Monday, November 29, 2010

Bondholder Bonanza in Europe

If you believe in reincarnation, think seriously about coming back as a holder of Euro-denominated bonds. (Or, skip the reincarnation part and just buy some.) Today, the bailout of Ireland makes clear that every nation in the European Union guarantees the obligations of every other EU nation, and also the obligations of every bank in every EU nation. Holders of European debt are in Heaven, dancing cheek to cheek with EU taxpayers.

The Germans (and French, kind of) made some noise about bondholders sharing in the losses from future national financial crises. But when push comes to shove, which could be in a week or two with Portugal, it's essentially a certainty that the dour Chancellor Merkel and frenetic President Sarkozy will hold their noses and sign another blank check. That's because the real beneficiaries of these bailouts aren't Ireland, Greece or whoever. They're German, French and other EU banks, which hold shiploads of Irish, Greek, etc. debt. A default by these nations would put the banks down the street from Chancellor Merkel's or President Sarkozy's office at risk, and those banks and their various constituencies are the real reason the wealthy EU nations are spreading Christmas cheer to the poorer EU nations.

It doesn't have to be this way. The sovereign debt crisis began with a dust up in Dubai about a year ago. While Dubai's problems quickly moved off the front page with the revelations of Greece economizing on the truth about its budget deficit, a workout continued quietly. Not long ago, the Dubai debt problem was resolved with some bond holders taking losses. Farther back in time, international financial crises in Latin America during the 1970s and 1980s involved banks taking losses on their loans. There is nothing magical about being a creditor that necessarily insulates one from loss.

The distressed nations can't devalue their currencies to boost their economies through exports (a standard maneuver in such circumstances). They all use the Euro, and its value is maintained by the European Central Bank. Only the long, poorly paved road of austerity and higher taxes is open to them. Without bailouts, defaults would loom and the debtor nations might have to leave the Euro bloc. Since Germany and France want the Euro to work, they are left with little choice except to make nice-nice with bondholders.

But just as American taxpayers are tired of bailing out bankers in New York, German taxpayers may eventually tire of bailing out the money men in Frankfurt. The poorer EU nations aren't leaving the Euro bloc--with Germany backstopping them, they have every incentive to stay. The Germans may, in the end, be the ones who leave. The more the Germans bail out profligacy in other nations and reckless lending by their own banks, the more their own financial condition will deteriorate. If Germany guaranteed all EU sovereign and bank debt, it would be in lousy shape. Since it more or less implicitly has done just that, it is. German taxpayers have already carried the substantial burden of incorporating East Germany in the West. They very possibly won't want the burden of incorporating the entire EU into Germany.

Tuesday, November 23, 2010


Turkey Day approaches, so let's see who's thankful.

GS to Feds. Goldman Sachs surely is thankful to the federal law enforcement personnel who are so assiduously pursuing suspected insider trading by hedge funds and other money managers. This evidently could be a big case, big enough to make the investing public forget all about ABACUS-2007-AC1 and Fabrice Tourre's juvenile e-mails.

Fed to Ireland. The Federal Reserve may be quietly grateful that Ireland is having such well-publicized debt problems. It's brought Europe's sovereign debt crisis back onto the front page, and if liquidity problems crop up as a result, the Fed will have more justification for its quantitative easing program.

G-20 to North Korea. The gonzo maniacs in North Korea, by revealing their uranium enrichment plant and shelling a South Korean island, have pushed the G-20 and the possibility of a currency devaluation war right out of the news. The potential for a real shooting war in Korea forces the international community to think about what it has in common, at a time when it should give that issue careful thought. Indeed, just days after they acrimoniously failed to reach a trade agreement, South Korea and the U.S. are vividly reminded that they are allies.

Lisa Murkowski to Palin (Bristol). The voting controversy over "Dancing With the Stars" has completely overshadowed any voting controversies in Alaska. For once, a Murkowski may be grateful to a Palin.

Charles Rangel to His Democratic Colleagues. One can't help but suspect that Congressman Rangel might be quietly thankful he's being tried and punished by a House of Representatives controlled by the outgoing Democratic majority. Things could well have been a lot tougher for him if he had stalled the proceedings into the next term.

David Cameron to William and Kate. The prospect of a royal wedding contrasts brightly against the dour grayness of governmental austerity. The prime minister may be grateful for the loss of some front page coverage.

NBA to LeBron. Just about everyone likes seeing a big talker taken down a notch. LeBron has provided this spectacle to basketball fans from sea to shining sea. Schadenfreude spurs growing fan interest with each Miami loss.

America to Salehis. We haven't seen Tareq and Michaele Salehi, the alleged White House party crashers, in the news for quite a while. That's something to be thankful for.

Sunday, November 21, 2010

The Euro at Gettysburg

The sovereign debt crisis in Europe is evolving into a struggle over European union. Despite decades of increasing commercial and financial harmonization, Europeans haven't resolved many of their underlying differences and the harmonies are becoming dissonant.

The initial problem was Greece. When Greece adopted the Euro, it hoped to benefit from a stable currency it could use to borrow at comparatively low rates. The key word here is borrow. Germany and other wealthy Euro bloc nations initially welcomed Greece, thinking they were getting easier access to an export customer. Everything worked fine as long as Greece could borrow enough to finance its purchases from Germany and other exporters. The tough task of building Greece's economy to balance its consumption of goods from other nations with industries and businesses of its own that would attract foreign customers somehow got lost in the glow of apparent short term prosperity.

Bailing Greece out required Germany to stop averting its eyes to the ultimate flaw in its strategy of growth through exports: a continuing trade imbalance with the rest of the world cannot be sustained indefinitely. Obdurate exporters sooner or later have to finance their export customers. Japan and China have financed America's consumption. Germany found out the hard way that many of its banks had financed Greece's consumption. Even though much of the German electorate went Tea Party, the German government ultimately joined in a bailout of Greece in order to bail out Germany's banks.

Now Ireland, bogged down in a real estate crisis, has been compelled to seek a bailout. Although the Irish government has the liquid resources to cover its debts until next year, it made the mistake of guaranteeing the obligations of Ireland's banks. This temporarily kept those banks from collapsing. But Irish banks are, to a large degree, mortgage banks. Ireland's real estate crisis may be more severe than America's, and the liabilities of Ireland's banks are enormous for a nation of Ireland's size. By backing Irish banks, Ireland's government transferred their potential insolvency onto itself. It now has little choice but to take a bailout the EU has been pressing upon it.

One of the weird things about the Irish crisis is that the bailers have been urging the bailee to take the handout. That's because the EU has much bigger problems that the Irish mess is exacerbating. Bond vigilantes see a row of dominos to exploit. If Ireland falls, Portugal is likely to be next, and Spain could follow. The EU desperately wants to forestall the domino effect. While it can keep Greece, Ireland and Portugal afloat, add Spain and all bets could be off.

The EU isn't limiting itself to assistance. It can't resist the temptation to seek change. Ireland has been urged by other EU nations to raise the level of its corporate income tax, which is set at a low rate to attract foreign investment. Other EU nations view the Irish corporate tax as a competitive threat. Ireland has firmly refused to raise its corporate taxes, fearing a further diminution of its now fading prosperity. Although everyone publicly insists that Ireland raising the corporate tax rate isn't a condition to the bailout, discussion of this point will likely not end with the bailout.

The intimations of other EU nations that Ireland raise its low corporate rate is a sign that the EU in its current iteration cannot last. Either the union becomes more centralized, with greater control exercised from Brussels, or the Euro must be abandoned and national currencies reinstated. Ireland's defiant refusal to change its tax laws tells us that the outcome isn't without doubt.

The bailers want more. Germany's chancellor, Angela Merkel, recently convinced other EU nations to agree that bond investors might have to share losses from sovereign debt defaults. The bond market threw a hissy fit. Its consternation was surely fueled by the experience of Dubai debtholders (remember the Dubai debt crisis, only a year ago but now seemingly so distant?), who recently had to compromise their claims. There is ultimately nothing golden about sovereign debt, and bondholders may be facing a loperamide moment as they attain a deepened appreciation of their risks. Unhappy bond investors may try to force the issue of union--either the EU becomes more like a single nation and its debt market stabilizes, or short sellers and their derivatives cousins clean up.

In a way, the European debt crisis resembles the battle of Gettysburg. Like the first day of the Civil War battle, the struggle over Greece's debt is where the lines were drawn and positions were taken. In the second day at Gettysburg, the fight went to the periphery. The far left flank of the Union line held at Little Round Top, and then the far right flank held in the contest for Culp's Hill. Europe's current problems are with nations on the periphery of the EU: Ireland and Portugal. Thus far, the EU seems to be holding. But the battle will be determined if and when it reaches the large nations of the EU. Spain may become the first large European nation to be targeted by bond speculators. It's trying to cope with a virulent real estate downturn. A trillion Euros of public debt and another trillion in private debt held by foreigners takes Spain's debt burdens beyond the capacity of existing EU bailout facilities. The willingness of Germany and other wealthy EU members to pony up more bailout money is by no means clear. Chances are they would only if they could impose greater centralized control.

The European imperative for union is in no wise as powerful as America's in 1861. (Remember Yugoslavia? Czechslovakia? The Soviet Union?) The EU has no heros, no 1st Minnesotas, or 20th Maines or Third Brigades from New York. Individual field commanders at Gettysburg--Buford, Reynolds, Hancock, Chamberlain and Greene--took turns acting on their own initiative to hold the line for the Union. But individual national leaders in the EU haven't such latitude; they must act collectively or not at all. If the crisis morphs into its third phase (i.e., Spain), the EU will be put to the test. By the third day of Gettysburg, the Union Army was buoyed by confidence from its successes on the first two days, and it met Pickett's challenge resolutely. But the desire for unity among EU nations is, at best, a work in progress. Before the Civil War, America was known as "these United States." Afterward, it was "the United States." Is Europe ready for that?

Wednesday, November 17, 2010

Stress Test Your Retirement

With stocks going nowhere for the past ten years or more, we now understand that retirement planning involves more than seeking the highest returns. Risk has to be managed. Savings must be protected. This is especially so as one grows older. With fewer working years left, those who have living memories of seeing or wearing leisure suits should think about downside risk as well as upside potential. It's a good idea to stress test your retirement.

A stress test would estimate how well your finances would look in adverse circumstances. There are different ways to do this, and some can become quite complex. There is no magical formula or golden number(s). Much depends on your appetite for risk, your life expectancy and your retirement goals. Let's start with individual factors.

1. Stocks. Assume a 50% drop in the stock market. That's not an unrealistic assumption since stocks dropped a bit more than that at their worst point in the 2008-09 financial crisis. They could drop like that again, notwithstanding every assurance from Wall Street and high ranking government officials. What impact would that have on your finances? If the answer is too much for your comfort level, then reduce your exposure to stocks until you feel comfortable.

2. Bonds. Assume a 20% loss of your taxable bond portfolio. This would be a very large loss for bond holdings, but could happen if the Fed has to raise interest rates sharply in order to combat inflation. (Indeed, the Fed's ongoing quantitative easing program--the purchase of Treasury securities with printed money in order to lower interest rates--has anomalously resulted in increased interest rates, suggesting bond investors expect inflation from the QE.) What impact would a 20% drop in your taxable bond holdings have on your equanimity? If the answer isn't conducive to equanimity, dial back your bond exposure.

3. Municipal Bonds. Assume a 20% loss in the value of your muni bond portfolio. This, too, would unusually large. But the growing crisis over state and municipal deficits, and the possibility that interest rates may rise because of or in spite of the Fed, could produce significant muni bond losses. How would this affect your sense of financial security? If you don't like the answer, trim your muni holdings.

4. Money Market Funds and Similar Products. As we know from the 2008-09 financial crisis, money market funds can go under. Less well-known similar products, most notoriously auction rate securities, may be less safe than money markets. Assume a liquidity crisis for your holdings of money market funds and other short term investments. What would you do if you couldn't get to these assets? If the answer is ugly, transfer your liquid assets to money market funds that invest only in U.S. Treasury securities, or to bank or credit union accounts and CDs that are fully insured by the federal government. Don't mess around searching for incremental increases in yield. Make sure your liquid assets are truly safe (because they may not be liquid otherwise).

5. Insurance Products. Insurance products are subject to the creditworthiness of the insurance company. Insurance companies make mistakes. If, like AIG, they make big enough mistakes and put the international financial system at the edge of the abyss, they will be bailed out by the government. But most insurance companies can't put the touch on taxpayers like that. Try to figure out how much you could salvage from your annuity or other insurance products if the insurer goes belly up. You might have to research the law of the state where the insurance company is chartered for the coverage provided by its guaranty association for life insurance. (One place to start is the website for the national umbrella organization for these associations, called the National Organization of Life & Health Insurance Guaranty Associations, The amount of coverage may be between a maximum of $100,000 to $500,000, depending on the state. If that limit spurs major heartburn, either avoid making a big investment in insurance products, or look to boost the non-insurance portion of your portfolio. Be cautious about exiting insurance products you've already bought, because the insurance companies may whack you with painful termination fees. But pay those fees if your exposure to insurance products makes you queasy.

6. Pension. Let's say your employer goes bankrupt and ditches its pension plan. Can you live with the reduced payments you might end up with? Figuring out how much your pension might be reduced in such a circumstance could be difficult and the stress test might have to be done with just an approximation (factoring in the limitations in coverage from the Pension Benefit Guaranty Corp., if applicable; see You could try assuming your pension payments turn out to be half of what you expected. Then, increase your current savings a lot because the loss of half a pension would be painful for just about anyone.

7. Social Security and Medicare. Social Security and Medicare will not disappear. They will be here as long as the Stars and Stripes fly. Of course, some modifications will surely be made, particularly in light of the recent mid-term elections. These modifications won't give you a warm glow. Assume your benefits are reduced by 15%. If that would increase your antacid budget, save more.

8. Health Insurance. If you're under 65, consider the impact of losing your health insurance. (Just about everyone 65 or older has Medicare coverage.) If you're in a group plan, research the cost of buying replacement coverage (which would be an expensive individual policy for most people). Then save more. If the health care reform of 2010 survives Republican attack in 2011 largely intact, you'll probably be able to get good coverage. If the 2010 health insurance reform is significantly cut back, you could be in a tight spot.

9. House. If your home is part of your retirement finances, consider the impact of a 25% drop in its value. Many homes have dropped more than that in the past few years. Don't think it can't happen again. Factor in the mortgage, home equity loan(s) and other liens on the house. If a 25% loss would ruin your day, save more.

We all know that, in a financial crisis, more than one asset class may go sour at the same time. Estimate the combined impact of such a morass. One thing that is certain is we will have another financial crisis like 2008-09. When is anyone's guess. But an enduring lesson of 2008 is that there are no new paradigms in the world of investments and finance. Sooner or later there will be another financial crisis. Those that prepare for it will probably do okay. Crisis deniers surely won't.

Where is there safety? Money market funds that invest solely in U.S. Treasury securities for one. Bank and credit union accounts and CDs that are fully insured by the federal government are another. See Longer term U.S. Treasury securities will be paid in full upon maturity, but are subject to interest rate risk during their terms. Gold and silver may look attractive at the moment, but their values have historically been extremely volatile. Invest in commodities at your peril.

If you don't like the results of your personal stress test, save more. That, more than anything else, will strengthen your finances. A diversified portfolio is prudent (stocks and bonds can help with your long term financial needs). But diversified doesn't necessarily mean high risk. Having 20% in stocks and 30% in bonds, with the rest in safe assets, may be as diversified as some people want to get, especially those over 70. All the nice looking statistics and charts that financial planners can generate about long term gains don't mean diddly if we're stuck in one of the decade long or longer time periods when financial assets sag. Allocate your assets in the way that facilitates sleep. You'll sleep better for it.

Sunday, November 14, 2010

Fallout From the G-20's Failure

Last week's G-20 meeting in Seoul was a failure. Basically, nothing got done, except for an exchange of volleys of antagonistic pronouncements. The major exporting nations--especially China and Germany--criticized America's profligacy and continued monetary easing. America called for structural change from the exporters, demanding that they boost domestic consumption and depend less on selling in America. U.S. officials scolded China for artificially depressing the value of its currency. The group as a whole issued a statement that muttered something about one for all and all for one. But the casual observer might wonder how many members had their fingers crossed behind their backs when they signed the statement.

As the meeting broke up, France's president, Nicholas Sarkozy, began a one-year term as the leader of the G-20. He immediately announced that the tasks at hand would take more than a year to complete, thereby absolving himself of responsibility for producing results. This inspiring act of leadership made clear that there ain't gonna be much happening soon G-20wise.

Perhaps we shouldn't have expected much. The history of the U.N., and before that the League of Nations, teaches that international organizations are always partial to dysfunction. Nevertheless, some world leaders raised expectations. The potential fallout from the failure isn't pretty.

Cranky Financial Markets. In the last couple of weeks, as it became increasingly clear that the G-20 meeting would be unsuccessful, the financial markets hesitated and then fell. Stocks and bonds are both lower (after anomalously rising together). Commodities have fallen back. This isn't surprising. For the past two years, governments worldwide have been transferring risk and losses from the financial markets to taxpayers. Speculators were probably hoping the G-20 would give them yet another undeserved windfall. But taxpayers in Europe and America have rebelled. Faced with risks that aren't being dumped on innocent bystanders, financial market players have apparently chosen to trim their sails.

Policy Makers, Be Not Proud. One thing is for sure, today's financial and economics policy makers are dead set on avoiding the governmental mistakes of the 1930s, which today's conventional wisdom holds responsible for turning a nasty recession into the Great Depression. Most central bankers and other policy makers seem to think they know what their predecessors did wrong, and how to avoid making the same mistakes. But the failure of the G-20 meeting is disquieting.

The member nations were simply doing what was in their interests. They weren't intent on messing up the world's economy, nor did they want to exacerbate the already rising tensions among them. They simply couldn't levitate themselves above their conflicting national interests to the supranational lovefest that the G-20 is supposed to foster. Each nation's domestic politics dictated its views. With the world economy too small a pie for every nation to get as much as it would like, we're now edging toward an international game of musical chairs.

And that's the way it was in the 1930s as well. None of the central bankers and other policy makers of that era whose mistakes are now so routinely and condescendingly decried meant to create a train wreck. Like their modern counterparts, they consulted with each other and tried to find common ground for constructive action. But they were driven, like today's policy makers, by the interests of their own nations. They looked at the rest of the world from differing frames of reference, each crafted by parochial interests. Yes, they blew it. But they weren't gonzo idiots. They simply did what nations generally do in times of international disagreement.

The G-20's failure last week is a disconcerting reminder of the way things fell apart in the 1930s. The G-20 also failed to find common ground, and their pledge to continue working together seemed like little more than press fodder to divert financial reporters while world leaders caught their flights out of Seoul. Before the Fed, the Treasury Department, and other policy makers in America and elsewhere confidently conclude they know how to avoid the mistakes of the 1930s, they ought to step back and think about what just happened. Human nature hasn't changed in the last 80 years. Even though the Fed is taking a sharply different tack from the Fed of the 1930s, its most recent quantitative easing program may provoke the currency, trade and other economic conflicts among nations that hindered recovery during the 1930s. The doyennes of central banking and fiscal policy should be not proud. Their deep and prolonged studies of the Great Depression, and the advantage of hindsight, may still be insufficient to keep us from falling into the abyss. When a group cannot agree on shared sacrifice for the greater common welfare, divided they will have to make their individual ways in a treacherous world.

Wednesday, November 10, 2010

Did Someone Forget to Tell the Bond Market About Quantitative Easing?

The idea behind the Fed's quantitative easing program is the Fed will print money that will be used to buy long term Treasury bonds. Its purchases, to total as much as $600 billion by September 30, 2011, are supposed to push down interest rates, thereby stimulating the moribund economy with lower borrowing costs.

A problem, it would appear, is that someone forgot to tell the bond market. A month ago, the yield on the 30-year Treasury bond was about 3.75%. Today, it trades around 4.25%. The 10-year Treasury note was yielding around 2.4% a month ago. Today, it hovers in the range of 2.6%. Are the bond traders crazy? Received wisdom in the financial markets is never to fight the Fed. But the bond market seems to be determinedly paddling upstream.

Then again, what if bond traders have it right? What if quantitative easing will be inflationary? It increases the quantity of dollars in the financial system, which is a precondition to inflation. Additionally, it puts downward pressure on the dollar, which raises the price of imports. That will have an inflationary impact. Bond investors demand higher yields when confronted with the prospect of inflation. And higher interest rates dampen economic growth. So QE, before it's hardly out of the gate, has already made things worse.

The Fed, however, has a reply: raising expectations of inflation would be good, since that would stimulate consumer spending. Beleaguered consumers, desperately trying to save some of their stagnant or shrinking incomes as a buffer against hard times, will be strong armed into spending their money whether or not they like it. It's for their own good, and the Fed is destroying their financial security in order to save them.

So quantitative easing is a win-win for the Fed. If QE lowers long term interest rates, it stimulates the economy by lowering borrowing costs. If QE increases inflationary expectations, it coerces consumers into spending. With the U.S. economy 70% consumption, a revival of consumption means revival of the economy. Of course, this works only if the Fed can prevent inflation from spinning out of control. High inflation doesn't produce prosperity--the late 1970s, a time of double-digit inflation, were an American nightmare, not the American Dream. The Fed has to produce Goldilocks inflation: not too hot and not too cold. Chairman Bernanke insists the agency can do that.

We must be in Lake Wobegon, where all monetary policy is above average. Here, a pure money print, which is what QE amounts to, cannot produce a bad result. One would have thought that conjuring up money from thin air would be undesirable. At least, so it would appear to those of us who had always thought money was supposed to be earned from productive work.

When the Federal Reserve comes across like a late night TV ad for no money down real estate, we know we're in trouble. The enduring foundational principle of all economics is that there ain't no such thing as a free lunch. The Fed is coming close to transgressing this, the most fundamental of the laws of economics. Those who put themselves above the law set themselves up for a fall. Perhaps it is true that actual national wealth can be created by flushing printed money into the financial system and deftly removing it when inflation flares. Then again, desperate times are when hope is most likely to triumph over experience. When it does, experience can administer painful lessons.

Tuesday, November 9, 2010

Will the Fed's Quantitative Easing Enrich Asia?

Just as leaves on a plant turn toward sunlight, capital seeks out the highest returns. The Fed's recently renewed quantitative easing program will dump $75 billion a month of printed money into the financial system between now and Sept. 30, 2011. That money will go somewhere, and overseas is a very likely destination.

The mechanism for this journey is the carry trade: speculators borrow dollars at the ultra low rates provided courtesy of the Fed, convert those dollars into the currency of a nation where higher returns are available, and invest in that nation. Since the highest returns generally available these days are in Asia, carry trade dollars will head across the Pacific. If higher returns were available in America, these dollars wouldn't go west. But the stagnation here makes Asia appear sunnier.

Some of the dollars will likely be invested in China, stimulating its already red hot economy. China, however, maintains currency controls that prevent unlimited capital inflows and outflows. Consequently, some carry trade dollars will flow to other Asian nations, stimulating their economies.

The carry trade has worked the other way. In the first half of the past decade (around 2001 to 2006), the Japanese central bank lowered interest rates to zero and tossed in some quantitative easing to boot, in a largely futile effort to revive Japan's economy. Speculators borrowed yen cheaply, converted it into currencies of nations with higher interest rates and invested in those nations to profit from the difference between national interest rate levels. America was a one beneficiary of the yen carry trade. Possibly, Japan's quantitative easing, leaving behind the stagnation in its native land, contributed to America's recent real estate and credit bubbles. Now, the Fed's quantitative easing is sparking fear in Asia of asset bubbles and heightened inflation.

Presumably, the Fed is aware of the potential for its quantitative easing program to stimulate other nations instead of America. Perhaps it hopes that juiced up Asian nations will import more from American exporters. That probably will happen to some degree. But there's no way of knowing how much benefit America will receive from such a circuitous route.

With the dollar being the world's reserve currency, the carry trade is easily done and easily unwound. Its biggest up front risk may be a revival of the dollar. But with the Fed publicly committed to quantitative easing, a strengthening of the dollar seems about as likely as confirmation of the Yeti.

The more ebullient carry traders become, the less likely quantitative easing will help America. Much of the Fed's big money dump could simply fly away overseas. Then what?

Sunday, November 7, 2010

How Much Do You Need For Retirement?

A pretty simple way to estimate how much money you need for retirement is:

1. Calculate how much annual income you want (or need) in retirement, using current dollars.

2. Subtract the amounts of Social Security benefits (including your spouse's benefits, if you're married), and pension income, if any, you (and your spouse, if married) expect.

3. Multiply by 30; we'll call the result your nominal target.

4. Adjust for inflation between now and your anticipated retirement age, by multiplying 1.03 by itself the number of times equal to the number of years until your retirement (i.e., 1.03 to the exponential power equal to the number of years until your retirement), and next multiplying the resulting number by the nominal target.

The number you end up with is your inflation adjusted target. Here's an example.

Let's say you'd like the inflation adjusted equivalent of $50,000 (in current dollars) a year for retirement. Your estimated Social Security benefits are $15,000 a year. You're lucky enough to have a pension that will pay $10,000 a year when you retire. Subtracting $15,000 and $10,000 from $50,000 leaves $25,000. Then multiply $25,000 by 30, getting $750,000. We assume inflation will be 3% a year (that's the approximate average annual inflation rate since World War II). We'll also assume you have 20 years to go before retirement. Multiply 1.03 by itself 20 times (that would be 1.03 to the 20th power, exponentially speaking). The result is about 1.8061, which you multiply with $750,000, getting $1,354,500 as your approximate inflation adjusted target.

If you have no pension, which is the case for most Americans, you'd subtract your $15,000 Social Security benefits from $50,000, getting $35,000. That figure multiplied by 30 yields $1,050,000. Multiply by 1.8061 to account for inflation, and your target becomes $1,896,400.

Note that your target number is in future inflation adjusted dollars. Since most people's incomes tend to keep pace with inflation, reaching the target isn't quite as hard as you might think. You can use this target without having to think about investment options or diversification strategies. Tired of stock market volatility? Slick financial advisers make you nervous? Don't want to invest in derivatives contracts or no money down real estate deals? That's okay. Save in CDs and money market accounts if you want. Work a second job, or drive the same car for 20 years. Don't splurge on a McMansion and learn the virtues of home cooked meals. Inherit the money, win the lottery, or get it any other way that's legal. It doesn't matter how you get the money, so long as you have enough.

This formula is just an approximation, and is meant to give you a ballpark sense of where you need to go. We assume that you're retiring in your early 60s (most people do so around age 62). That's why we use a multiplier of 30--many financial advisers would use a multiplier of 25, but they're assuming retirement at age 65 or later. The multiplier of 30 also helps account for the fact that most pensions are not increased for inflation, so they lose value over time. We also assume that once you've accumulated the needed total, you invest it in a conservatively diversified portfolio during retirement. If you want to stick with all CDs in retirement, you should use a larger multiplier, like 35 or 40. Of course, this money isn't for your kids' college expenses or other non-retirement uses. That has to be saved in addition to your retirement money.

It isn't easy to save for retirement. Then again, nothing worthwhile comes easily. Most people go through life and then retire on whatever they have available when retirement time rolls around. Even if you can't imagine how you'd ever hit your target, starting to prepare is the first step in ultimately being prepared. Many folks would be happy to accumulate half their target. But they have to start saving to get there. The worst thing you can do is nothing. For more on retirement, see
, and Good luck.

Thursday, November 4, 2010

How Gridlock in Washington Endangers the Economic Recovery

The political gridlock that just was elected to office could make things worse. By definition, gridlock means the status quo is preserved, because nothing can be done to change it. The status quo is a mess, and preserving it is exactly what we don't need. Let's look at some of the key economic issues.

Real estate. The real estate market and its associated mortgage crisis were the origins of the Great Recession. When the credit carousel stopped turning in 2008, trillions of dollars of losses cascaded on banks, investors, homeowners and ultimately taxpayers. Financial crises such as this work themselves out through the allocation and realization of those losses. Losses must be taken by someone or they will continue to hover over the economy, discouraging consumption and investment, and hindering recovery. Over the past two years, some of the losses have been taken, by banks writing down loans and other assets, investors seeing lower prices on mortgage-backed investments, homeowners suffering falling home values, and taxpayers subsidizing all of the foregoing. But there remain tons of unbooked losses, and also the painful problem of what to do with Fannie Mae and Freddie Mac (i.e., to what extent will taxpayers provide future subsidies to the housing market). Liberals can't envision a U.S. housing market without federal support, and conservatives can't stomach perpetuation of such massive subsidies and bailouts. The current chaos and confusion in the real estate market, amplified by the burgeoning foreclosure mess, will continue. The process of loss allocation and realization will continue, but in the haphazard, ad hoc, unfair and lunatic way it now operates. Consequently, real estate and housing will stay sick puppies, dragging on economic recovery.

Fiscal Policy. The Bush tax cuts will be extended for almost everyone. If the Republicans have their way, they'll be extended for everyone. But doing so will conflict with a cherished Republican goal of shrinking federal deficits. In theory, deficits could be reduced by cutting spending. In fact, the newly elected coalition government in the U.K. is taking this approach. But Britain's parliamentary system of government enables such decisive action. America's Constitutional limitation and division of authority acts in the opposite direction, permitting the electorate to choose a chief executive and chambers of the legislature from different parties. Gridlock will preclude major spending cuts. Fiscal policy will remain the mosh pit it is today and deficits will lurch on.

Even in situations where Congress can act, it won't have easy choices. Federally funded unemployment benefits for the long term unemployed will expire at the end of this month. Congress has three weeks to act. Extending benefits would help keep the economy muddling forward. Cutting off benefits would help reduce the deficit (although not by much, maybe a couple billion, which in context is peanuts). But it will also increase the doom and gloom among the electorate. Lengthening the line at the food bank won't spur consumer spending, even if passbook savings accounts pay 0.00001% per annum.

Monetary Policy. The Fed, being somewhat insulated from politics, will continue with monetary policy, and its recent announcement of $600 billion of quantitative easing reflects a clear, if not unanimous, choice to provide more stimulus. Congressman Ron Paul, cynosure of libertarians and Tea Partiers, and soon to be the chairman of the House Subcommittee for Domestic Monetary Policy and Technology, has already announced that he plans to scrutinize the Fed closely, questioning the fundamental premises of its policies and actions. Paul travels leagues farther than mainstream Republicans in challenging conventional monetary policy, subscribing to the gold standard and doubting the wisdom of central banking at all. Chairman Bernanke can look forward to providing the subcommittee with the pleasure of his testimonial company on a regular basis. The Fed's renewed program of quantitative easing will face head winds from the direction of Capitol Hill.

The last industrialized nation to suffer a financial crisis and recession like America's was Japan. The Japanese government reacted indecisively, often sinking into dysfunction because each of its options was painful and it was reluctant to impose the costs of washing the crisis' losses out of the economy. So it allowed the losses to linger, dampening economic recovery to this day. The gridlock soon to settle into Washington could easily lead to similar dysfunction, letting the economic recovery meander. The Japanese central bank lowered interest rates to essentially zero and also conducted quantitative easing. But, in a dark omen for the Fed, monetary policy in Japan wasn't enough.

If the government is capable at all of restoring prosperity, a question not without doubt, it will have to act with unity of purpose and decisive amounts of fiscal stimulus as well as monetary accommodation. That ain't gonna happen. Have an umbrella ready for the next two years because storm clouds are gathering. And recall that old timers who lived through the Depression would often carry a roll of hundreds of dollars in their pockets, simply because cash money felt good. When times are tough, cash talks and just about everything else walks.

Wednesday, November 3, 2010

November 2010

This month, the San Francisco Giants, a team few people outside of the Bay Area notice, with a roster of players few people outside of the Bay Area notice, brought home San Francisco's first World Series title. Improving as they progressed through the playoffs, the Giants determinedly won the championship, conceding only one game of the final series to the Rangers. Edgar Renteria, an aging Giants infielder on the verge of retirement, hit the winning home run in the last game, going out like the champion he became. It was a lyrical, magical victory, befitting the golden city by the bay, poetically inevitable and long to be remembered by baseball fans of all persuasions.

And, oh yeah, there were mid-term elections yesterday. As expected, the Republicans took control of the House of Representatives. Not unexpectedly, the Democrats kept control of the Senate. Gridlock is in our future. Then, today, the Federal Reserve announced that it would print $600 billion and use it over the next eleven months to buy long term U.S. Treasury securities in an effort to stimulate the economy. Various Wall Street analysts had prognosticated that the Fed would announce at least $500 billion, which is financial markets speak for saying they wanted more than $500 billion. The $600 billion was a tepid ante up by the Fed. The Dow Jones Industrial Average offered fair commentary, rising 26 points, or less than 0.25%. In spite of all the headlines, soundbites, points and counterpoints, nothing really surprising happened in the world of politics or in the financial markets. Nor will any of it be remembered like the Giants' World Series win.