Handling Finances

Now that people are starting to get their tax rebates, our economy is in for some serious stimulation!  The idea is that we’re supposed to go out and buy new stuff which will keep businesses rolling along which will keep people employed.  Some might argue that we need a recession to drive inefficient companies out of business (freeing up workers and resources for better-run companies) but it’s a rather unpopular idea — especially now that our retirement savings are almost universally invested in the stock markets after years of our government giving tax breaks for 401(k) contributions.

If we step back for a moment and consider that the economy won’t totally collapse if every penny of the 100 billion is turned into profits and wages (it won’t), it will become clear that paying off debt will actually do as much or more to stimulate the economy than simply spending on consumer products.

Increasing future spending.

First of all, with every penny you pay back on your debt, you free up the monthly interest to be spent on other things.  Putting the $600 individual rebate toward debt could save as much as $150 a year in interest at an all-to-common 25% interest rate!  Today’s politicians are no-doubt counting on the stimulus today so they can take credit for the booming economy, but if we’re willing to think just a couple years out, the sustained effect of $100 billion less debt would be huge (and wouldn’t largely be wasted in profits to foreign countries).

Free up financial markets.

One of the biggest reasons for the current recessionary scare is sub-prime lending.  Sub-prime lending is hugely profitable as long as the economy is booming because lenders can charge exorbitant interest rates that more than cover defaults.  Of course, the banks book their profit each year and don’t generally set aside some of that profit to cover future defaults if the economy goes bad (or it wouldn’t be profit) so they’re stuck with huge numbers of bad loans that are no longer profitable as people become unable to repay them.

Banks don’t really want you to pay back your loan faster since they don’t earn as much interest that way, but in this case, the financial markets are so gummed up that every dollar they get back will be one more dollar they can lend out — further greasing the skids of our economy and getting everything moving again.

Ultimately, do what’s best for you!

Nobody’s trying to tell you what to do with your money, but I hate to hear people say that you should spend it or save it.  Politicians will benefit more if you spend it ASAP and make them look like they lead the economy well.  Companies worldwide will benefit more if you spend it on consumer products and a small fraction of it will go towards jobs.  The economy will benefit if loans are repaid (especially sub-prime loans) and banks will benefit if you continue to make minimum payments no matter what else you do.

In the end, look for where the money will do the most good in your personal financial situation.  While there are no strings attached, with the government running a huge yearly deficit (it doesn’t look so bad until you add in the regular “emergency was spending” to the budget), we’ll get stuck with the tab in the form of increased taxes or decreased services (say a 50% cut in social security payments?) in the long run.  While I’m a big fan of doing what’s best for my country and the world, ultimately, what keeps you self-sufficient will benefit those around you the most in the long-run.

I’ve read a lot of commentary on the economic stimulus package that passed this week, including quite a few comments from fellow financial bloggers like My Two Dollars and I’ve Paid For This Twice Already. People generally think the stimulus package is a great idea or the stupidest thing they’ve ever heard, but I’ve rarely seen much discussion of why our government thinks it needs to prop up the economy. No, it’s not a matter of keeping the 1-2% of jobs we might lose in a recession. Quite simply, our government is one of the only governments in the developed world that has done away with state-funded retirement pensions and instead invested our retirement funds in the stock market through 401(k) and IRA plans.

Yes, we still have social security, but it was always intended to simply supplement pensions earned through employment — with average monthly payments sitting around $1000, it’s hardly enough to cover rent or mortgage payments in many communities! That’s totally fine if we assume that most retirees have significant savings, but since only 36% of workers offered 401(k) plans in 2004 participated, it’s pretty clear that there’s going to be a whole lot of retirees in poverty in the next few decades.

But here’s the kicker — if the stock market drops dramatically, even those with retirement investments will be depending on insufficient social security payments! The whole idea that government pensions (A.K.A. social security) should be privatized might make sense by itself, but history has shown that the average American is not willing or able to save for their retirement and when they do, poor investment decisions and volatile market conditions risk personal retirement savings across the board! Neither can we move back to employer-based pensions as they’ve been reduced or outright removed as corporations recognized the huge savings in paying defined contributions (i.e. 401(k)) vs. defined benefits (pensions).

I have my own opinions about the wisdom of privatizing social security (I still can’t understand why Bush says we should emulate Chile where privatization has slashed benefits and greatly increased government costs) but this article isn’t really about how we, as a culture, should take care of our elderly. The point is that we can’t just continue to ignore the elephant in the room and pretend that this is all about the economy or just blink in amazement wondering why both major political parties agree that more debt will help the nation. The real issue here is that if the market drops, our current and future retirees will suddenly face poverty with only an unfunded government pension as a safety net. Until we acknowledge this problem and find ways avoid the potential consequences (besides simply borrowing more from China to keep stock markets high), the problem will only get worse.

Of course, we could always cut social security altogether, let the stock market go where it will, and simply let the unprepared starve in the streets, but never forget that a society is judged based on how it treats the poorest, not based on how easy it is for the rich and educated to succeed!