Engineers who design large structures must consider what their profession calls the "scale-effect" problem, or what may happen when a material, formula or a design technique is used to build a structure larger than whatever has been built before. As the size increases, factors that had not previously been considered may come into play that cause the structure to fail.
There is a scale-effect problem with the concept of relying on corporate stocks as the main source of funds for retirement plans. The formulas underlying this concept were developed for individual or organizational portfolios and are based on the assumption that, for all practical purposes, there will always be an infinite number of buyers when stocks must be sold. But these same formulas are now being applied to entire generations, a vastly greater scale than ever contemplated by those who originated them.
According to Richard Mahoney of the Center for the Study of American Business, more than two-thirds of all listed U.S. stocks are in retirement accounts. Millions of Baby Boomers are buying stocks, directly or through pension and mutual funds, in the front, or build-up half, of what has become a national stocks-for-retirement cycle. But no one has explained how the back, or liquidation half, of the cycle may work. There has not been a publicized engineering like system-failure analysis of how the cycle can handle its intended load.
The load is expected to reach a plateau in about 2030 and continue for decades. The Census Bureau projects that during this period, one of every three adults, including all Baby Boomers, will be over 65. Nothing that we know today explains how millions of people will be able to retire comfortably in their mid-60s on intergenerational transfer payments if the ratio of workers to retirees approaches 2-to-1. Because Social Security is based primarily on intergenerational transfers, there are proposals to use its receipts to buy stocks in hopes that price gains will put the program on a sounder financial basis.
There is a big unrecognized problem with this: Although stocks have helped pay for many retirements so far, the size of the national stocks-for-retirement cycle is unprecedented and its premise appears to be flawed. With most stocks now paying minimal dividends, if any, the only reason to buy them for retirement accounts is to sell them eventually for gains. The gains, however, are not free -- they are costs to the next round of buyers. When Boomers sell stocks to pay for their retirement, the largest pool of domestic buyers will have to be workers with disposable incomes or workers' retirement plans.
But when retirees sell stocks to workers, the gains are intergenerational transfers -- just what demographic projections show will not be sustainable because of the 2-to-1 ratio. Despite the assertions of privatization advocates, using Social Security funds to buy and then sell stocks to workers for gains cannot change the fact that the program will still be a levy on the next generation.
Unless this explanation is wrong, Social Security is just the tip of the retirement iceberg. It is a warning that most retirement programs that expect to sell stocks to workers for gains are at risk, and that includes pension plans, annuities and individual retirement accounts. The stocks-for-retirement cycle appears to have turned the U.S. stock market into an intergenerational pyramid scheme. It works for many retirees now, but it can be sustained only while workers' savings flow into the base faster than retirees' liquidations flow out from the top. Population projections indicate that this can't go on forever.
There is no precedent for a singularly large generation making a planned shift from saving and buying stocks to selling them, in order to finance consumption, to a pool of buyers that is growing more slowly. If the shift doesn't work, it may lead to disillusionment with the country's financial institutions and a prolonged depression.
Many financial planners advise people to convert part of their portfolios from stocks to income-producing investments as they approach retirement. At the individual level, this may be good advice. But it still requires selling stocks to make the conversion. From a national standpoint, the advice does not reduce the need for mass selling. It just starts the selling earlier.
Some advocates of stocks for retirement hope that foreign buyers will absorb the Boomers' stocks. But there has been no publicized explanation of who will be able to do it. The total value of U.S. stocks is about half of the world's total. Asia is no longer the economic powerhouse it once was. And the aging populations of Europe may face larger employment, retirement and investment problems than we do. Foreign buyers may be the answer, but so far there has not been enough sound analysis to bet the future on them.
The fundamental question is how millions of people will be supported during their later years. If they can't live on intergenerational transfers, either through the government or from stock sales, they will have to work or have other sources of income.
Sooner or later this question will call for a reassessment of how savings are invested, how companies are managed and even how the economy should work. The country has the choice of doing the reassessment in time to prevent a disaster or waiting until it is trying to recover from one. If it is done soon, business can lead it. If it is not done until there are serious troubles, these will become political problems and the government will lead the reassessment.
The reassessment will probably show that besides products and services, America's aging population will need two main things from companies and investments.
First, because many Boomers will not be able to retire in their mid-60s, they will have to work for more years than previous generations. They will need secure jobs with adequate benefits, even if their capabilities decline. This will require companies to reverse the practice of encouraging early retirements and offering part-time employment to minimize benefit costs.
Second, those who do retire will need investments that provide income from then-current earnings streams, not stocks to sell into declining markets. This is what utilities provided before deregulation. Meeting these needs may require major changes in the role of companies and the way they are managed. Stock prices will probably become much less important.
History is not much help for predicting unprecedented events, and retirement investment predictions based on how stocks have performed in the past are largely meaningless. We do know that there are risks in continuing to invest according to the old formulas. Until the risks are understood, stocks should be considered as dependable for Baby Boomers' retirement portfolios as a bicycle on ice.
THORNTON PARKER is a consultant in Washington.
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