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February 28, 2005
And Another Excellent WSJ Article--This Time by Mark Whitehouse
The Wall Street Journal cleans up. Here is Mark Whitehouse:
WSJ.com - Social Security Overhaul Plan Leans on a Bullish Market: In selling the idea of private Social Security accounts to Americans, President Bush has repeatedly made a bullish prediction: The stock market will help younger workers get a 'better deal' than they would from traditional Social Security. A number of prominent economists have two problems with Mr. Bush's pitch. First, they say it's too optimistic about the long-term prospects for stocks. Second, it ignores an irrefutable rule of finance: There is no free lunch. Or, put another way, greater returns bear greater risks. 'You can't just sort of invent free return,' says William Dudley, chief U.S. economist at Goldman Sachs Group Inc. in New York. 'If it was that easy, you wouldn't have a Social Security problem in the first place.'...
The program's actuaries predict that over the period of a typical American's career, or 44 years, stocks would return an average of 6.5%, corporate bonds 3.5% and government bonds 3%, all in 'real' terms -- that is, after inflation.... Problem is, the forecasts raise some serious doubts -- to say nothing of conflicts. For example, there is that assumption of a 6.5% annual return on stocks. By contrast, the actuaries' prediction that the Social Security system will become unable to pay full benefits in 2042 assumes that the economy will grow at a rate of 1.9% a year between now and then -- a tepid pace that would be unlikely to produce stock-market returns of nearly 6.5%. Many economists are critical of the idea that stock returns can be so high relative to gross domestic product growth. 'That stretches the imagination,' says David Rosenberg, chief U.S. economist at Merrill Lynch & Co. in New York.
The long-term return on stocks comes from two main sources: growth in corporate earnings and payouts to shareholders, which include dividends and share buybacks. Earnings tend to grow in line with the economy, which means that 1.9% GDP growth typically would produce 1.9% earnings growth. Add to that dividends, which in recent years have averaged about 1.7% of a stock's price, and buybacks, which have averaged about 1%, and the total real return for stocks comes to about 4.6%. Most economists who predict higher stock returns assume higher GDP growth as well.... [C]orporate earnings can't grow faster than the economy forever. If they did, 'then gradually income from the economy would be completely absorbed by the stock market,' says Ethan Harris, chief U.S. economist for Lehman Brothers in New York.... [A] P/E ratio of more than 20 means that the market expects stocks to yield less than 1/20 of their price, or less than 5%. That is easier to reconcile with the Social Security actuaries' GDP forecast, and comes very close to 4.81% -- the average estimate among 10 economists polled for this article....
Under the most recent Social Security-overhaul plan, people who invest in personal accounts will be forgoing a guaranteed 3% real return... the offset rate the government will use to reduce traditional benefit payments.... [U]nless the government lowers the offset rate or real interest rates increase significantly, personal accounts strike many economists as a poor deal on a risk-adjusted basis. 'Would a rational investor borrow funds at a 3% real rate to invest in order to earn a 1½%-2% real rate?' asked Mr. Dudley of Goldman Sachs in a recent research note. 'We doubt it.'
The most bizarre thing--no, it isn't the most bizarre thing, it is just one of many bizarre things that make me question the good faith or the competence--no, make that the good faith and the competence--of those designing and arguing for the Bush private accounts plan--is the 3% + inflation offset required for those who fund their private accounts. This is likely to generate a substantial increase in elderly poverty when a bunch of people reach 65 and find that their private accounts have not been worth the Social Security benefit reductions they cost.
Posted by DeLong at February 28, 2005 08:30 AM
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Comments
"This is likely to generate a substantial increase in elderly poverty when a bunch of people reach 65 and find that their private accounts have not been worth the Social Security benefit reductions they cost."
Freedom's just another word for nothing left to lose...
Posted by: DRK at February 28, 2005 08:44 AM
>'Would a rational investor borrow funds at a 3% real rate to invest in order to earn a 1½%-2% real rate?' asked Mr. Dudley of Goldman Sachs in a recent research note. 'We doubt it.'<
I'm missing something: why would the real rate on investments be 1.5-2%? I thought the real rate on investments in the stock market over time is estimated at 4.8%, in an earlier papragraph?
Posted by: Ushma at February 28, 2005 09:03 AM
You have to pay back the 3% you "borrow" in the form of reduced benefits.
Posted by: T.A. at February 28, 2005 10:13 AM
This is very likely OT, but I found it nevertheless interesting: Today's piece by John Fund (opinionjournal.com) on "Flat taxes".
He hails the new Eastern European countries' flat taxe systems for being so easy that "a little old lady on a home computer [could do] the work of all these thousands of bureaucrats and accountants."
Only thing he doesn't address: easiness doesn't automatically mean *non-progressive nor *low. But after all, its the WSJ.
Posted by: Dinsky at February 28, 2005 10:13 AM
Well, OK, but also: the public can't *on average* make money from interest or the stock market, etc. over and above productivity increase itself. (Thinking they can is perhaps the fundamental economic fallacy, yet very common!) Think: If everyone put money in the bank to earn interest and be quite well-off many years in the bank, according to R. Santorum's "magic of compound interest" - who would pay for the interest to the account holders? Someone has to borrow money, pay interest on the loans, etc. to finance those who are making money. A similar problem applies to stocks etc. - someone has to buy what is sold at those high prices, and eventually lose money, or there must be money expansion or inflation to keep it from ever going down. People just have to divide their consumption into whatever productivity there is, and they can't all get richer just playing games with the exchange medium. Why oh why don't commentators - not to mention even the public - get this?
Posted by: Neil' at February 28, 2005 02:28 PM
T.A., thanks!
Posted by: Ushma at February 28, 2005 06:15 PM
True, stock returns cannot exceed the rate of economic growth indefinitely. But using this argument to put an upper bound on the returns to privatized Social Security accounts is not so simple. Mark Whitehouse cites economic growth projections of 1.9%. But isn't that growth likely to increase as vast sums of savings are shifted from government debt into the private sector? It is illogical to treat economic growth as independent of investment.
Posted by: James Einloth at March 5, 2005 05:52 PM
If growth increases, then the SS actuaries' assumptions are too conservative and there is even less argument for any benefit cuts. But the pure Bush plan has massive borrowing to cover the shortfall generated by the new accounts, so debt reduction seems very implausible.
Posted by: john at March 6, 2005 03:17 PM
What puzzles ME is that there are so many distinguished economists AGAINST President Bush's plan.
If private social security accounts are such a BAD idea, why not nationalize all of IRAs, 401k's,
and 403b's and turn the money over to the government?
Guys, have you lost track what you learned in grad school that choice is good?
Posted by: Manfred at March 8, 2005 11:25 AM