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As Social Security begins to collapse and the millions of baby boomers begin to retire, many will wonder where all the money went. It was only last year when would-be retirees lamented,

“My portfolio is down 50%, so I can’t retire. I don’t even open up those statements anymore”

Dow 2006 - 2010

Did you see these people on the news? I remember them clearly. But now that the market has recovered, they are long forgotten. And the lesson was not learned. Most people have their entire retirement account invested in mutual funds. As soon as the market goes down again they will be in the same unenviable position.

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The Social Security system, or more accurately Social Insecurity, is a great example of government mismanagement. Instead of collecting more money than it pays out, and investing the money it has collected, the government is now paying out more money than it collects. And instead of investing to get rich, it simply spent the money to make us poorer. To the tune of $2.5 trillion.

This article on Yahoo has some interesting facts about Social Insecurity. The article neglects to mention one of the biggest problems with the system. And that is the fact that people are living longer. It is estimated that people are living as much as half a year longer with each passing year. That means that in 20 years people could be living 10 years longer. Does the government factor this in to the Social Security payments estimates? No.

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Last night I was watching the news (a terrible habit I need to get rid of!) and there was another story about how bad the economy is and how hard it is to find a job. I always have the same reaction when people say they are looking for a job. It makes me wonder, “Who wants a job?”

Having a job for decades and retiring on a pension was a system that ended in the 1980’s. Since then, the economy has changed so rapidly that working in the same job for 20 years is nearly impossible. Besides that, the financial mismanagement of companies and the government has made pensions and social security unreliable.

So what’s the solution?

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The new record breaking budget deficit of $1.8 trillion could have massive repercussions for the economies of this country and for the entire world. The future deficits are expected to rise. This deficit might be the straw that breaks the dollar’s back.

Image courtesy of The Heritage Foundation

There have been many factors that have been putting pressure on the dollar, going back nearly 100 years when the government started running a deficit. It’s been a free ride for the last century because the dollar was the default currency for the world. America was the most powerful economic superpower, and the only country that was a military threat was the USSR. It was like having an infinite line of credit; we could print as much money as we wanted.

What has changed?

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This is Top Investing Mistake #16. For the other 15, see below.

Top Investing Mistake #16: Not Taking Responsibility

Have you ever heard someone say the following?

My accountant handles that.

The idea of letting someone else manage a complicated part of our lives is not new. We often use experts in the fields of finance, taxes and health. When we are sick, we go to a doctor. At tax time, we let the tax preparer do the work. And for investing, many people rely on their financial advisor.

Getting great expert advice in these fields is a great idea. But it carries with it a certain danger.

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In the olden days (circa 1970), people expected the government and other institutions to take care of them. They depended on the government to educate them through the school system. The depended on Social Security and their company’s pension plan for retirement income. And they depended on Medicare and Medicaid to handle their medical expenses.

How times have changed. Since those good old days, the dollar was taken off the gold standard. That means that the government could print as much money as it wanted. It could pay its own deficit with the money that it printed. This means that there is no limit to the amount of money that the government can spend. And that’s why it is spending money faster and faster. It is spending money that it doesn’t even have.

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It looks like Bernie Madoff will spend the rest of his life in prison. That was after stealing $50 billion of investor’s money. Did you know that there is a Ponzi scheme that is 200 times bigger than Madoff’s? It’s called Social Security.

Social Security currently has liabililites of $10 trillion. Many people think that there is a certain amount of money set aside to pay back this massive debt. Guess what. There isn’t. The government already spent the money. Just like Bernie Madoff.

This point of this post is not to be critical of the government. America is the best country in the world, and has perhaps the best government system. But the day of reconing is soon upon us; the govenment has borrowed more money than it can pay back. And people counting on Social Security are likely to be left holding the (empty) bag.

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Imagine what it would be like to be a typical American man or woman, age 65. They have worked hard for 40 years. They served their company. Perhaps even served their country. Now it’s time to retire. There’s only one small problem.

They don’t have enough money. They wake up one morning to discover that they have spent their entire life working for the dream of a comfortable retirement. This bliss is shattered when they notice that Social Security will barely pay enough to get by. They are surprised that the meager interest on their life savings is less than their food bills. It’s sad, and it’s happening to millions of baby boomers who are retiring in the next few years.

How did this happen?

It happened for the same reason that saving three dollars a day on a latte doesn’t work. The financial advisors say, if you save three dollars a day, in 40 years you will have a million dollars. There’s only one problem with this method. In 40 years, $1 million won’t be worth much.

Have you ever heard (or even said) “I remember when the newspaper costs a nickel!” Have you noticed how prices are always rising? The technical term for ever-increasing prices is inflation. For people in America today, inflation has been very real. The price of housing has doubled in the last five years. And before the price of gas took a tumble, it had doubled as well.

Look at the following chart. Have you ever seen a chart that looks like this?

This sort of chart is often depicted by people promoting saving. However, this chart is not about how much money you will have if you save a few dollars a day. This chart shows how little you can buy in 40 years with the dollar.

The chart shows how the purchasing power of a dollar decreases over time. The US government says that inflation is about 5% on average. That means after 40 years, something that cost one dollar today will cost 7 dollars. What you pay $1 for today will cost $7 in 40 years. That is why the chart above shows $1 becoming $7 after 40 years.

This chart was created using Microsoft Excel, a simple software that can be used to create charts. I got the 5% figure from the American government. These results were generated from using mathematical formulas, and government statistics. If you believe what the government says, then this chart is a picture of hard math. I can tell you for sure that the computer software does not lie.

The reason that the hard-working retiree is having a financial challenge is evident from the above chart. The value of his savings has decreased because of inflation. And since the government statistics are not accurate, his Social Security income has actually decreased because of inflation as well. The amount of stuff that he can buy has decreased.

Reason #4: Prices Rise Faster than Low Paying Savings Accounts and Other Poor Investments

Saving doesn’t work because inflation reduces what we can buy with the money we have saved. People think that they will have a lot of money saved up when they retire, but that money buys little. It only seems like a lot of money, because we are thinking in present-day dollars. That’s why the newspaper seems cheap if it only costs a nickel. But think about what life was like back to when a newspaper only cost a nickel. Everything else was much cheaper as well. The newspaper was just as expensive back then, compared to whatever else you could buy for a nickel.

Savings accounts, CDs and mutual funds only pay about as much as the government set interest rate. Returns are further diminished when the government collects its taxes on the interest. That’s why inflation and taxes eat up more than low-quality investments pay. And therefore, savers lose money over the long term.

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As I wrote about in a previous post, Obama has taken massive action in the first few days of his administration. That is really outstanding. He has already distinguished himself as being different from most politicians, and is already starting to follow through on his hundreds of campaign promises in a big way.

All that is wonderful. The problem is that America is in financial trouble far deeper than most people imagine. So far, the government is spending about $800 billion to help the economy. Consider this: Social Security has $10 trillion in liabilities. That is over 10 times as much as the recent economic stimulus package. What radical changes is Obama going to make to solve this huge problem?

Besides Social Security, we have an even bigger problem: Medicare. Medicare has liabilities of $62 trillion! So, adding these two liabilities together, we need 100 times as much money as the government is spending already! How is Obama going to solve this unbelievably challenging problem?

Unfortunately, most Americans are not even aware of the problems of Social Security and Medicare. They blissfully assume that the government will take care of them in the future. But I suggest you, that ignorance is not bliss. There will come a day in the near future when these benefits will be significantly reduced or disappear altogether.

Most people don’t want to deal with the fact that our government has put the country hopelessly in debt. We are soon coming to the point where we will not be able to make payments on the national debt, and the entire structure of the American economy will change radically. I just hope that Obama can find some way to solve these daunting problems.

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At a recent campaign function Barack Obama said our money invested in the market had less value now than the money sitting safely in Social Security. A quick look at the financial papers sure shows massive drops in the value of stocks and bonds, and other investments. Real estate, once the national piggy bank, is no longer a safe bet either.

So, a nice steady check from the government appears to be the safest place for your money.

It sounds right. But is it?

By its very definition, Social Security is a Ponzi scheme. It takes money from new workers (investors) to pay off retired workers (prior investors). Social Security is a little more successful than most Ponzi schemes because masters of regular schemes run out of new investors, fold, and go into hiding–or jail. With its power to tax, throw you in jail, seize your assets, and even send the SWAT team to your house, Social Security can last longer.

Even with that power, Social Security can not defy the laws of financial physics forever. If you look at the books, the dollar that you and your employer donated to Social Security is long gone. In fact, based on expected receipts, it’s into negative numbers. Even if the stock market can’t go below 0.

When Social Security was created birth rates were increasing, a trend with no signs of ending. That is no longer the case. And, as the Singularity dawns, people will be living longer. A lack of new investors coupled with increasing demands of current investors spells a serious problem for any Ponzi scheme.

The sad fact is Social Security’s books look like a monster Enron.

There are some moves afoot to change that. Making rich people pay more is always the obvious solution. But, pulling money out of productive people to bolster up a non-productive entity is never wise economically. Like fixing up that old Volkswagen Rabbit I used to own–my increased contributions in repairs never really changed the fact that it was a dilapidated vehicle.

So, is it all bad? Even as the Singularity begins to stress investment systems like Social Security, it will also uncork innovation on a scale never seen before. Using the power of exponential computing gains, investments and wealth will increase at a similar dramatic scale.

It’s one of the reasons why we are now creating investment systems powered by advanced technology. Our belief is that this will deliver the power of exponential wealth gains to regular investors and traders. Once this is achieved, our reliance on Social Security and other non-returning investments will decrease and the taxes put in place to ensure our station in the workaday world will be mere speed bumps on the highway of increasing gains. 

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