I teach financial literacy and I’ll tell you what frightens me.
Today, I had a 30 year old tell me that he was comfortable with his retirement plan because he and his wife were on track to have $1.5 million in his investment account and 401(k) when they retire in 35 years. They would be out of debt, with a paid off house and with the kids out of the house their expenses would be dramatically lower than they are today. All that considered and add in Social Security and he thought they would be fine.
Knowing that this particular fellow is not what I would call ‘purposefully frugal’, my response to him was that if he retired tomorrow and he had that $1.5 million today, he would probably run out of money by the time he died even if he only lived to 85. Which, of course, is statistically likely for someone who is 65 today, so chances are pretty good that by the time this young man reaches 65, thirty-five years from now, his life expectancy will be even higher.
Naturally he asked me why I said that. My reply was this:
IF, Social Security is still around in 35 years – and that’s a huge question mark right now – it will be dramatically different. However, we’ll assume it will contribute something to their income. And we’ll come back to that. My bigger concern is that he and his wife are basically ignoring what inflation does to the cost of living.
The stock market is like an ecosystem.
It’s like a forest that is constantly growing and dying. And when one part dies another one pops up. Statistically, the stock market grows at an average of about 9% each year but taxes will eat some of that. Inflation, on the other hand, while it’s still a whopping 8+% this year and the stock market is trying to recover, it averages only about 3% a year over time. Last September’s weather situation of hurricane Ian ravaging Florida and the South Carolina coast lends itself to an appropriate analogy.
Think about what happens to coastal properties when they’re hit by a hurricane. All the dead trees die and are replaced with new growth that is bigger and stronger and more resistant to the next hurricane. The stock market is very similar in that when a bear market hits some industries die and are replaced with entirely new industries. And you can define THAT growth as a measure of true inflation. Not what the government says using the CPI. The price of a stock may go backward temporarily during a bear market – like last year – but eventually the market recovers and prices go back up and pass where they were before the bear market started.
Over time everything is more expensive and some things you’ll be paying for 35 years from now, don’t even exist yet, so if your investments aren’t growing more than what the market is doing then, in effect, you’re falling behind. If someone had told me when I was 30 that before I retire I’d be buying a new phone every couple years for $1000 a pop, I would have told them to stop smoking crack.
Things change.
Think of it another way. If your annual raise or promotion is 5% and inflation is 8% then you just lost 3% of your income. If you’re in business you’re either growing or dying. There is no such thing as maintenance because growth in your market and inflation we’ll eventually eat up every penny of your profits if your growth doesn’t keep pace with the environment around you.
But while inflation isn’t ALWAYS this high, it will still eat up a lot of what your cost of living will be during both your accumulation phase and your retirement and there is no stopping its impact on your wallet.
Consider this. If your investments grow at 9% per year and all-in, Federal, State, Local, property, etc. taxes cost you 3% then your actual growth is only 6%, right? Add in an average of 3% inflation, and that 6% quickly becomes worth – in terms of goods and services you pay for – only 3%. Still, 3% a year added to $1.5 million is $45,000 a year, just about what this fellow makes per year, so naturally he’s thinking “all good”.
Here’s a problem. Even though their home will be paid off, it’s still not an asset. The appreciation on the property can’t be accessed unless they sell it or get another mortgage. And the upkeep and property taxes are a drain on their income so it’s actually a liability. That’s something few people consider.
Here’s another one. Food.
Two people, eating just twice a day, spending just $5 a meal per person TODAY costs $7,300 annually. In 35 years, at just a 3% rate of inflation, the same meal that cost $5 today will cost $13.66. Almost 3 times as much. Add the annual inflation rate to that cost and, assuming they eat every day, and retire 35 years from now, then over just 20 years in retirement, that cost becomes almost $600,000. Make that $10 a meal today and then it becomes $1.14 million over that same period. Throw in a few years like we’ve had recently and that cost will double again by that time.
Will Social Security cover that cost? Maybe. Maybe not. Do you want to bet your life on it?
And then of course, add this. According to a recent report from RBC Wealth Management, the projected lifetime cost of care for someone who is a healthy 65-year-old in 2022, is $404,253 – and that doesn’t factor in long-term care costs, which could be as high as $100,000 a year.
When RBC asked people how much they think they’ll spend on health care at age 65, on average, they said about $2,700 a year. In reality, experts estimate at age 65, today, the annual spend on health care for a healthy couple is close to $5,700 per person ($11,400 for a married couple). That will be likely three or more times that cost by the time our guy and his wife retire in 2057.
And those are out of pocket costs. Medicare, if that still exists, will only cover a certain number of expenses, which means people have to fill that gap. Those costs start to add up quickly as we age.
The bottom line is to plan for about three times more than you think you’ll need today, because rising costs even without rising taxes and bear markets factored in will eat a major chunk of your savings down the road.
Regardless of what your political affiliation is, you’ve likely noticed by now that inflation is taking money out of your pocket everywhere, on pretty much everything. What you may not know, is just how much more money certain of our elected “representatives” plan on raiding your bankroll in the future as well.
Those of you who know me well know by now that I’m the kind of guy who actually reads the text of laws that are proposed or passed, because it’s my experience that’s so much garbage is hidden from the public in the fine print of proposals that are spun in the public forum to be helpful, when in fact they mostly make matters worse. I like to actually know what’s in them. You should too.
This Inflation Reduction Act we’re hearing about is one such proposal.
The public forums tout that it has got all sorts of stuff that makes it people say “Oh yeah, we need that” like lower drug costs for those with Medicare, supposedly cleaner air (some estimates put emissions reduction at 40 percent by 2030), more stable health care premiums for millions of low income folks, and maybe significant savings on power bills for most Americans, among other things. All good, right?
But this is exactly one of those examples that is titled so it sounds good…but oh my gosh, it ain’t.
And again, while you might think I’m biased because I’m a Libertarian, facts are facts whether you’re conservative, liberal or somewhere in between.
First, since the government has no money of its own, where is all the money to pay for these wonderful things going to come from? One guess. Do we get any real say so on that? Nope.
More importantly, here’s the bottom line: the Inflation Reduction Act will have ZERO impact on reducing inflation.
The Wharton School of Business, well known for its objective points of view, says this:
“Over the first five years (2022 – 2026), CBO [Congressional Budget Office] estimates only $21 billion in accumulated deficit reduction. Over the same period, however, payments to liquidity constrained households, including enhanced subsidies for the Affordable Care Act, exceed total deficit reduction, with the sum mostly financed by entities and households that are not liquidity constrained. The impact on inflation could be positive or negative under CBO’s estimate. Regardless, any change would be too small to be detectable in PCE inflation estimates that the Bureau of Economic Analysis reports to the first decimal place.
Statistically, even ignoring its composition, CBO’s estimated $21 billion in total deficit reduction amounts to less than 0.018% (2/100th of one percent) of cumulative projected GDP over the same years. That is a tiny fraction of its (single) standard deviation of variation. The impact on inflation is statistically indistinguishable from zero.”
Read that again – The impact on inflation is statistically indistinguishable from ZERO. And make no mistake, the authors of this bill knew that from the get-go, so why call it “The Inflation Reduction Act”??
Because it sounds “meaningful and positive” to the generally uniformed and apathetic populace that we are.
And so you know, the Personal Consumption Expenditures Index (the PCE mentioned above) encompasses a broader range of goods and services than the Consumer Price Index (which the govt uses to measure inflation rates) from a broader range of buyers and is widely held in academic circles as a much better barometer of consumer costs.
More importantly, even it if did reduce inflation, (you sure won’t hear THIS mentioned on TV) this proposal effectively breaks President Biden’s campaign promise not to raise taxes on individuals earning less than $400,000.
Next year alone, the effects of this legislation will raise taxes on EVERY SINGLE INCOME CATEGORY, including people earning less than $10,000 per year!
Wait…what?
Yessiree. This proposal will hike taxes on Americans earning less than $200,000 per year (not just folks making over $400,000) by a whopping $16.5 billion plus next year alone. By the end of the decade, roughly half of the new taxes raised by the plan would come from families earning less than $200,000.
How do I know?
The US Senate’s Joint Committee on Taxation tables for Average Tax Rates under the present laws versus the proposed laws tells me (and you) so. See for yourself.
Overall, the “Inflation Reduction Act” will increase taxes and tax collections by roughly $470 billion.
You can’t make this shit up.
“But wait John, a lot of those increased taxes will come from tariffs on oil and gas producers and forcing corporations to pay their ‘fair share’ of taxes!”
Yep. That’s true. Along with 87,000 new IRS agents to go after those extra tax $$, this legislation will set higher fees on gas and oil and will impose a 15% minimum corporate tax rate.
And if you think that hike in the corporate tax rate is going to make some personal difference to you, I have no doubt you’re absolutely right…but not in a good way.
There are 17.5 million corporations in the US. Only 9,000 made over $1 billion in income last year. That’s 5/100ths of 1%, meaning a REALLY small number when you look are the big picture. 55 of them paid zero taxes. Is that REQUIRED minimum aimed at only the big dogs that pay a far less that average low amount?
Nope.
Of the 17.5 million US corps, 12.4 million have less than 5 employees. Over 14 million have less than 10. And more than 15 million of those 17.5 million corporations in the US had UNDER $1 million in sales revenue. Make note that $1 million is income, not profit. While the general public thinks the average company has a 36% profit margin, in reality that number is 7.5%.
So, put your business hat on and let’s do a little math.
Suppose you’re one of the 15.4 million business owners that make under $1 million a year. And let’s say you’re one of the lucky .11% of those that make right at the top, $999,999 a year and you have a (true) average profit margin of 7.5%. That means your annual income from your business is just shy of $75,000.
Chances are pretty good your taxes just went up. Where’s that money going to come from?
Hmmm…let’s see. You could reduce your family’s standard of living…or NOT. You could fire one of your 4 employees. No, they really need that job and who would do the work that they do? So, you raise your prices and blame it on inflation.
If you don’t believe that the increase in corporate taxes and fees to oil and gas companies won’t simply be passed along to consumers – meaning you – in the form of higher prices across the board then you clearly haven’t been an adult for very long.
With inflation at a 40-year high, the GDP (Gross Domestic Product) shrinking for two straight quarters (meaning we’re in a recession despite the Biden administration’s lame attempt to move the goal posts), labor force participation hovering at around a 45-year low and every major stock market index — including the S&P 500, NASDAQ, Dow Jones Industrial Average, Russell 2000, and the New York Stock Exchange composite — having seen double-digit declines in 2022, equating to trillions of dollars in American workers’ retirement savings up in smoke, now comes this.
Let’s see it for what it really is folks.
This so-called “Inflation Reduction Act” is nothing more than a thinly veiled, obverse-named attempt to pass pet priorities ahead of the midterm elections under the guise of reducing inflation. In reality, consumers (meaning you and I) will pay more — to the IRS and on everyday goods and services. Get ready.
One of the nerdier things that I do is that I read the CPI (Consumer Price Index) so that my students and clients don’t have to. I’ve found that there’s a whole lot of people who don’t understand what the CPI is or how it relates to our inflation rate or why they should even care.
So, if you’ll let me explain, I won’t bore you with jargon and I’ll try to explain exactly how changes in the Consumer Price Index directly impact the money that goes into, and out of, your pockets.
The Consumer Price Index or CPI for short is compiled and released every month by the Bureau of Labor Statistics (BLS), which is a sub-agency of the Department of Labor and it represents “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
Without going into too much detail about how the info is collected, the term “market basket” means the detailed expenditure information provided by families and individuals on what they actually bought, taken from surveys and purchase diaries of about 24,000 consumers from around the country, on their spending habits, buying all manner of things from soup to vehicles and televisions to eye exams. The things that are included in the ‘market basket’ are changed/updated every five years to keep up with tech and trends. The current CPI is based on 582 items available in 2020.
That figure is called the base.
They then compare that to current prices in order to get the CPI index. For fellow numbers nerds, here is the equation.
For everyone else, what that index number tells us is what determines the reported rate of inflation.
The uncomfortable truth is that that survey info is collected every two years. For example, according to the Bureau of Labor’s own website, reading the fine print you learn that CPI data in 2020 and 2021 was based on data collected from the Consumer Expenditure Surveys for 2017 and 2018. Meaning that the info we have for 2022 is really from 2020.
Here’s the first paragraph of the June 2022 CPI data, released July 13th.
“The Consumer Price Index for All Urban Consumers (CPI-U) increased 1.3 percent in June on a seasonally adjusted basis after rising 1.0 percent in May, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 9.1 percent before seasonal adjustment.”
If you didn’t know any better you might say, “Well those numbers in the first sentence aren’t that bad. 1.3% doesn’t sound so terrible.”
But then when you read the last sentence and understand that 1+% number is monthly and that 9.1% number represents the current annual inflation rate for 2022, if we continue to see over 1% month over month increases by the end of the year, we will easily be in double digit inflation.
Remember, the prices they’re basing this on are already dated and the BLS has changed the ‘market basket’ dramatically since the turn of the century so it’s no wonder that some conspiracy theorist economists are saying that the ‘real’ inflation rate is more like 17%.
It’s not really, so don’t panic, but it’s likely going to get worse before it gets better.
US Misery Index chart 1948-2022
For those of you not long in the tooth enough to remember the “Misery Index” back during the Jimmy Carter years, the misery index measured the inflation rate, the unemployment rate, and the interest rate, all of which we’re in double digit territory. Trust me on this one, no one in their right mind wants a repeat of that era.
While I don’t expect interest rates to jump to double digits you should be aware that the Federal Reserve has leaked that they could hike interest rates by a full percentage point at its next meeting for the first time since the Gen Z generation began (30 years ago). In June, the Fed raised interest rates by three-quarters of a percentage point, which it hadn’t done since 1994. Apparently, their previous efforts to stop the rampant inflation isn’t working.
So, if this is really bad, what should it look like?
In terms of economic cycles, a moderate amount of inflation, about 2%, is generally considered to be a sign of a healthy economy, because as the economy grows, people have more discretionary money to spend and the demand for all manner of stuff increases. This increase in demand then pushes prices higher, little by little, as manufacturers try to supply more of whatever the things are that buyers – both consumers and businesses – want. Employees benefit too, because this economic growth drives an increase in demand for labor, and as a result, unemployment decreases and wages generally increase.
More workers getting a paycheck and workers with better wages buy more stuff, and so this “positive” trend continues. Inflation isn’t the cause, but it is a continuous by-product of an obviously healthy and growing economy.
However, should inflation suddenly spike, like it has recently. That could also lead to a slowdown in the economy, because things get too expensive to buy, which in turn, will cause less demand, less manufacturing and unemployment to increase.
For example, I’m spending about $100 more per month on gasoline than I did last year. That means that I don’t have that $100, or the difference in food costs and just about everything else, to spend elsewhere.
When my wallet closes up so does hundreds of thousands of others.
In contrast, low inflation (less than 1%) is equally as bad, because it usually signals a slowing economy and a lower demand for goods and services can depress wages and can even lead to increases in unemployment. Low inflation also means lower interest rates. Too low interest rates discourage lending because lenders typically don’t want to lend money at rates that don’t give them a decent return. Too slow and a recession sets in.
It’s not hard to figure out that both too low and too high inflation are “negative” trends. So, the Fed tries to do a balancing act and sometimes – like now, apparently – they trip up.
Combine that with a full-on Bear market and we’re probably in for a rough rest of the year.
There you have it. Everything you need to know about the relationship of CPI and inflation in a nutshell. Think of inflation as a dragon you must slay to survive because if you do nothing, it will eat your wealth bones and all.
In my book, The Millennial Money Tree, I talk about how you should prepare for inflation in your future. You really need to consider it a sort of variable tax on everything that almost always goes up and rarely comes down. And not all commodities have the same inflation rate.
I’m sure we’ve all heard commentary from our grandparents about how much cheaper things were ‘back in the day’. In most cases that’s true. And in some cases, it seems radically true today, like gasoline, which is about 30% higher than it should be if inflation were the only culprit in its increase in price. Unfortunately, it’s not.
I’ve also heard Gen Zs and Millennials complain about the necessity of student loans to attend their college of choice because costs have increased “so dramatically” since their parents/grandparents attended college. I can attest to some truth of that matter since I know that the cost of one year of tuition at my alma mater in 1975 was $15,000 and change. In 2022 a single year’s tuition is just shy of $45,000 – a 200% increase.
According to the National Center for Education Statistics, the price to attend a four-year private college, full-time in 1980, was $10,231 annually — including tuition, fees, room and board. Today that’s $36,087 (including tuition, fees, room and board for undergraduates at private schools living on campus). That’s a 252% increase.
However, choice has a lot to do with cost. You can still get a 4-year college degree for under $40k (meaning less than $10,000/yr) in many states if you live there.
Let this sink in. When you take into consideration that the average hourly wage in 1975 was $6.50 (the minimum wage back then was $2.10) and as of Jul 12, 2022, (according to ziprecruiter.com) the average hourly pay in the United States is currently $33.77 an hour (that’s a 419% increase) is it any surprise that college costs have increased over so many years?
It shouldn’t be…to anyone, but that’s the price of financial illiteracy.
This may sound harsh but unfortunately, had their parents had a better understanding of inflation, they might have planned better, or at the very least, prepared their sons and daughters for the ‘sticker shock’ predictable increase in college tuition. While pundits and complainers blame the high costs on greedy colleges when the student loan system was taken over by the Department of Education and defaulted loans were guaranteed by the US government, the reality is that while college tuitions may have jumped since that system started, had they kept pace with inflation all along, they’d be pretty much right where they are anyway.
According to InflationData.com’s inflation calculator, which uses data directly from the CPI Index, the total inflation from January 1980 to December 2021 is 258.36%, so $10,231 after inflation for that time period is $36,663.54.
The simplest explanation of inflation is that the same amount of money will lose its value in the future so you will have to have more money years down the road to pay for the same things you might buy today. And unlike the last 40+ years, wage increases today aren’t keeping pace with inflation, so there’s that to think about as well. That may change, but it may not.
Let’s imagine you want to know what your one-year-old child might be paying for his or her college tuition. The easiest way is to take a look at historic values and calculate for what is better known as ‘future value’. For example, the dollar had an average inflation rate of 2.53% per year between 2002 and today (20 years), meaning a cumulative total price increase of 64.71%. That means that today’s prices are 1.65 times higher than average prices since 2002, according to the Bureau of Labor Statistics Consumer Price Index.
We can use the Vertex42.com Inflation Calculatorto calculate future costs. So, if we plug in the current average cost of college tuition of $36,087 and we assume the inflation stays relatively the same as it has the last 20 years at 2.53% then in 2042 we find that the average cost of college tuition for one year might be $59,479.86.
Ouch! That’s more than the current average annual income in the US today.
But remember, the rate of inflation just last year, in 2021, was 7.0% annually and for May 2022, the year-to-year inflation rate was 8.6% and June was 9.1%, so 2022 is likely to be even higher than 2021, skewing that 20-year average in a direction we don’t want it to go. Just a 1% increase in that average means the price of college tuition for a single year doubles to $72,222.92 by 2042.
But is a 3.53% inflation rate over the next 20 years realistic?
Unfortunately, that’s really conservative. If you were planning for retirement you’d be using a longer timeframe to get a better idea of historic averages.
According to worlddata.com, “During the observation period from 1960 to 2021, the average [US] inflation rate was 3.8% per year. Overall, the price increase was 829.57%.” Meaning an item that cost $100 in 1960, was $929.57 in the beginning of 2022.
At that 3.8% average, let’s say 40 years from now, you better be prepared to be paying 344% more for the things you buy today.
Holy cats. So…what to do now?
What actions can you take right now to combat the negative impact that inflation has on your dreams of financial freedom in the future? Or a college education for your kids free from the burden of tremendous student loan debt before they even start their career path?
First, don’t freak out. The high inflation rates won’t be around forever. If you don’t have one already, now’s the time to create a budget and stick to it. Do the math to figure out what you’ll need down the road and start a savings and investment plan to make it your reality. You can’t hit a target you can’t see.
Find a side hustle and make some extra money. You might get lucky and turn a passion/hobby into a full-time income.
Also, Bear markets present lots of bargains and the good news is they generally don’t last a whole year, so buy strong companies while the prices are low. Particularly companies that are strong dividend providers. Those dividends over time plus the increase in value of the underlying stock can spell a double dip uptick for your portfolio (large or small) and dividends will keep coming as long as you continue to own the stock. Cash flow for doing nothing but making a smart decision.
And don’t get me started on the bargain basement prices of crypto right now. If you’re into cryptocurrencies, forget the ‘alt’ coins and buy Bitcoin or Ethereum. Everything else follows the path that those two set. One Bitcoin might pay for several college tuitions 20 years from now if it does what it has done in the last 10 years, but that’s a risk like any over investment. All crypto is far more a long-term play than traditional equities. Don’t say I didn’t warn you.
Cut corners where you can and be prepared for even higher prices down the road short-term. Inflation tends to make prices go up like rocket but once the economy starts to recover, prices tend to come down like a feather – slow – and sideways a lot. But know that not all prices will come down.
Hopefully, I’ll have happier news to report in the future but remember, the best time to plant a money tree was 20 years ago. The second best time is right now.
And if you haven’t done so already, get my book and learn how to plant your own money tree.
PS. Infodata.com also has a really cool Cost of Living Calculator that compares cities you might be thinking of moving to. Location can do a lot to free up money you might otherwise be spending on housing and transportation.
Even numbers nerds like me find these kinds of documents a necessary evil to stay up on the reality of the future of retirement benefits ala the US government. Reading them requires a constant caffeine drip because they are about as interesting as a Quantum physics textbook to anyone other than Quantum physics devotees. The 2022 report is the 82nd report that has been prepared with the help of the Social Security Administration’s actuaries (the government’s numbers nerds), since the beginning of the program. The Trustees Report estimates the cash inflow and outflow of the various funds, considering projections of both demographic and economic factors.
As people watch their 401(k) balances fall off a cliff…again…people worry. Not just about whether they’ll have enough money to retire when they want to, but if they’ll be able to retire at all if Social Security goes bust. As a result, I get a constant stream of questions about the predicted insolvency of Social Security.
Here’s what we know about retirement benefits, courtesy of the 2022 Social Security Trustee Report:
“The Old-Age and Survivors Insurance (OASI) Trust Fund, which pays retirement and survivors benefits, will be able to pay scheduled benefits on a timely basis until 2034, one year later than reported last year. At that time, the fund’s reserves will become depleted and continuing tax income will be sufficient to pay 77 percent of scheduled benefits.”
And regarding Medicare Part A, the news is even worse:
“The Hospital Insurance (HI) Trust Fund, or Medicare Part A, which helps pay for services such as inpatient hospital care, will be able to pay scheduled benefits until 2028, two years later than reported last year. At that time, the fund’s reserves will become depleted and continuing total program income will be sufficient to pay 90 percent of total scheduled benefits.”
That’s not exactly distant future.
And while they don’t expect to go belly up, I know a whole lot of people who will look at a nearly ¼ reduction in their Social Security check as right next to a death knell because they rely so heavily on that money every month to pay their bills.
After paying into the system for 30 to 40 years, people naturally wonder what the heck went wrong with a system that’s been paying out for 80 plus years. And if you don’t all the behind-the-scenes shenanigans that has gone on regarding how the Social Security “trust fund” is accounted for on the government’s balance sheets, it kinda looks like a big Ponzi scheme that is finally falling apart at the seams because there’s not enough new money coming in to pay out what was promised. In fact, when you understand all the details of how the government set this up and how they continue to mess with it, it looks even more like a Ponzi scheme!
In order to really understand how we got in this predicament you really have to understand the history of Social Security.
FDR signing the Social Security Act in 1935
I talk about this problem in detail in my book The Millennial Money Tree but I’ll summarize it for you here. The Social Security Act, signed into law by President Franklin D. Roosevelt in 1935, created Social Security, which was deemed a “federal safety net for elderly, unemployed and disadvantaged Americans”. The main stipulation of the original Social Security Act was to pay financial benefits to retirees over age 65 based on lifetime payroll tax contributions.
Widows and old folks. How magnanimous of our elected officials. Sounds good, right?
Until you realize that the average American worker in 1935 died before they reached the age of 60. It wasn’t until 1950 that the average life expectancy reached 65. Meaning, that you had to outlive the average Joe before you ever saw a dime.
Textile factory workers circa 1935
Contrast that to today when the average life expectancy is 76 and more than 1/3 will likely live well past 90. That means they could be entitled to Social Security benefits for almost 1/3 of their lifespan. See the difference? Negative six years vs a likely minimum of 11 years (all things being equal starting at 65 rather than age 62 like you can nowadays) and probably much longer than that.
And here’s the bigger problem.
Social Security is paid for by the FICA payroll tax and taxes on the benefits themselves. FICA stands for the Federal Insurance Contributions Act and that money is deducted from each and every paycheck. Naturally, most people think they are “entitled” to receive Social Security benefits since they’ve paid into the OASDI program for so long. But the mistake is in the second part of that last sentence. There is no Old-Age, Survivors and Disability “Insurance program” in the traditional (or legal) sense. Our government perpetuates the belief that you are entitled to Social Security by referring to money taken out of your paycheck as “contributions” but Social Security is a tax like any other tax. And, believe it or not, legally, you’re not ‘entitled’ to a dime if they shut it down.
Here’s the bigger problem: The number of people paying into the system is getting smaller and smaller and the number of people getting paid out from the system is increasing dramatically year over year.
Baby boomers are turning 65 at a rate of about 10,000 a day until 2029 and the vast majority of them will be dependent on Social Security for a good part of their income for rest of their lives – which may well be 20 to 30+ years. In the US, there are about 57 million people in retirement today, by 2034 there will be in excess of 76 million. And, so you have an idea of the complexity of this problem, the number of workers paying into the program was 16.5 per retiree in 1950; by 1960 that number was only 5.1. It has since declined to 2.8 in 2021 according to the ’22 Trustees’ report.
And as a result, here’s where the balance sheet stands:
“The asset reserves of the combined trust funds were about $2.85 trillion at the end of 2021. The combined trust fund reserves decline on a present value basis after 2021, but remain positive through 2034. However, after 2034 this cumulative amount declines and becomes negative in 2035, which means that the combined OASI and DI Trust Funds have a net unfunded obligation through the end of each year after 2034. Through the end of 2096, the combined funds have a present value unfunded obligation of $20.4 trillion.”
Read that last part again. $20. 4 trillion dollars?? That’s only about 10% less than our entire national debt and darn near our entire current GDP.
Holy cats that’s a lot of money. Where in heaven is that going to come from?
Is it any wonder why people call it a big Ponzi scheme? The whole premise being that as the population grew, there would be more people paying into the program to support the outflow of benefit $$ and fewer people taking more out than paid in because some percentage would die before they ever got a dime.
Oops.
So, what’s to be done?
Well, first you need to understand that this isn’t the first time that Social Security has been in dire straits. Way back when, Social Security benefits were tax-free, but that all ended in 1983 with the signing of the Social Security amendments to keep the program from going broke back then. The Bandaid brand solution was that since your employer paid half of the FICA tax for you, you should be willing to pay taxes on the half you didn’t pay for initially.
Come on, it’s patriotic to pay taxes, right?
So then, part of Social Security benefits became taxable for people who earned above a certain amount beginning in 1984. If the sum of your adjusted gross income, nontaxable interest and half of your Social Security benefit exceeded that amount, up to 50% of your Social Security benefit was subject to income tax. But of course, down the road more money was needed so now, up to 85% of benefits are taxed for those with incomes above certain levels. Higher-income taxpayers also pay a Medicare premium surtax, the higher the income, the higher the surtax.
Today, the first tax bracket typically allows the government to tax 50% of a retiree’s Social Security income, and the second bracket moves up to the 85% level. Which means that for someone with a $1,000-per-month Social Security income, that either $500 or $850 could be subject to taxation along with any of the retiree’s other income sources.
Interestingly, when I wrote my book, in 2020, the expectation of payouts after 2034 was 89% in the Trustees’ report from 2019, but the scuttlebutt from insiders was already at 77%. Now, just two years later they’re admitting that number is accurate. What’s it going to be 12 years from now?
So yeah…while you can’t really call it a Ponzi scheme because the government doesn’t profit from it and they keep making changes to fix it (more like kicking the can down the road until they can’t), from my point of view, if it looks like a duck, walks like a duck and sounds like a duck? It’s a least some kind of waterfowl.
You’re definitely going to see some more changes come within the next decade. It may be a reduction in benefits payable to people in the future, or more taxation somewhere to fund the currently obligations – most likely both. And while Congress always talks as if such changes will only affect the wealthy, far too many people who consider themselves middle class will pay a bigger than fair share of these future penalties. That’s a given.
You’ll be wise to prepare in advance to be one of them.
I’m sailing along enjoying my day and I get an email.
Voyager Digital, a leading cryptocurrency exchange, has “temporarily” suspended ALL trading, deposits, withdrawals and loyalty rewards, effective at 2:00 p.m. Eastern Daylight Time, July 1, 2022.
Wait…what? I had some crypto in there.
The word “temporarily”, in this case is interchangeable with “indefinitely” since according to Stephen Ehrlich, Chief Executive Officer of Voyager, “This decision gives us additional time to continue exploring strategic alternatives with various interested parties while preserving the value of the Voyager platform we have built together. We will provide additional information at the appropriate time.”
How much time? Good question.
Guys like me, long in the tooth in the financial services industry, understand that spin all too well – they’re currently insolvent and it’s ‘all hands on deck’ to find somebody to bail them out before the peasants storm the gates with rakes, pitchforks and torches.
For those of you who are not familiar with the brand, Voyager Digital LLC is — or maybe I should say used to be — a cryptocurrency investment firm.
You deposited dollars or crypto into Voyager, and you could earn up to 12% interest on your deposits. Their mobile app allowed you to trade about 100 different cryptocurrencies commission-free and they also even offered a debit card. Customers were encouraged to deposit their US dollars (which were supposedly insured by the FDIC through their banking partner Metropolitan Bank), which were immediately converted to the USDC stablecoin, which Voyager then paid a yield of up to 9% on.
“Earn like crypto, spend like cash.” from a Voyager promo
The company claimed 3.5 million customers. As of June 30, Voyager Digital disclosed that it held just over $685 million worth of crypto assets, but that it had loaned out $1.12 billion worth. It also supposedly held just shy of $356 million worth of customers’ cash and was holding nearly $168.7 million worth of crypto collateral. They revised those numbers immediately after the announcement on July 1. How screwed is Voyager now? A little over two thirds of their assets are MIA.
So what happened?
Well, even really smart guys get hoodwinked once in a while, and the decision-makers at Voyager thought it was a wise business decision to lend the Singapore-based hedge fund Three Arrows Capital (3AC) 15,250 Bitcoins and $350 million of the stablecoin USDC. At recent prices, the total loan equates to more than $680 million. In other words, about the same amount that Voyager held on June 30 in total crypto currency.
3AC defaulted on that loan.
The once-mega fund, founded by Credit Suisse traders Zhu Su and Kyle Davies in 2012, managed an estimated $10 billion in assets at one point and was a kingpin dynamo among crypto finance players. They have since filed Chapter 15 bankruptcy in New York, which will allow the foreign firm (3AC is based in Singapore) to protect its stateside assets while the liquidation is carried out in the British Virgin Islands following recent a court order there. Its insolvency has forced other major industry players to reshuffle operations and limit customer withdrawals as well amid a crypto selloff that, for whatever reason, despite the fact that it has happened every Bitcoin cycle to date, seemed to catch plenty of them off guard.
Voyager says it intends to pursue recovery from 3AC, but while they may be first in line, the likelihood that they’ll recover any significant portion of that default is slim to none. Which, in turn, has pushed them (Voyager) to the brink of insolvency.
Voyager very much wanted its customers to treat the company like their bank — and deposit their money. It encouraged customers to directly deposit their paychecks into their Voyager debit card account. In fact, the company offered even greater interest rates if you owned their VGX via their “loyalty program”. This was, of course, targeted directly at the cryptocurrency audience: “When you buy or trade crypto with Voyager, you can earn up to 12% APR on over 30 different crypto assets, trade commission-free, and more.” (source: Voyager’s VGX Whitepaper)
But Voyager Digital is not a bank.
If they were a bank, “insolvency” is the key element of a bank failure. That’s a scary scenario if you have your money in a failing bank, but if you’re not aware, you might find it surprising to learn that banks fail all the time.
In fact, there were 561 bank failures in the US from 2001 through to the beginning of 2022.
They don’t get much news beyond maybe the local community because we’re not talking about the “too big to fail” banks like Bank of America. And when banks fail the FDIC (Federal Deposit Insurance Corporation) comes in to rescue depositors. Normally, that happens in just a few days’ time, since, in most cases, a financially healthy bank will take over the failing banks assets and with the help of the FDIC own reserves, cover any excess losses.
Voyager repeatedly and consistently, anywhere and everywhere, led customers to believe their US dollar deposits were safe, insured up to $250,000 by the FDIC, if Voyager failed, the truth was revealed in small print when you signed up. They counted on the fact that nobody reads that stuff. Customers’ dollars were transformed into Voyager’s USDC the moment they were deposited, Voyager then used the USDC as collateral for loans it took out elsewhere.
So was their claim of FDIC insurance a straight up lie?
Well technically no. All that money was insured…for like a nanosecond. And I highly doubt that Voyager’s balance sheet actually holds $356 million in “customers’ cash” anywhere. Maybe cash paid by customers but not cash they are holding for customers. Big difference.
You see, Voyager has an omnibus account with Metropolitan Commercial Bank in New York City, where it deposited its customers’ dollars. An omnibus account is a single holding account for money from multiple investors. Voyager acts as the money manager of the omnibus account and maintains full control of the money, which they immediately transformed into USDC.
Since it’s clear that Voyager Digital LLC is NOT a bank, the FDIC treats money that it holds in omnibus accounts much differently than a regular account
For example, on the FDIC website it states, “Federal law requires the FDIC to make payments of insured deposits “as soon as possible” upon the failure of an insured institution” and further “It is the FDIC’s goal to make deposit insurance payments within two business day of the failure of the insured institution.”
While every bank failure is unique, the term “institution” in this case refers to a chartered bank, i.e. Metropolitan Bank, not companies like Voyager and there are standard policies and procedures that the FDIC MUST follow in making any deposit insurance payments.
It also states that “Some deposits that require supplemental documentation from the depositors, such as accounts linked to a formal written trust agreement, funds placed by a fiduciary on behalf of an owner such as a deposit broker or deposits placed by an administrator of an employee benefit plan may take a little longer. The timing of the completion of the deposit insurance determination is based solely on the depositor providing the documentation needed by the FDIC to determine insurance coverage.”
That second sentence being especially important in this case.
Voyager would be considered “a deposit broker” acting as a fiduciary on behalf of its account holders, meaning the FDIC pushes the onus of providing proper documentation BACK to Voyager before any payouts are made.
For anyone NOT familiar with that term, a “fiduciary” is a person (or company) who serves as an agent on behalf of their client(s) in opening a deposit account or purchasing assets (in this case various forms of cryptocurrency) via an insured entity. In order to determine the deposit insurance coverage for such deposits, the FDIC will need to obtain from the fiduciary (Voyager) supplemental information such as a complete list of the owner or owners of each deposit and the dollar interest of each owner in the deposit account.
Here’s the kicker.
In a set-up like Voyager, even though the FDIC provides what’s called “pass-through deposit insurance coverage” to the actual account owners of any fiduciary-linked deposit(s), the FDIC does NOT pay that deposit insurance DIRECTLY to the owners or customers. Instead, the FDIC will pay the deposit insurance coverage to the fiduciary (Voyager). In turn, Voyager (acting its capacity as a fiduciary) will then be responsible for distributing the deposit insurance payments to their customers.
And perhaps even more importantly, the FDIC does not attempt to supervise the relationships between fiduciaries and customers or the distribution of funds from fiduciaries to customers.
Metropolitan Bank isn’t failing. In fact, they’re being sure to CYA, in a recent statement by Metropolitan Bank, it said “The omnibus account holds US Dollars only. It does not hold cryptocurrency or any other asset.” And further “FDIC insurance does not protect against the failure of Voyager, any act or omission of Voyager or its employees, or the loss in value of cryptocurrency or other assets.”
So, as soon as Voyager provides the needed information (and unfortunately there is no forced timeline here) since this is a completely new situation, there will likely be some announcement that anyone who thought they were entitled to some form of restitution by Voyager is SOL (Shit Outta Luck).
It also doesn’t help anything that Voyager is being sued for trademark infringement by US Bank in Federal Court in Minnesota, for their use of the word Voyager on its debit card, a trademark that US bank has held for decades. Duh. And at the end of this past March, Voyager got cease and desist letters and orders from the state securities agencies in Alabama, Kentucky, New Jersey, Oklahoma, Texas, Vermont, and Washington, who consider Voyager’s yield platform to be an unregistered offering of securities. Or that they’ve been running at a $40+ million annual operating loss for like…ever.
When it rains…it pours.
Full disclaimer: I do (or did…who knows what happens with the cryptos) have a few cryptocurrencies stored in a Voyager account. Not really anything I will lose sleep over but a pisser nonetheless. However, this is EXACTLY why I have active exchange accounts in five different exchanges and keep most of my cryptos locked up OFFLINE. This is a perfect example of the saying “Not your keys, not your crypto”.
Teachable moment here for all you novice crypto investors.
I will note that I can still log onto the Voyager app and watch my portfolio go up and down, but of course, I can’t sell, trade or transfer anything. That has got to be super painful to some friends of mine that were all-in on Voyager and all its financial products, or anyone that had some serious money parked there. BTW, for future reference, according to the FDIC, LLCs cannot be banks, ever. So when you see “LLC,” any claim of FDIC insurance is false, and customer documents supplied by third-party companies (like Voyager in this scenario) become public record, so any privacy you thought you may have had with Voyager is out the window.
