Scanning through the news the last few weeks and you’re most likely to have seen talking heads micro analyzing every development in the crises playing out in Greece. If you scanned down further on a financial website or the front page of the Wall Street Journal, you may have also noticed Chinese stock markets are down more than 30% in the last few weeks. Click around a little more or turn beyond the front page and you may also have noticed that Puerto Rico is also in big trouble. What’s the common denominator in all these financial crises? They’re all man made. Digging further- there all made by men and women who think they can circumvent basic economic principles of supply and demand. They are wrong- it’s really just that simple.
What’s the end game for our portfolio and retirement strategy? In short- we’re going to need to save a whole lot more money than our parents to pay for a similar living standard. Why? Stick with me as I walk through the logic.
In Greece, we see the toxic combination of massive entitlements and an unproductive economy all wrapped up in the quagmire of the common currency (the euro). Bad idea. Essentially Greece can’t support its “promises” (i.e. exorbitant pension benefits, etc.) to its people based on the revenue coming in from it taxing power (or lack thereof). For years, it has financed the gap with borrowing from its euro-brethren and the country has now reached the point where it can’t afford to pay back the loans. So now they must pick one of two terrible scenarios. Option 1: Massive austerity (benefit cuts) and tax increases in exchange for more “debt relief” from the European Union. Option 2: exit the euro, print drachmas and see a massive loss of purchasing power and standard of living. Pick your poison Greece- both will be awful.
Puerto Rico: Much like Greece, this U.S. territory made similar promises to its massive base of government employees that can’t be supported relative to the productivity of its economy. Again, this has resulted in another debt crises that is likely heading directly to a default, leaving bond holders with worthless pieces of paper that were once interest paying bonds.
Let’s move on to the most impactful story, the “economic miracle” in China. For the last 15 or 20 years, proponents of central planning (i.e. political elite make economic decisions with some market forces) have lauded the world’s growth engine. Essentially, introducing a little capitalism drove amazing growth and kept the people “fat and happy” so they don’t revolt against the communist party. But keeping control and maintaining that growth pace on a much larger economy has become a problem. How to mask it? Massive borrowing to finance unproductive projects like vacant apartment complexes. When that becomes overwhelming, introduce artificial incentives to drive stock market prices. While that worked in the near term (stock market up 150% in the last year) the bubble euphoria ultimately collapses on itself as amateurs jump in late, people borrow to buy more stocks and valuations skyrocket. Then the music stops and prices crash just as fast as they rose. In my opinion, Greece and Puerto Rico are nothing compared to the potential impact on our economy given China’s recent contribution to global GDP growth.
We can go on and on with examples – including the debt crises of tomorrow, the city of Chicago, many states, and even the United States’ unsustainable entitlement commitments but the point is this: Supposedly “enlightened” and “highly educated” government officials can tell such wonderful stories and make promises sell the electorate on a utopia but ultimately, someone needs to pay for this. The Ponzi scheme can go on for years as tax revenues don’t support the rich payouts – meanwhile the debt burden grows. But ultimately, economic principles win out and when they do, it’s painful.
So what does this mean to you? In short- save a lot of money. Why? Because in my opinion, it’s a really bad idea to assume historical returns on equities going forward or high interest payments on bonds when thinking about your retirement plan. In my opinion we are witnessing multiple case studies on what happens when elitist politicians are more concerned with maintaining their place in the ivory tower than they are the long-term sustainability of the country, state or city they were entrusted to lead. Ultimately, all these financial commitments can be handled one of two ways – either they are paid back in full (financed by growth-suppressing tax rates) or reduced/eliminated (financed by defaulting or restructuring loans and cutting entitlements like social security & Medicare). My guess? We’ll probably see some combination of both. Buckle up.