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Election Year Brings Many Financial Management Issues to the Forefront

TROY, Michigan - March 1, 2004 - By Kevin J. Delaere, CFPTM, CPA

As we swing into another vigorous political election cycle, we will be hearing from many sides on the issues of the day. I want to comment on some of these issues as we go along. One recent concern has been the Federal deficit, currently at $407 billion (over the last 12 months) and projected to rise to $521 billion for this fiscal year. Also, the total gross Federal debt outstanding is about $7.5 trillion dollars and rising. These numbers sound big, and in many contexts they are, while in others they are not.

Let us first look at the bright side. While a $521 billion deficit is large, as a share of GDP it amounts to 4.5%. That compares to deficit to GDP ratios of about 3% in Europe and 6% in Japan. The gross debt to GDP ratio in the U.S. is about 65% (down from a 67% peak in 1996), compared to a 75% ratio of debt to GDP in Europe and a whopping 140% ratio in Japan. To get to Japan’s debt to GDP ratio, the U.S. would have to run additional deficits totaling between $8 and $10 trillion dollars! So, if Japan is the “canary in the mine”, we have quite a bit of breathing space before the problem turns into a crisis.

That said; let us look at the problems. Yes, with an $11+ trillion economy (GDP) that is expanding about $500 billion a year, we can support a $500 billion deficit for now. But, what about down the road? Here is the rub – we have a rapidly aging population (the baby boomers) that will be retiring and starting to collect Social Security and Medicare benefits in about 15 years. At that point, the Social Security system, which currently has a small surplus, drops sharply into large deficits for many years.

So, should we do something now to prepare? Last week Fed Chairman Greenspan gave some support for two options: 1) cut future benefits and 2) partially privatize the system. The linkage of these two options by Greenspan is not an accident. The problem with option 1 is that if future benefits are cut (or payroll taxes increased again) then the return on investment for a worker who is in the 20 to 40 year old range goes negative. In other words, right now a 30 year old worker who pays into Social Security can expect to get back just about the same amount after he or she retires – no interest, no investment income. If future benefits are cut, then their return goes negative. Partial privatization may allow these people to have a retirement investment account that could grow. Another helpful option would be to get the Federal budget back into surplus and retire some of the current debt over the next 15 years (that is – go back to running budget surpluses) so we would have borrowing capacity to cushion the heavy future retirement expense. I tend to think all three options should be used.

These are very tough political and demographic issues that, while not a threat to the U.S. economy and financial markets today, will grow worse over time and the sooner we address them, the less painful the solution will be. As always, please feel free to call me with any questions or concerns at 248-362-5000.