Uncle Sam’s Ponzi finance

There are two ways to conquer and enslave a nation … One is by sword … The other is by debt. — John Adams

Blame it on Otto von Bismarck, the first German Chancellor.

In 1889, he introduced the concept of social insurance by creating a retirement program. No dummy he, the “Iron Chancellor,” set the retirement age at 70, at a time when the average male lived to 37 and the average female to 40. The funding mechanism was simple: current workers paid for retirees. Those few who lived to collect their pensions benefitted handsomely, especially the original recipients who had paid little or nothing into the system.

Fast forward to 1920. Charles Ponzi, an immigrant, concocted a scheme to buy postal reply coupons in Italy and exchange them for U.S. stamps, pocketing the difference in price. The first investors received a 50 percent return within 45 days. Rather than invest the funds, however, Ponzi spent the money on himself and on new investors by paying dividends with the original investors’ funds. In 2011 dollars, Ponzi defrauded the public out of $225 million before his eponymous scheme ended.

The second big Ponzi scheme imploded in 2008 when Bernie Madoff made off (pun intended) with $20 billion of investor funds. Early investors enjoyed extraordinary returns; later investors were stuck with the losses.

The biggest Ponzi scheme, according to Daniel Stelter in a Dec. 14, 2012 article for the Boston Consulting Group, “… is still ongoing … [T]he developed world has borrowed significantly from future wealth to fund today’s consumption.” The leading economy with the most funds at risk is the USA. Historically, Ponzi and Madoff are pikers compared with Uncle Sam.

Our largest entitlement programs — Social Security and Medicare — are both built on Bismarck’s model: current workers support retirees. Today’s politicians, however, ignore the changes that have occurred in the last 123 years. In 2013, life expectancy has doubled, but the retirement age has remained relatively static. Compounding this problem is a declining birth rate that is less than half the rate when social insurance was introduced, and a declining participation rate in the workforce. The iron chancellor also never anticipated politicians, elected to feel the public’s pain, who couldn’t say “no” to the growth of entitlements by putting them on budget autopilot. Nor have our politicians come to grips with the explosion of technology that demands a highly educated workforce. The failure of our public primary and secondary-education system means fewer educated workers to support the retirees.

The impending implosion is seen in the 2012 federal spending numbers. First, the president’s own Office of Management and Budget, in analyzing President Barack Obama’s 2013 budget, projects publicly held debt will rise steadily until, in 2084, the debt reaches 200 percent of the nation’s GDP. Second, the U.S. civilian labor-force participation is collapsing, according to the U.S. Bureau of Labor Statistics. In 2007, the participation rate was 66.4 percent; today it’s 63.6 percent. Third, the civilian employment-to-population rate is also collapsing, falling from 64.5 percent in 2000 to under 59 percent today. Fourth, the current growth in GDP is falling far behind the trend line of the last 20 years. To date, continued economic growth has been the main factor in propping up Uncle Sam’s extravagance (along with historically low interest rates).

There are numerous other indicators of a pending implosion. In the past 20 years, federal spending has outpaced inflation by 71 percent; the debt of each American, adjusted for inflation, has risen from $23,000 to $30,000 in a decade; in the same period, public U.S. debt has jumped from 33.6 percent of GDP to 73 percent; the feds borrow $3.20 of every $10 expended; and the official $16-trillion debt doesn’t include the $45 trillion owed for Social Security and Medicare, nor does it include retirement promises to federal employees.

What is the cost of not acting now to prevent a Ponzi implosion? If you’re not a numbers person, just look at the impact on the Greek economy today. The country is unraveling because the government currently spends 55 percent of the nation’s GDP, a figure that, if uncorrected, will continue to rise to meet government promises. For years, Greece has ignored dealing with the problems of an aging population, shrinking workforce, slow growth, and chronic under-investing in the country’s infrastructure. Greece’s failure to deal with its structural problems has caused economic paralysis and political disintegration.

Uncle Sam still has not faced up to the structural disintegration of our own country. On Jan.1, the Congress passed legislation primarily to protect the “middle class” against a rise in tax rates and solve the so-called “fiscal cliff.” The deal projects more than $40 in new tax revenue from the “rich” for each dollar in spending cuts, according to CBO calculations. The president signaled his concern for debt and deficit reduction by forging a deal with Congress that cuts only $1.5 billion per year ($15 billion spread over 10 years). Seen in the context of a $3.5 trillion annual budget, that’s a cut of 0.0004285. Let me translate: For every $1,000 of spending, the president and Congress will cut fewer than 43 cents.

I admire the Beltway’s financial alchemy. Only in the Land of Oz could this legislation be considered serious. If the public buys it, it can only be a testimonial of our greed or stupidity.

The country desperately needs a model of fiscal prudence, someone who truly cares about the country. I turn to Harry Truman. When he retired from the presidency in 1952, he drove himself and Bess to Missouri. Truman lived on his army pension, bought his own stamps, and paid for all his travel expenses and food. When offered corporate positions at high salaries, he declined, suggesting the offers were merely for access to the office of the president. In short, the office was not for sale. At age 87, he refused the Congressional Medal of Honor because he didn’t think he had done anything unusual to deserve it.

Consider this quote by Harry Truman. “My choices in life were either to be a piano player in a whore house or a politician. And to tell the truth, there’s hardly any difference.”

While waiting for the next piano player or Otto von Bismarck to rescue us from eating our own seed corn, my suggestion to corporate executives is to consider diversifying, paying attention to the balance sheet, anticipating inflation, and reducing costs. I also recommend innovating, reviewing performance targets and the business model, and reaching out to older workers for staffing as we wait for a refocus on growing the economy.

Happy New Year!

Norman Poltenson is the publisher of The Central New York Business Journal. Contact him at npoltenson@cnybj.com

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