A whole new level of bad
How to live and not work with the new normal
Welcome to Known Unknowns, a newsletter that when inflation goes up, starts getting real.
A permanent state of transitory
There has been so much news in the last few weeks. GDP is down, inflation is up, but it’s too soon to call it stagflation. The PCE numbers are out, inflation is still really high, and we are still blaming transitory factors that aren’t going away anytime soon—isn’t everything in life transitory? To deal with this, the Fed is expected to make real rates a little less negative this week. Or with 3.5% unemployment and 8.5% inflation, it will stop accommodating quite so much. It may go to neutral next year sometime.
Last time I made my case for permanently higher inflation, even after all these shocks go away and the Fed has its long-overdue come-to-Jesus moment and returns to rules-based policy. There are many structural forces that may mean a higher inflation rate will prevail for a long time.
But what does that mean? We lived with 4 or 5% inflation before. And in many ways, it is the uncertainty and volatility that matter with inflation, not the level. So, if inflation is 4%, the Fed somehow adjusts its target to that and keeps inflation steady, is it such a big deal?
Kind of. We live in a different world than in the late 1980s. Employers have gotten used to giving lower pay raises. The labor force is less unionized, which means less pressure for automatic cost-of-living increases. That means a higher inflation environment will be worse for low-wage workers who have less power.
Market structure is also different. Industries are now dominated by larger, more productive firms that can afford to deal with rising input costs without raising prices because they have bigger profit margins. Rising prices are harder on smaller firms who already are barely hanging on and have less pricing power than they used to. The Amazon effect means more transparent prices, so it’s harder to increase prices when needed.
And don’t get too excited if you anticipate the return of high-interest rates on your savings. Banks are less interested in retail banking, and the world is hungrier for dollars and dollar assets. So even if interest rates increase some, they may not increase enough to compensate savers for inflation. Forget 8% CD rates. Safe assets may not offer a positive real return any time soon. All I can suggest is diversify as much as you can.
What’s an aspiring retiree supposed to do?
This is a pension newsletter, and we have not discussed retirement lately, especially what retirees are supposed to do with all this uncertainty.
Lots of people are hoping to retire soon. Maybe they already did because of the pandemic, or maybe after all these years of stress they want to enjoy life and stop working. But things are looking pretty grim. Inflation is up, the market is down, and many people say a recession is coming soon. But in many ways, it has never been a better time to retire.
Hear me out here.
OK, maybe the outlook was slightly better in 2019, but cycles happen. If you look at the data, Boomers are retiring in better shape than previous generations. They are retiring with more wealth, low-interest rates mean Social Security is worth more (and it covers more people), and even Medicare is more generous. Some improvements came from the shift to defined contribution (DC) plans. They are cheaper and more mobile, which means more people have access to some retirement plan. DB plans were expensive, tied you to a single job, and few people had them (39% of workers at their peak). More coverage means more people have retirement assets.
True, people need more money because they live longer. And medical care is better, which means you live longer and better, but it is also much more expensive. In many ways, these are good problems to have. The higher quality of life also means working part-time is more of an option. Before, when people retired, they were too old and sick.
But some people really love to complain the move to DC was a disaster. The latest line of attack is they are a problem because rich people have lots of money in their accounts. Yes, if you save the maximum amount every year and the stock market goes way up (or you have access to good private equity funds—to be fair, I am not sure why that is an investment option in tax-advantaged accounts), you may end up with a few million in a retirement account. But that does not negate that DC plans expanded coverage to people who otherwise would not have retirement benefits. It did a lot to increase stock ownership among the middle class and even some lower earners. A rich person benefiting is not enough reason to say a policy is terrible. Well, not always, student loan forgiveness is a terrible idea, but I digress.
That said, there are problems with DC plans. It is tough to figure out how much to spend each year, especially in this environment. And we give people terrible advice. And I don’t just mean the option of letting people invest 20% of their retirement assets in Bitcoin (really, Fidelity?!). The 4% rule or spend your RMD strategies don’t solve the right risk problem, which is consistent, reliable income in retirement. In fact, they both suggest spending less now, just when inflation is up, and many retirees finally feel safe traveling and seeing friends again. In finance, any strategy that asks you to cut back on spending at the worst possible time is what we call sub-optimal (when we are being polite). And yet this is the best we offer people? We can do so much better.
In the meantime, China is expanding pension accounts where savers will invest their assets in mutual funds. Great! They are diversifying out of real estate, and I hope their markets keep growing for their sake.
More thoughts on student loan forgiveness
It’s a really bad economic policy; it’s regressive, potentially inflationary, and makes a bad problem worse. But what really bothers me about it is this: a trillion-dollar wealth transfer could happen by executive order. Look, sometimes we have bad economic policies. It happens; not all policies will please economists. But at least if they are ratified by Congress, then they reflect the will of the voters who’ll pay for them. Forgiveness-enthusiasts like to compare student loan forgiveness to bailing out banks. But TARP was passed by Congress. If you think we should forgive student debt, then elect more people to Congress who will do that for you!
This is a whole new level of bad.
Speaking of people who think rich people getting richer is necessarily bad
I reviewed Thomas Piketty’s latest book for City Journal.
Until next time, Pension Geeks!