try to compensate for lower expected returns by engaging in riskier investment strategies, but we’re talking about a perfectly prudent population.
Under the circumstances, I don’t think anyone would be saying “saving for your retirement is a pyramid scheme—it depends on the assumption of future economic growth!”
Actually the problem goes beyond a simple slow down in economic growth and there was significant hand-wringing about it a while back. It was called the “Asset Market Meltdown Hypothesis.”
As it was often put, “so exactly who is the baby boom generation planning on selling its 401(k) assets to?”
The issue is was that real rates of return to should vary inversely to the supply of capital. There are only so many good investment opportunities, so the more people invest, the lower the rate of return. The way this ought to play out in the asset markets is that prices should rise very quickly as people pour their money in but then grow very slowly, once everyone is in.
That’s depressing enough as it goes, but the kicker is that the reverse should happen on the other side. That is, asset prices should fall rapidly as everyone tries to sell out, then hit some bottom level and grow steadily from there.
Perhaps, disconcertingly the US stock market looks like it could be in the middle of such a story.
You can see a little bit of a take-off in the 1980 then another sharp jump upwards in the mid 1990s and of course, the market has moved essentially sideways since then.
We can also see that the excess growth period matches the increased percentage of workers using 401(k)s
The core issue, that Matt hints at, is that having an equity stake in the America’s future capital is not somehow more fundamentally sound than having an equity stake in America’s future labor.
International capital flows could mitigate this somewhat by allowing American corporations to seek out opportunities in other countries the drive down in the real rate of return could be avoided. However, at the same time international labor flows could solve the Social Security problem.
Also, to turn your mind around. Here are inflation adjusted stock market values
Here are inflation adjusted stock market values per US worker
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Tuesday ~ February 22nd, 2011 at 8:28 pm
Felix
Calling Social Security a Ponzi scheme is popular with people of my ilk. But, if it is, then life is a Ponzi scheme. It’s interesting that people take literally the accounting artifact of the “Social Security Trust Fund.” The trust fund seems a fairly good attempt to be honest. Better to have some accounting for what you’ll need down the road than to just wing it.
Down the road, old folks (and kids) are supported by the productive people in the middle. That won’t change until someone figures out ways old folks and/or kids can be productive. US baby boomers didn’t have as many kids as their folks. They “saved the world from crushing humanity”, expecting, perhaps, other people’s kids to support them in their old age. So they’ll not have it as cushy as their folks unless Gen-X is real, real productive. Not impossible. There’s a lot of waste out there
Anyway, no charts needed. The demographers were talking about the crash of 2006+ 20 years ago. Just as in the ’70s they had the ’80s and ’90s as boom times.
“Someone” who finds ways for old folks to be productive is likely to be someone who’s looking out for the buck. Think Scarlett O’Hara, not Ashley Wilkes. You want to hear about something good? Listen for “someones”. They must be out there.
Wednesday ~ February 23rd, 2011 at 1:18 am
Can’t be beat the bulge | Brucetheeconomist's Blog
[...] http://modeledbehavior.com/2011/02/22/the-401k-pyramid/ [...]
Wednesday ~ February 23rd, 2011 at 12:03 pm
anon
The issue is was that real rates of return to should vary inversely to the supply of capital. There are only so many good investment opportunities, so the more people invest, the lower the rate of return.
This only applies as long as no people are dissaving from their 401(k)’s. As old folks start drawing down their retirement savings, real rates of return ought to shoot back up.
Looking at asset prices alone in this context is misleading: one needs to consider dividends and coupon payments, as well as real interest rates.
It is also wrong to state that “having an equity stake in the America’s future capital is not … more fundamentally sound than having an equity stake in America’s future labor”. Stakeholders can easily have property rights on future capital: they cannot claim property rights on other people’s future labor, unless some rather “peculiar institutions” are (re)instated.
Wednesday ~ February 23rd, 2011 at 1:33 pm
Wonks Anonymous
“International capital flows could mitigate this somewhat by allowing American corporations to seek out opportunities in other countries the drive down in the real rate of return could be avoided. However, at the same time international labor flows could solve the Social Security problem.”
In economist fantasy land. In the world of likely possibilities, capital flows much more easily across borders than labor.